ACC200 Introduction To Management Accounting

Question:

Assignment

Beztec Limited produces two models of Printers: the Lexon, which Beztec has produced since 2014 and sells for $990; and the Protox, a newer model introduced in 2016 that sells for $1254. Based on the following income statement for the year ended 31 December 2017, senior management at Beztec have decided to concentrate marketing resources on the Protox model and to begin to phase out the Lexon model because the Protox generates a much bigger operating profit per unit.

Details for cost of goods sold for Lexon and Protox are:

^a Lexon requires 1.5 hours per unit and Protox  requires 3.5 hours per unit. The direct production labour rate is $13.20 per hour.

^bMachine costs include lease costs of the machine, repairs and maintenance. Lexon requires 8 machine-hours per unit and Protox requires 4 machine-hours per unit. The machine-hour rate is $19.80 per hour.

^c Production overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.

Beztec’s management accountant, Sue Smith, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s production overhead costs for the year ended 31December 2017.

After completing her analysis, Smith shows the results to Steven Kay, the CEO of Beztec. Kay does not like what he sees. ‘If you show headquarters this analysis, they are going to ask us to phase out the Protox line, which we have just introduced. This whole costing stuff has been a major problem for us. First, Lexon was not profitable and now Protox.

'Looking at the ABC analysis, I see problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. We can’t afford to phase out either product, please alter the costs produced by the ABC system.’

Smith knows that her numbers are fairly accurate. As a quick check, she calculates the profitability of Lexon and Protox using more and different activity drivers. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is confident that headquarters, knowing that Protox was introduced only recently, will not phase out Protox. She is also aware that a sizeable portion of Kay’s bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Kay to do something. She asks for your advice.

Required

1. Discuss the importance of accurate product costing. In your discussion you should highlight the problems associated with using traditional costing system which Beztec has been using.

2. Calculate the cost driver rates for the various activities identified in the activity-based costing (ABC) system.

Answer:

Introduction

The present report is developed for providing an analysis of the case study of Beztec Limited that is involved in manufacturing of two models of printers, that is, Lexon and Protox. The company is initially following the traditional method of costing and is facing issues in realizing profits from its product line of Lexon. The company has thus decided to introduce a new product line, Protox, that they believe to generate much higher profit as compared to that of Lexon. The management accountant, Smith, has advised the management for adopting the use of ABC (Activity-based Costing) system so that it can accurate measure both direct and indirect cost involved in production. However, ABC method has depicted that its new product line also does not seem to be profitable and thus Kay, CEO of the company has advised Smith to alter the results produced. In this context, the report has discussed the benefits of using the method of accurate product costing over traditional method of costing to provide accurate results that facilitates in taking correct decision. Also, it has provided a calculation regarding the cost driver rates for various activities under the ABC system and the cost of each model of printer of company under the activity based costing. The report has also conducted a profitability analysis by calculating the gross profit and gross profit percentage per unit for both model as per the ABC system. In addition to this, it has also provided recommendations to Smith for resolving the ethical dilemma faced of altering the results derived with the use of ABC systems. At last, it has also sated the technique to dispose the amount of over or under applied overhead costs with the use of system of activity based costing.

1. Product costing can be regarded as the process of allocating costs to the inventory and production based on expenditure incurred during these processes while manufacturing of a product. There is need for accurate estimation of the product cost to take important decisions for improving the profitability position of a company by reduction in the operational costs. The major goals that can be achieved by estimation of product costs are developing strategies for reducing material cost, labor cost or the subcontractor cost. The major benefit of determination of accurate product costing is achieving accuracy for keeping a track of operational expenses. The use of product costing helps in assigning the cost to the value created by them for the business. It also proves to be very useful in developing budgets by determination of overall expenses that will be involved in completion of a project. The development of budget helps in assessing whether the various stages of a project are meeting the cost expectations and identifying the variances easily. This helps in keeping a track of project cost and resolving the costing issues in advance for ensuring successful completion of a project. The lack of accurate product costing can lead to difficulty in analyzing the cash flows and determining the success of a project (Maingi, 2013).

The determination of accurate product cost is very useful in making important decision involving return realized on capital invested and estimating the profit to be achieved from an action. For example, business managers adopt the use of absorption costing that involves segregating the overall cost involved in production into different products manufactured. Therefore, it can be said that there is high importance of estimating the accurate cost for taking significant decisions in developing a new product line using methods for reduction in the operational costs. It is required for controlling the expenses in current production process, preventing the overruns of future jobs and developing a cost history for estimating the success of a future product or service planning to be launched (Hansen, 2007).

The business managers at present are emphasizing on adopting the use of accurate product methods as compared to the traditional method of costing. For example, management of Beztec has adopted the sue of activity based costing for determination of overhead costs for its product lines. The method of activity based costing helps in determination the accurate cost incurred in developing a product by identifying the overall activities involved in production and then allocating the cost based on actual consumption. The use of accurate product costing is becoming important for business entities due to problems associated with the traditional costing system that has been used by Beztec previously. The traditional cost methods do not seem to be adequate in estimating the overhead costs involved in manufacturing of a product as it allocates the cost based on volume such as total products manufactured, direct labor hours consumed or number of machine hours involved. Therefore, the allocation of indirect costs that are not incurred due to volume is not possible under the method of traditional costing system. This weakness of the traditional costing system is causing the business entities such as Beztec to adopt the use of accurate product costing methods (Emblemsvåg and Bras, 2012).

