The Cost Accounting System of Bagalot PLC - Coursework Example

A Case Study for Bagalot PLC in (Management and Measurement Performance) Accounting and Cost Table of Contents Question 1 2 Question 2 4 Question 3 6 Compare and Contrast the Profitability of Briefcases 6 6 Recommendation for Enhancing Profitability 7 Requirement of Information 7 Question 4 8 Question 5 10 Reasons of variances in the Revenue 10 Requirement of the Further Information 10 Question 6 11 Question 7 15 Activity Based Costing 15 Activity Based Management 16 Implementation of both the Concepts in Service Industries 16 References 18 Bibliography 19 Question 1 The cost accounting system of Bagalot PLC is basically based on the direct cost. Direct material and direct labour costs have been charged for each unit of product. Again the material cost has been considered as the price paid for the annual purchasing agreement of the raw material. Bonuses paid to labours on the basis of standard run times for each product has been encompassed in the labour cost. These are the processes of charging direct cost on the products in the entire Bagalot PLC. In case of overhead cost both Bristol and Bath plants allocate the overhead costs on their products as a percentage of the production-run direct labour cost. On the overall analysis, it can be stated that the cost system in Bagalot PLC is not appropriate and it requires certain changes. To justify this, light can be thrown on the findings of the internal team, which is appointed to study the overhead costs in both the plants. The findings can be summarised and demonstrated as follows: Machine related expenses depend more upon the machine hours than the production-run labour hours Different kinds of products require different set ups and all set-ups cost differently Post production activities conducted differently in both the plants and consume different times Work burden and time consumptions have increased for packing and shipping The above outcomes signify the importance of the production and post-production related activities. If the overhead cost of a product is calculated based on the production-run direct labour, then the other activities will be surely ignored. It implies that the adopted mechanism for the cost calculation is not effective as it takes into account only the partial costs. Based on the above explanation, it can be recommended to the Bagalot management to bring certain transformation in the cost system or to change the method of the cost estimation. In this note, the management can be proposed to adopt ‘Activity Based Costing’ (ABC). In this case, one question can crop up that whether both the plants should adopt the technique or not. It is true that variations in the activities are less in the Bath plant, but the mechanism of estimating overhead expenses is similar. Therefore, it will be better if ABC method can be applied in both the plants. There are several activities in Bristol plant and few activities in Bath plant. The activities are ‘receiving and production control’, ‘packaging and shipping’, ‘plant management and facilities’ and most importantly ‘set up labour’. By implementing ABC method, the organisation will be able to monitor each activity that has contribution in direct overhead. It will result in effective cost structure as well as transparent mechanism. Question 2 To apply ABC method, it is important to determine the cost drivers based on two stages: The cost drivers that will ‘trace the costs of inputs into the cost pools’ The cost drivers that will ‘trace the cost pools into the product costs’ (Williamson, n.d.). Activity Cost Pools Cost Drivers Ratios (Only for Bristol plant) Bristol Plant (Total) Briefcase 1 Designer Label * 203 Wallet (Bath Plant) Machine Related Machine Hours 35:22:63 120,000 35000 22000 Plant Management and Facilities Related Costs Production Runs 10:100:150 39,000 1500 15000 6,000 Set up Labour Set Ups 10:100:150 12,000 461 4615 Receiving and Production Control Production Runs 10:100:150 60,000 2308 23077 3,000 Packaging and Shipping Number of Shipments 10:220:170 50000 1250 27500 3000 Total Activity Cost 40519 92192 12000 Production (Units) 7000 4000 3000 Activity Cost per Unit 5.788 23.048 4 Direct Labour Cost 4.00 5.00 8.00 Direct Material Cost 6.00 7.00 8.00 Activity -based Production Cost 15.78 35.048 20 Question 3 Compare and Contrast the Profitability of Briefcases In the last part, cost of each products of Bagalot has been calculated according to the activity based costing method. In this portion of the paper, the profitability of the Briefcases based on the new approach (ABC method) will be computed. A comparative analysis between the old and new methods can be presented in a tabular format to figure out the best approach. Products Selling Price of the each product Cost of products (New Method) Margin Cost of products (Old Method) Margin Briefcase1 22.00 15.78 28.3% 19.52 11.3% Designer Label*203 40.00 35.048 12.38% 23.90 40.3% From the overall analysis, it is evident that Briefcase1 can enjoy higher profitability whereas the Designer Label*203 might face lower margin after adopting the new