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ACTIVITY BASED COSTING Solved

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Activity Based Costing (ABC)

Case Overview

The case focuses on ABC analysis of the two products of 4D Entertainment, which are Zenith and Pinnacle. In order to take the future decisions the overhead costs of both the product should be needed to be calculated appropriately. In the case, the activity cost of each of the activity was calculated. The profitability of both the two models of 4D Entertainment was calculated. Then the difference in the profitability of the products using ABC costing method is compared with the company’s existing costing method. Then the accuracy as well as limitations of the ABC system is discussed. The utility of the information collected from ABC analysis is used in managing the business of 4D Entertainment. Finally, some recommendations are given to the controller of 4D, Tina Wesley (Arnold, 2013).

Case Analysis

  1. Activity Rate- The activity rate is usually calculated by dividing the activity costs by the cost driver. The information gathered by Tina Wesley is used to calculate the activity cost of each activity of the two products.
  • Soldering- The cost driver units of Zenith and Pinnacle is $1296000 and $214000 respectively. Thus, the ratio between the soldering cost of the two models is $1296000:$214000=648:107. The soldering rates are $648 and $107 respectively and total soldering costs is $1872400. Therefore, the soldering cost of Zenith is $ 1607040 and of Pinnacle is $
  • Shipment- The cost driver units of Zenith and Pinnacle is $1500 and $500 respectively. Thus, the ratio between the shipment cost of the two models is $1500:$500=3:1. The shipment rates are $3 and $1 respectively and total shipment costs is $1480000. Therefore, the shipment cost of Zenith is $ 1110000 and of Pinnacle is $ 370000 (Brealey, Myers and Allen, 2011).
  • Quality Control- The cost driver units of Zenith and Pinnacle is $54000 and $18000 respectively. Thus, the ratio between the quality control cost of the two models is $54000:$18000=3:1. The quality control rates are $3 and $1 respectively and total quality control costs is $1749600. Therefore, the quality control cost of Zenith is $ 1312200 and of Pinnacle is $
  • Purchase Orders- The cost driver units of Zenith and Pinnacle is $16640 and $4160 respectively. Thus, the ratio between the purchase order cost of the two models is $16640:$4160=4:1. The purchase orders rates are $4 and $1 respectively and total purchase orders costs is $582400. Therefore, the purchase order cost of Zenith is $ 465920 and of Pinnacle is $
  • Machine Power- The cost driver units of Zenith and Pinnacle is $144000 and $10000 respectively. Thus, the ratio between the purchase order cost of the two models is $144000:$10000=72:5. The machine power rates are $72 and $5 respectively and total machine power costs is $61600. Therefore, the purchase order cost of Zenith is $ 57600 and of Pinnacle is $
  • Machine Setup- The cost driver units of Zenith and Pinnacle is $360 and $100 respectively. Thus, the ratio between the machine setup of the two models is $360:$100=18:5. The machine setup rates are $18 and $5 respectively and total machine setup costs is $414000. Therefore, the machine setup cost of Zenith is $ 324000 and of Pinnacle is $ 90000 (Berk, 2013).

So, from the available information given by Tina Wesley, the activity cost of all the activities is identified.

  1. Total Sales Revenue as per the income statement on the year ending 30 November 2014 of Zenith is $30600000 and of Pinnacle is $4400000. The COGS for Zenith is $19890000 and for Pinnacle is $3080000.

Profitability Analysis using ABC Method:

Zenith $

Pinnacle $

Sales

30600000

4400000

COGS

19890000

3080000

Gross Profit

10710000

1320000

Operating Expenses

4876760

1283240

Soldering Costs

1607040

265360

Shipment Costs

1110000

370000

Quality Control Costs

1312200

437400

Purchase Order Costs

465920

116480

Machine Power Costs

57600

4000

Machine Setup Costs

324000

90000

Net Income

5833240

36760

(Brigham and Houston, 2012)

  1. The profitability position as per the ABC method is slightly better than that of the existing method of the company is mainly because it will help the company maintain proper cost accuracy by getting closer to true profitability and true cost. It will help Tina Wesley to understand the true costs and ROI from each of the two product models better.
  2. In context to Warden’s worry the accuracy and limitations of the ABC analysis are-
  • Accuracy-
  • It allocates the value of the overheads clearly.
  • It provides more accurate and reliable determination of product costs.
  • It provides detailed information on profitability from each product model.
  • Limitations-
  • It is difficult to choose the best cost driver.
  • It is difficult to analyze the cost with the activities (Eun and Resnick, 2012).
  1. ABC information is helpful for 4D Entertainment in following ways-
  • It helps in getting the correct value of all the costs.
  • It helps in fixing the sales revenue based on the cost analysis.
  • It helps in controlling the overheads and expenses.
  • It helps in improving the profitability of the company for both Zenith and Pinnacle.
  • It helps in maintaining the sales of Zenith and prevents phasing out of Pinnacle.
  1. Tina Wesley should follow the information acquired from the ABC analysis of both the products of 4 D Technology. This will help her evaluate the correct cost position of the company and provide it to Donald Warden, which could solve the problems, Warden highlighted in her previous analysis (Grieve, 2013).

 

References

Arnold, G. (2013). Corporate financial management. Harlow, England: Pearson.

Berk, J. (2013). Corporate Finance. Harlow: Pearson/Education.

Brealey, R., Myers, S. and Allen, F. (2011). Principles of corporate finance. New York: McGraw-Hill/Irwin.

Brigham, E. and Houston, J. (2012). Fundamentals of financial management. Mason, Ohio: South-Western Cengage Learning.

Eun, C. and Resnick, B. (2012). International financial management. New York, NY: McGraw-Hill.

Grieve, I. (2013). Microsoft Dynamics GP 2013 financial management. Birmingham, UK: Packt Pub.

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