2. Calculation of overhead rate for each identified activity

The calculation of the overhead rate for each unit of activity involves identifying the total cost of each activity and then dividing it by the total number of units of each activity to obtain the overhead rate.

(Emblemsvåg and Bras, 2012)

3. Calculation of cost of each model manufactured by the company through applying the activity based costing approach

(Hansen, 2007)

Note: For detailed calculation please refer to the excel sheet

4. Analyzing the profitability position of each model through calculating gross profit of each model and gross profit percentage of each model using activity based costing approach

(Bradtke, 2007).

5. Smith, the management accountant of Beztec, has advocated the use of activity-based costing method for gathering the information related to overhead costs involved in each of its product line of Protox and Lexon. This has been done as the use of traditional method of costing is not proving to be adequate for identifying the overhead costs. As such, the initial product line of Beztec, lexon, has not generated profitable results due to inadequate identification of the indirect costs with the sue of traditional costing method. As such, Smith has emphasized on the use of ABC system for identifying the overhead costs so that its new product line Proton becomes profitable. The use of ABC system has depicted that the new product line of Beztec, Protox, is also not profitable. Smith has depicted these results to Steven Kay, the CEO of the company, and he has advised Smith to alter the results derived with the use of ABC system. This is because Smith believes they cannot show these results to the headquarters as initially the product line of Lexon was not profitable and now their new product line Protox has also depicted negative costing results.

However, Smith has re-checked the results derived with the use of ABC system and have found them to be accurate. As such, Smith is facing ethical dilemma for deciding the ways she should respond to the suggestion of Kay as it would be unethical on her part to alter the results derived with the use of ABC system according to APES 110 Code of Ethics. Accounting Professional & Ethical Standards Board Limited (APESB) has stated that it’s the responsibility of the accountancy professional to act in the direction of maximizing the public interest. As per the code, an accounting professional need to give the professional judgment without any biasness and should provide a fair view of the financial performance of an entity to its stakeholders. It is the responsibility of accounting professional to apply the safeguards for eliminating the threats to an acceptable level. Therefore, as per the code of ethics Smith has the responsibility of presenting true and fair view of the financial results to the headquarters so that they can take accurate decisions for its future growth and development. The manipulation of costing results would be unethical on the part of Smith as it could lead to misleading the Board about its actual financial position as well as can have a negative impact on its future growth prospects. As such, it is advised to Smith to develop an understanding to Kay about the future implications of such an alteration caused in the results produced by ABC system. The importance of depicting true result before the headquarters should be explained to Kay for taking significant decisions for reducing the operating costs to make Protox profitable (APES 110 Code of Ethics for Professional Accountants, 2010).

6. The use of a predetermined overhead rate can result in over or under allocation of overhead costs. This is because of the occurrence of variances due to difference between the actual overhead incurred and the estimated overhead cost calculated based on a predetermined overhead rate incurred during the manufacturing process. The predetermined overhead rate is calculated based on estimated hours of labor or machine. However, the rate determined varies as the actual hours of labor or machine varies at the end of production period. Therefore, such variances can result in causing overhead or under applied overhead (CCH Australia Limited, 2009). The three ways that can be used for disposing the amount of over or under applied overhead costs are as follows:

• Assigning the over or under applied overhead cost to work in progress, finished goods or cost of goods sold
• Transferring the complete cost in over or under applied overhead to the cost of goods sold
• Developing distinct account for over or under applied overhead cost and then transferring it afterwards (Bhimani, 2006).

Conclusion

It can be stated from the analysis of the case study issues that has been carried out in this report that determination of accurate product costs is of utmost significant for sustaining the future growth prospects of a company. This is because it facilitates in taking accurate decision relating to developing strategies for controlling and monitoring the overhead costs that is not determined with the sue of traditional costing method. Beztec has also adopted the use of ABC model for estimating the overhead cost of its new product line of Protox that is not possible with the use of traditional method of costing. The differences resulting between the overhead cost determined and that incurred can be used to calculate the overhead cost. It is also recommended based on overall analysis of the case study issues that accounting professionals must adopt the use of techniques of accurate product costing to depict the accurate results to the management so that they can take effective decisions regarding the future growth strategies of a company. APES 110 code of ethics provides guidance to the accounting professionals for maintaining integrity, honesty and transparency in developing financial results to protect the interest of the stakeholders.

References

APES 110 Code of Ethics for Professional Accountants. 2010. [Online]. Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed on: 15 September 2018].

Bhimani, A. 2006. Contemporary Issues in Management Accounting. Oxford University Press.

Emblemsvåg, J. and Bras, B. 2012. Activity-Based Cost and Environmental Management: A Different Approach to ISO 14000 Compliance. Springer Science & Business Media.

Maingi, J. 2013. Advantages & Disadvantages of activity based costing with reference to economic value addition. GRIN Verlag.

Hansen, D. 2007. Cost Management: Accounting and Control. Cengage Learning.

Bradtke, D. 2007. Activity-Based-Costing. GRIN Verlag.

CCH Australia Limited. 2009. Australian Master Accountants Guide. CCH Australia Limited.