Business for Ascertaining the Cost of a Product - Assignment Example

Running Head: Management Accounting Management Accounting Submitted by: XXXXXXX Number: XXXXXXXXX XXXXXXXXX XX – XX – 2010 University of XXXXXXXXX Question 1: a) Discuss the accountant’s statement as a basis for the decision on what to produce, based on absorption costing and discuss two other costing techniques that can be used by the business for ascertaining the cost of a product. The accountant has made the decision to avoid the production of two products (Zodiac and Aston) based on absorption costing. The absorption costing method concentrates on both the fixed as well as the variable costs. Hence this method is not very beneficial in the decision making and budgeting processes (Garrison, Noreen and Brewer 2009). The method emphasizes on the total costs incurred and the cost volume profits of the relationship are not considered. As far as the decision provided by the accountant, it is solely based on absorption costing. It is imperative to note that a major part of the costs of the two products are due to fixed overheads and administrative expenses. Moreover, these expenses are incurred even if the production of these two products is dropped. Hence a better costing method has to be adopted to effectively allocate the overheads. The two methods suited for Rothfield Plc are activity based costing and marginal costing. Activity Based Costing: ABC is a modern accounting system in which the expenses and overheads are segregated based on the functions of the organisation, which is followed by allocation of the costs to each of the items in respect to the volume of the activity (Kaplan & Anderson, 2007). The use of ABC costing allows the company to accurately assign the costs for all the activities of each of the product or service (Drury, 2005). Rothfield Plc can allocate the fixed overheads based on the usage of these resources by the various production processes. Marginal Costing or Variable Costing: Marginal Costing provides a clear explanation of the impact of changes in volume of output on the profits and the changes on the profits. There is also a clear differentiation between the fixed and variable costs as well. As explained by Dyson (2007), the fixed costs are never charged to the production and instead the fixed costs are treated as period charges. Hence Rothfield Plc can adopt this method to estimate the potential profits effectively. b) Consider all four products and test whether both input constraints are effective. The two input constraints in December 2010 are as follows: a. Number of labor hours limited to 45,000 hours b. Number of machine hours limited to a maximum of 45,000 hours In order to test the effectiveness of the input constraints, the total number of labor hours and machine hours for all the four products are determined. Labor Hours: The total labor hours are estimated based on the demand and labor hours per unit of production of each of the products. Product Cortina Noddy Zodiac Aston Labor Rate per hour £15 £15 £15 £15 Direct Labor per unit £30 £45 £40 £35 Labor hours per unit 2.00 3.00 2.67 2.33 Expected Demand 5,000 6,000 3,000 4,000 Total Hours per product 10,000 18,000 8,000 9,333 Total Labor Hours 45,333 The total labor hours required to meet the estimated production levels are slightly higher (by 333 hours). Hence, it is evident that some of level of production of either one or some of the products has to be reduced. Machine Hours: The expected total machine hours are determined from the demand and the machine hour per unit production of each of the four products. Product Cortina Noddy Zodiac Aston Machine Rate per hour £50 £50 £50 £50 Variable M/c Cost per unit £60 £90 £120 £150 Machine hours per unit 1.20 1.80 2.40 3.00 Expected Demand 5,000 6,000 3,000 4,000 Total Hours per product 6,000 10,800 7,200 12,000 Total Labor Hours 36,000 It is evident that the machine hours are underutilized at 36,000 hours in the month whereas they can run up to 45,000 hours. c) Redraft the statement to show the optimum amount of each product that should be produced and the total profit that will be earned using an opportunity cost approach. From the estimates provided by the accountant, the fixed costs that will be incurred in December 2010, irrespective of the production levels and products are as follows: Fixed Factory Overheads = £ 864,000 Administration Overheads = £ 180,000 Total Fixed Costs = £ 1,044,000 It is essential that whatever the production combination, the contributions from the sales are significant so that these fixed costs are covered and a profit is earned. The contributions per unit of the four products are computed as follows: Product Cortina Noddy Zodiac Aston Selling Price £250 £250 £235 £278 Direct Material £50 £30 £50 £45 Direct Labor £30 £45 £40 £35 Total Variable costs per unit £80 £75 £90 £80 Contribution per unit £170 £175 £145 £198 It has been estimated earlier that the number of labor hours required to meet the demand exceeds the available labor hours (45,000 hours) by 333 hours. Hence the level of production of the product with the lowest contribution (Zodiac) is reduced to adjust for the labor hours. Machine hours per unit = 2.40 hours No. of units that require 333 hours  140 units Hence the total production of Zodiac is reduced to 2,860 units. Based on the revised production level, the maximum profit level is estimated as shown below: Optimum Production Level (max Profits) Product Cortina Noddy Zodiac Aston Contribution per unit £170 £175 £145 £198 Production Level 5000 6000 2860 4000 Total Contribution £850,000 £1,050,000 £414,700 £792,000 Total Contribution £3,106,700 Fixed Costs £1,044,000 Net Profit £2,062,700 Hence the total profit that will be earned using the opportunity cost approach is estimated to be £2,062,700. d) Quantify and comment on the effect on profits of the decision not to increase direct labour hours. In