Accounting Principles - Term Paper Example

Introduction Accounting is the profession dedicated to identifying, recording, tracking, monitoring, and reporting all the financial activity of an enterprise (Weygant & Kieso & Kimmel, 2001). There are different branches within the accounting profession that target and administer different areas within the accounting system of a firm. Some of these areas include cost accounting, auditing, bookkeeping, financial accounting and accounting information systems. The main focus of this paper is cost accounting is which also referred to as managerial accounting. Managerial accounting involves providing information to managers or people inside that are responsible for controlling the operations of a firm (Garrison & Noreen, 2003). The case study utilized to apply managerial costing accounting concepts is a company called Bushman Boots PTY LDT. The case a firm that is having problems with the cost structure of the firm even since a new product called the Bush Bashers was released (BB). A cost analysis is necessary to find the root of the problem at Bushman Boots. Bushman Boots problem analysis The manager responsible to analyze the problem at Bushman Boots is Sandra Slaugher, the Sales Manager. By studying the market and performing an analysis of the sales numbers Sandra noticed the company has a product mix problem regarding the positioning, pricing and profitability of the company’s boots products. The Wonder Walkers (WW) is the company’s traditional product that used to be a very good seller. The pricing structure and cost structure changed when the new product Bush Bashers was introduced. BB is a higher quality product which has actually been selling extremely well. Despite the good sales the profit margins of the company are down and Sandra wants to find the root of the problem. Since the introduction of the new the product the company has separate production lines for the two products, but the enterprise is still utilizing a cost mechanism based on the prior cost assumption before the arrival of Bush Bashers. One of the key assumptions is that direct labor is the cost driver that determines the overhead rate to be allocated to the cost of the product. Sandra interviewed a cost clerk working in the accounting department and asks for information about the current system, various data to create new analysis and the pricing methodology. Sandra found that the company is currently still utilizing the old cost system and that the methodology for pricing of its products is to add a 45% markup to the cost of the product to assign a wholesale price and to allow retailers to utilize a 90% markup of their wholesale selling price. One key metric in this system is that the company must obtain a 30% profit margin at all times to stay profitable. The company assumes it is obtaining a 45% markup and the company is well over its 30% gross margin buffer zone on both products, but this is not necessarily true. Sandra or any competent manager would initialize realize that due to the product mix the cost being calculated by the accounting department based on the current methodology are distorted. The selling behavior is a good indicator of the possibility since the new product is selling beyond expectation and the old product which is good product has sales which are lagging. The assumption would be that the new product is under priced and the old product is overpriced right now. In order to prove this theory Sandra perform three analyzes to determine the cost and selling prices of the two products. Three analysis realized which are illustrated in Appendix A,B,C are a cost analysis and price determination based on the current cost system, a departmental cost structure and pricing allocation and an activity based cost system analysis. Current Cost system The first analysis is a cost analysis based on the current system which was the system in placed before the introduction of the Bush Bashers boots products. This system determines cost by adding direct cost and a global overhead which is determined based on a budgeted production which uses man hours as the cost driver to determined overhead costs. The company produces 80,000 units of BB and 300,000 units of WW. The overhead rate per hour based on the current formula is $58.78 overhead rate per hour. The BB product takes 0.20 hr to produce per unit, while the WW takes 0.11 hrs per unit to produce. The direct cost per unit of BB is $28 and $21.6 per unit of WW. By inserting all these variables into the cost formula the final outcome is that the cost per pair of Bush Bashers boots is $39.76 and $28.07 for the Wonder Walkers. By applying a 45% markup the selling price rounded to the nearest dollar of the Bush Bashers is $58 and $41 for the Wonder Walkers. Departmental Cost Appendix B is the second analysis which is cost analysis based on departments (BB and WW production departments). The analysis depicts a detail segmentation of the cost associated with each department. In order to separate cost new overhead was divided into four main categories maintenance, setup, cutting and assembly with two depreciation costs related to cutting and assembly. The final outcome of the analysis illustrates that the actual cost of the Bush Walkers is $43.09 and the actual cost of the Wonder Walkers is $27.18. The price of these two products based on the company policy of 45% markup is $63 and $39 respectively based on the new cost calculated. This means that the company was selling the BB too cheap and is true markup was not really 45% since real cost were inaccurate. The company was charging $5 less than it should have been charging for the BB product, thus its effective markup was 34.6% instead of 45%. The discrepancy in markup also means that company was not achieving its minimum 30% gross margin policy on this product due to the cost determination error. The action gross margin been achieved was 25.71%. The WW was also been affected by this costing determination error. The product price point was been placed at too high a selling price. Selling goods follows the law of supply and demand. If the price of a product is too high the demand will be lower. The right price was suppose to be lower, thus sales will immediately pick up once the price of the product is lowered. Activity Based Costing The third analysis performed is an activity based costing analysis (ABC). Activity based costing is an alternative cost methodology or system that defines processes, identifies costs drivers and determines unit costs of products and services (Defenselink). The result of the ABC analysis illustrated in Appendix C shows a similar pattern of under pricing for the BB and actually shows the same pattern for the WW product. The manager for sure knows that the BB price is too low, but this second analysis shows the same tendency for the WW. In this analyzes man hours was not utilized the main cost driver, thus this account for the discrepancy between analyzes B and this 3rd analysis. The main purpose of this analyzes was not if the pricing strategy was correct, but to determine the root of the high cost structure of the enterprise. The analysis shows that the biggest overhead cost for the BB product is the setup costs which account for 38% of its overhead and for the WW product the biggest cost factor is the related maintenance cost per hour which account for 33.33% of the overhead rate of this product. The discrepancy between the departmental analysis and the ABC analysis for WW are based on maintenance cost which the management admitted machine hour was not a truly good cost driver. Conclusion The conclusion management can make from this analysis is that the reason profitability is down is that the Bush Basher product is under priced and the Wonder Walker is overpriced. Another important lesson the company learned is that its current cost system is obsolete and needs to be immediately replaced with a departmental costing system or a refined ABC system that utilizes a better cost driver than machine hours to determine maintenance costs. Cost analysis is an analytical tool that can help managers decipher inefficiencies within an operation and help them make important strategic decisions. References Defenselink.mil. Activity Based Costing. Available from [Accessed 25 October 2007]. Garrison, R. and Eric, N. (2003). Managerial Accounting (10th Edition). Boston: McGraw-Hill. 4-5. Weygandt, J. and Donald, K. and Paul, D. (2001). Accounting Principles (6th Edition). New York: McGraw Hill. 2-3. Appendix D: Bush Basher Boots Appendix E: Wonder Walkers Boots Read More