approach of costing. Recommendation for Enhancing Profitability There are few activities in the activity pools that can be reduced to a certain extent especially in case of Designer Label*203. Packaging and shipping cost for the product need to be minimised as it is almost 22 times of the Briefcase1. The packaging department can bring certain alteration in the process. This product line is mainly focused on the customised products. Therefore, the product itself can serve the requirement of the customer and in that case packaging need not be too prominent. Apart from this, it has been found that huge amount has been associated with the Designer Label*203 for receiving and production control. It is ten times higher than the receiving and production control cost of Briefcase1. The same thing takes place with the plant management and facilities related costs. It is obvious that because of the customised nature, Designer Label*203 may require extra time and can consume certain extra cost but there is a limit. Production statistics reveal that the organisation needs to bear immense cost for the Designer Label*203 products. Eventually, it can be concluded that the management needs to monitor the activity pool strictly with the aim that the company can acquire optimum cost for its entire product lines. Requirement of Information In the last section of this paper, few recommendations have been provided. The analysis can be concrete with the help of further information. It has been found that the costs such as plant management and facilities related costs, receiving and production control and packaging and shipping cost are comparatively higher for the Designer Label*203 than the Briefcase 1. Therefore, it has been recommended to monitor those costs minutely. Basically, it has been assumed that costs are comparatively higher, but there is no evidence that can indicate the extent to which the costs need to be reduced. In the article, it has been clearly stated that for each set of the Designer Label*203 briefcase different setups are required. It signifies the reason of increasing the setup labour overhead. Similarly, certain information related to the activity pool costs is required for undertaking in-depth analysis of the cost system. Question 4 While evaluating the overall performance of the Bristol plant, Tom Hanks had proposed to include two additional product lines. The first one is the holiday beach bags and second one is the satchel. Before analysing the effectiveness of the product, it is necessary to understand the manufacturing plan of the product. The management has decided to produce the bags during the time frame of the three months that is the month of January, February and March. For the rest of the year, production will become idle. To make the plan effective the Bagalot management has intended to expand their production capacity through enhancing the capacity of the leased space and machines. It has also been decided that the additional capacity will be reserved only for the production of holiday beach bags. It indicates that the entire additional capacity will be inoperative for the rest of the year and that can have inverse affect on the entire production system of Bristol plant. In this note, the discussion regarding the outcome of this production plan can be started. In this scenario, it is quite evident that the company wants to continue its production only in the first three months of a year as the management have an experience of the market demand for the beach bags. It may happen that for the rest of the year there will not be any demand for this kind of bags. Therefore, to continue production in the rest of the year will not be a feasible option as it will lead to the production as well as inventory wastage. Moreover, the management has already decided to reserve the additional capacity for the beach bags. Hence, it cannot be utilised for the other product lines. Sticking on the production of the beach bags, it can be recommended to the Bristol plant authority of Bagalot PLC, that they should enhance the product varieties of this particular product range (beach bags). Recently they have intended to produce the holiday beach bags. They can go for designer beach bags. According to the analysis of the Bagalot management, January to March is the season time for holiday beach bags. Therefore, the company can take into account the immediate previous quarter for the production of the designer beach bags. The recommendation can also be justified. As designer products used to be customised, it consumes more time then the ordinary ones. It implies that order for designer beach bags will definitely come before the actual season time. Apart from producing designer beach bags, it can be further advised to the Bagalot management to expand the market. For effective and optimum utilisation of the production capacity, they can bring certain changes in the marketing plan. The other geographic locations that have different sets of holiday periods can be targeted. Thus, the organisation will be able to continue their production throughout the year. There will not be any huge changes