Activity-Based Costing: Starbucks Company's - Case Study Example

? MANAGEMENT ACCOUNTING By Presented Introduction The company that is selected as an example in the application of management accounting techniques is Starbucks Coffee Company. This is the premier retailer and roaster of specialty coffee in the world. Starbucks Company buys and roasts the high-quality whole bean coffees and together with other products such as tea beverages, handcrafted coffee, and a number of fresh foods, they are sold by the company via the retail sores operated by Starbucks. The company also produces and sells a variety of beverages that are ready-to-drink. The channels that are outside of the company-operated retail stores are all known as specialty operations collectively. The company generates its revenue via the company-operated retail outlets or stores and the specialty operations. The specialty operations comprise of the retail stores that are licensed by the local business partners, tea and packaged coffee through licenses in warehouse club stores, grocery, arranged licenses with the business partners and arrangements with the foodservice companies. The revenue that is obtained from the company-operated retail outlets accounts for the largest revenue contribution as opposed to the specialty operations. As at October 3rd the year 2010, the number of Starbucks employees were approximately 137,000 worldwide with the employees in US being about 107,000 people, and 101,000 employees in the company-operated retail outlets and the remaining spread in the regional offices, store development, and roasting, administrative, and warehouse operations. The revenue of Starbucks Company has been on the rise year after year. The most impressive values were the growth in the last year’s annual report indicating an increase in revenue from $10.7billion to 11.7billion. The Starbucks Company has also been able to reduce the sales percentage that is devoted to general, administrative costs, and selling from 38.26% to 36.71 percent. The gross profit for Starbucks Company as at the October 2/ 2011 was 6,751.1 US dollars and their net income averaged at 1,245.7 US dollars (Starbucks, 2012). Activity-Based Costing Activity based costing abbreviated, as ABC is a concept where the producers or manufactures assign the manufacturing costs to their products in a manner that is logical. Drury (year:pp 223) a proposes that there are three cost systems that define which type of costs are assigned to the cost objects. These include the direct costing system, which involve only the assigning of the direct costs to the cost product. Indirect costs are not assigned to the product hence, reported as contributions to the indirect cost. The direct cost is only recommended where the indirect costs form a low proportion of the company’s total costs. ABC assigns the indirect costs to the product cost. The ABC system first assigns the costs to the activities that form the real overhead causes, and then assigns the costs of the overhead activities to only products that actually require the activities (Accounting Coach, 2012). Application to the company The Starbucks Company buys and roasts coffee the high quality whole been coffee and then sells it together with the other products that are earlier outlined. The high-quality whole been coffee requires certain activities such as roasting, packaging, and testing and several machine set ups since the coffee is sold in small quantities through the company-operated outlets or stores. The system of activity costing will help the company by first recognizing that the roasting, packaging, and testing and the machine setups are activities that the company incurs certain costs and hence the company consumes its major resources via these activities. The Starbucks Company, therefore, will calculate the cost of these resources that are used in each of the outlined activities. This forms the first level of application of the ABC system in the assigning of costs to the products. The second part involves the assigning of each of these costs only to the products that needed these activities. This implies that the costs of tea beverages will be inclusive of only the activities that the tea beverages require and the same applies for the beverages that are ready-to-drink, and the high-quality coffee. If there is a product that uses the machine that the coffee uses then other costs will ne assigned to these products. Tradition costing system This system of costing traces the overheads to products by using a simple allocation, which is normally described as the overhead allocation rates. This system varies directly with the produced volume. The traditional costing systems are very appropriate for the assigning of the cost of unit level activities to the objects cost (Drury, 2007: p 231). This system simply refers to the allocation of costs base on the machine hours. This costing system as opposed to ABC does not divide or separate cost by allocation or function or by manufacturing process parts. Traditional costing system takes a total cost and then divides it by each process part leading to an equal assignment of the cost that is estimated to each or every manufacturing process parts. In the application of this system to the Starbucks Company, the costs of the products will be allocated based on a single-volume measures, and these measures may include direct cost of labor, direct hours of labor, or machine hours (Encyclopedia of Management, n.d). A comparison of Activity Based costing and tradition based system Considering the traditional cost accounting, the assumption made is that the cost objects consume the resources while in the activity based costing assumes that the cost objects are consuming the activities. Traditional costing utilizes the volume related assignment or allocation bases most times whereas the activity based costing utilizes the drivers found at the various levels. The activity based costing is process oriented while the traditional cost accounting is actually structure –oriented (Emblems, n.d). Profitability analysis Profitability analysis is defined as an analysis of revenue and costs to determine if a venture that a company wants to invest in will profit the firm and if yes by how much. The information on profitability analysis is vital in deciding on various investment ventures. The length or period required for the repayment of the initial capital is always a critical factor to consider. The profit of any business is defined as the difference that is found between the company’s revenues and costs. We have the gross profit and the operating profit. Gross profit is the amount that is calculated by deducting the sales cost from the sales revenue (turnover) while the operating profit is calculated by subtracting the overhead expenses from the initially calculated gross profit. Using the above mentioned profitability calculations; one is able to compare the profits of a business in a single year with others, and the profitability of the different businesses. Comparing the profitability of Starbucks Company from the previous years up to 2011, the company has been recording an upward trend showing that the company is doing fine financially and an investment into the Starbucks Company by any shareholder will definitely yield to a profit. Another important or vital measure that tells how well a business or company is being run is the liquidity ratio. Looking at the current liabilities and the current assets in Starbucks company Balance sheet, and finding the liquidity ratio provides vital information required to make important investment decisions (Wilson, 2012). Conclusion Activity based costing abbreviated, as ABC, traditional costing system, and profitability analysis are important cost accounting concepts that Starbucks Company will find to be very important in their operations. The company sells high quality coffee, tea beverages, and ready-to-drink beverages all of which the costs needs to be determined if the company is to keep increasing the profit margin as outlined in the 2011 annual financial report. The company is on an expansion trend and this depicts an investment venture, therefore, the profitability analysis concept will become a major tool that the management and investors will employ in order to make good investment decisions. Drury (2007: p 49) proposes that the manufacturing organizations or companies assign a cost to their products with two major reasons. These are external financial needs and internal profit measurement, and for decision making purposes. In the case of decision-making, product costs that are more accurate are needed for various purposes some of which include legal requirements, financial accounting, and meeting of the external financial accounting requirements. The need for different accuracy levels and different costs for various purposes in different companies or organizations has made some companies to maintain two costing systems that are separate, one being for decision-making and the other one for profit measurement and inventory valuation. List of References Accounting Coach., 2012. Activity Based Costing. [Online] Available at [Accessed January 24, 2012] Drury, C., 2007. Management and Cost Accounting. Mason, OH: South- Western Cengage Learning. Emblems., N.D. ABC (Activity Based Costing).[online] Available at [Accessed January 24, 2012] Encyclopedia Of Management., N.D. What Is Activity Based Costing. [Online] Available at [Accessed January 24, 2012] Starbucks Company., 2011. Starbucks Investor Relations: Annual Reports. [Online] Available at: [Accessed January 24, 2012] Wilson., 2012. Finance Theory: Analysis Of Profitability, Liquidity, And Performance. [Online] Available at [Accessed January 24, 2012] Read More