case the management has no constraint on increasing the labor hours, then the entire demand estimated could be supplied by the company. Due to the labor hour constraint, the production level of Zodiac was reduced from 3,000 units to 2,860 units. The additional profit that could have been earned by removing the labor hour constraint is as follows: Contribution per unit of Zodiac = £ 145 Additional no. of units = 240 Additional Profits = £ 34,800 The management will be losing the opportunity to earn this additional £ 34,800 if it continues to be unwilling to increase the labor hours beyond 45,000 in December 2010. Question 2: a) KoolShop Ltd. and Annual Budgeting System: In the case of KoolShop Ltd., the company set up separate divisions for each county and hence using an annual budgeting system can be useful in such a scenario. Budgeting is development of details plans for the fund allocation in a business. This helps provide a clear financial picture of the business and the plans of how the business plans to spend its financial resources. Development of an annual budgeting system will prove to be very beneficial for the company as it will permit each location to plan their finances well and this will also provide Jane to keep track of the overall plans of the stores. Also it is essential to note that annual budgets are working operational plans for the company. The benefits of adopting the annual budgeting plans will be many in the case of KoolShop Ltd., as it allows setting up standards based on which the actual performance can be measured (Kemp & Dunbar, 2003). It will also allow Jane to focus on the attention of current and future operations and will permit better reassessment of the aims and goals of the company. This helps in improving the chances of accomplishing the goals of the company as well. Jane will also be able to coordinate the overall operations of all the locations and have a strong control to effectively develop strategies for all locations. Using the annual budget system will also permit better communication throughout the organisation and will also help in bringing out the changes needed and assisting Jane achieve these changes as well. b) i) Fixed Budgets: Fixed Budget will not prove to be effective in the case of KoolShop Ltd. Fixed budgets are drafted and does not allow change or any form of variation in the daily activities. Also, in the case of KoolShop Ltd., this will not be impactful as the company deals with fashion industry which needs continuous changes and flexibility (Kemp & Dunbar, 2003). ii) Flexible Budgets: Flexible Budgets on the other hand as the name suggests are more flexible. This has been explained as, “A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity” (Accounting Coach, 2010). This form of budgeting is impactful in the case of companies which deal with fashion and continuously face changes in their product lines. Clothing stores is also one such industry and hence using the flexible budgeting here will prove to be very effective and efficient for KoolShop Ltd. It is essential to note that the flexible budgets provide a chance for better and more meaningful comparisons as it ‘flexs’ the actual volumes. Also this method will help Jane deal with the uncertainty levels and will also help focus on the expected outcomes of the various activities of the business (Kemp & Dunbar, 2003). On the whole adopting a flexible budget proves to be more effective than fixed budget for the case of KoolShop Ltd. iii) Rolling Budgets: Rolling Budgets can be defined as, “Method in which a budget established at the beginning of an accounting period is continually amended to reflect variances that arise due to changing circumstances” (Business Dictionary, 2010). The main purpose of this budget is to make accurate forecasts and to provide the mangers with a chance to review the plans. In the case of KoolShop Ltd., this will prove to be very helpful as it allows more accurate forecasting and planning and also is more useful to the company. This method of budgeting is very advantages as it involves regular reassessment which will allow Jane to keep a tab on all the changes and make strategic plans accordingly. Also, this helps in reducing the uncertainty which in turn will help Jane make more informed decisions (Kemp & Dunbar, 2003). In the case of KoolShop, the decision are made based on the plans and hence using a rolling budget will help the plans stay constantly updated, thereby allowing better strategic decision making. Although this method is expensive and time consuming it will prove to be very helpful for Jane as the budget tends to be continuous and can help in making more effective and efficient decisions. The only drawbacks of this method are that it is time consuming and expensive and the volume of work included in very high (Black Hall, 2010). However the positive aspects of the rolling budgets is much higher than the negative and hence this method will prove to be very beneficial for the company. References Accounting Coach. (2010). What is a flexible budget? Retrieved September 22, 2010, from http://blog.accountingcoach.com/flexible-budget/ Black Hall. (2010). Solution 9.3. Retrieved September 23, 2010, from Rolling budgets: http://www.blackhallpublishing.com/webresources/html/solutions/ma_s09-03.htm Business Dictionary. (2010). Rolling Budget. Retrieved September 22, 2010, from http://www.businessdictionary.com/definition/rolling-budget.html Drury, C. (2005). Management Accounting for Business. London: Thomson Learning. Dyson, J. R. (2007). Accounting for Non-accounting Students. Financial Times Management. Garrison, R., Noreen, E., & Brewer, P. (2009). Managerial Accounting (13 ed.). McGraw-Hill/Irwin. Kaplan, R. S., & Anderson, S. R. (2007). Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits . Harvard Business Press. Kemp, S., & Dunbar, E. (2003). Budgeting for Managers. McGraw-Hill Read More