in the activity based cost of the two products of Bristol plant, Briefcase 1 and Designer Label*203 briefcases. The reason behind it is that activity based cost is calculated focussing upon the proportion of each products on the activities. It is true that all the activity cost will be enhanced to certain extent for the inclusion of the new product line. For example, plant management and facilities related costs will be increased for the additional capacity of the plant. Similarly, if the company produce designer beach bags for three months then set-up labour will be increased. As with the increment of the activity pool costs, proportions of the cost drivers for each product will also amplify. Therefore, cost of each product line will not face huge changes. Question 5 Reasons of variances in the Revenue It has been found that 25000 units have been produced in the Bristol plant but the forecasted production was 28000 units. It indicates a fall of 3000 units from the expected production. Still there is an increment in the overall revenue. The reason behind it can be the enhancement in the production of the Designer label*203 briefcases and increment of the demand for this product from the customer end. Requirement of the Further Information An in-depth analysis cannot be conducted to demonstrate the reason of the sale variances in the Bristol plant. The reason behind this is the unavailability of the information. Firstly, there were no specification regarding the forecasted production and revenue of the Designer label*203 briefcases. Hence, it becomes difficult to understand the changes in the production and revenue for this product. Even a comparative analysis between the variances of the two product lines of the Bristol plant cannot be expressed due to this reason. It is mentioned in the article that Designer label*203 briefcases have a huge importance in the Bristol plant for its demand and margin. Therefore, production and revenue variance related information is the utmost requirement to analyse the changes in the revenue in the Bristol plant. Question 6 In addition to the briefcase and wallet, Bagalot has decided to produce holiday beach bags and hand-made satchel. Both are innovative and complementary idea but in the present scenario, when cost has become the major constraint, these production ideas cannot be fruitful. In this part of the discussion, it will be critically analysed that whether the decision of producing satchel will be effective and profitable for the organisation or not. Profitability: The kind of satchel that has been intended to produce is not a designer satchel. Therefore, management thought that the cost will also be less, but their estimation shows negative contribution margin. In simple terms, it can be expressed that Bagalot will face loss of £1 if they buy new material for the satchel. The calculation can be shown as follows: Costs (per satchel) Break-up Amount (£) Amount (£) Direct Labour Cost £3 Direct Material Cost New material cost per meter £2 £6 Material required for each satchel £3 Total Cost £9 Selling Price per Satchel £8 Profit/Lose per Unit (£1) On the basis of the above estimation, it is evident that there are no chances of making profit through buying new material. But there is an alternative, which is utilisation of the scrap material accumulated while producing briefcases. By adopting this strategy, the organisation will be able to minimise costs or it can be said that this strategy paves the way for earning profits. The implications on profits can be demonstrated as follows: Costs (per satchel) Amount (£) Direct Labour Cost £3 Direct Material Cost Nil Total Cost £3 Selling Price per Satchel £8 Profit/Lose per Unit £5 According to the above estimation, the organisation will be able to earn more profit. From the above calculation, it has been assumed that there will not be any material costs, but it is likely that the material costs need to be charged. In that case also it will be negligible. Even if it can be assumed that few new materials will be required for the satchel, the production will not reach to a break even points. On the basis of the above discussion, it can be stated that by adopting this strategy profitability can be ensured. Optimum Utilisation of Resources: Besides the profitability, the organisation will be able to utilise the resources in a better manner. Moreover, it can be stated that the organisation will be able to acquire optimum utilisation of the resources. Risk Minimisation: Producing satchel indicates enhancement of the product line. Therefore, the risk associated with production and other activities in Bristol plant can be diversified in this newly included product lines. No Fixed Cost: The management of the organisation has decided to make all the units of the satchel manually. Hence, there is no requirement of installing new machineries or any other fixed assets. Enhance Customer Base: The designers of Bagalot have been decided to attach doll on the satchel. It refers that the satchels are mainly manufactured for the kids or teenager girls and these are the main target customers. None of the two target group is the end users of the briefcases or of wallets. Therefore, the organisation will able to cater to in a completely new segment. It is true that Bagalot mainly deals with retailers, but now the organisation can serve the retailers who sale satchels. It implies an opportunity to enhance the customer base. On the basis of the above discussion, it can be recommended to Bagalot PLC to manufacture satchel. It will not only enable the company to earn profits from the particular segment but will also be beneficial for the entire Bristol plant. Moreover, a positive impact on the other segments can be ensured. Eventually, it can be concluded that production of satchel will prove to be a win-win situation for the organisation in all respect. Therefore, they should manufacture satchel through utilising the scrap materials of briefcases. Question 7 Before understanding the implication of the techniques of activity based costing (ABC) and activity based management (ABM) in the service industry, it is essential to built understanding with the two concepts and its techniques. Activity Based Costing ABC is an effective method of applying cost control. It can be used either for job costing system or process costing system. Basically, this method is used to refine the costing system for reaping better results. ABC approach is also helpful for rectifying the inaccurate cost information. It can be considered as the modern approach of cost allocation. The basic assumption of this costing method is that activities provide rise to the costs. On the basis of this fact, a relationship can be developed between the products and the activities through allocating cost of activities to a product (Jain & Narang, 2005). Activity Based Management ABM process enables the managers to conceptualise the cost of business process, product and customer profitability and improvement criteria. Several activities consume resources such as equipment, material and people that can be measured. Again, activities are triggered by few events and decisions and those can be counted and reviewed respectively. Finally, the outputs that are produced from the activities can be measured. Therefore, it can be concluded that all the activities can be used to form the business processes and the entire process will be quite transparent (Saferpak, n.d.). Implementation of both the Concepts in Service Industries From various researches, it is quite evident that ABC and ABM concepts can improve the information allocation and cost measurement in an effective manner for the service departments within the manufacturing organisations. But service firms can also adopt ABC concepts. Activity Based Cost can enable the service firms to determine cost of each activity. This can discard or modify the activities that are unnecessarily increasing the costs. It can be better explained with the help of an example. Suppose in an insurance company, the operation department is over- employed. Through the ABC approach, it can be measured that how much cost the company has to bear for the operating activity and the scenario of the disguised unemployment will become apparent to the management and they can take actions accordingly. There is a contradiction among the scholars regarding the implementation of the ABC method in the service industry. Few of them believe that ABC and ABM cannot be fully implemented in a service organisation as people out there are struggling with the changeover from the organisational unit to the activity and from budget to actual cost (Ali, 2003). The Activity Based Costing can be adopted to estimate the standard-full-cost per service unit. For instance, in a hospital, standard full cost can be determined for the tests conducted in the laboratory or in a surgical operation. Basically, it has been found that a service organisation associates with several major and minor services and the importance of these services are not equal. Therefore, through ABC and ABM methods the service organisations can conduct a frequent cost based analysis and can reduce irrelevant costs (Baker, 1998). References Ali, M. F., 2003. Activity Based Costing/Management in Service Industry. AiMCORP. [Online] Available at: http://www.aimamc.com/staci/articles/abcm.htm [Accessed December 27, 2010]. Baker, J. J., 1998. Activity-Based Costing and Activity-Based Management for Health Care. Jones & Bartlett Learning. Jain, S. P. & Narang, K. L., 2005. Cost Accounting. Kalyani Publishers. Saferpak, No Date. Activity Based Management. The Basics of Activity Based Management. [Online] Available at: http://www.saferpak.com/abm_articles/Basics%20of%20ABM%20Word.pdf [Accessed December 27, 2010]. Williamson, D., No Date. Worked Example. Activity Based Costing. [Online] Available at: http://business.fortunecity.com/discount/29/abcworkex.htm [Accessed December 27, 2010]. Bibliography Bhar, B. K., 1970. Cost Accounting. Academic Publishers. Chadwick, L., 1993. Management Accounting. Routledge. Kinney, M. R. & Raiborn, C. A., 2008. Cost Accounting: Foundations and Evolutions. Cengage Learning. Khan, M. Y., 2006. Management Accounting. Tata McGraw-Hill. Read More