Classification And Costing Techniques In The Decorative Materials Industry

As part of the formal assessment for the Diploma in Strategic Management and Leadership programme you are required to submit an assignment for each module. Please refer to your Student Handbook for full details of the programme assessment scheme and general information on preparing and submitting assignments. 

After completing the module you should be able to: 

LO1 Be able to apply cost concepts to the decision-making process 
LO2 Be able to apply forecasting techniques to obtain information for decision making 
LO3 Be able to participate in the budgetary process of an organisation 
LO4 Be able to recommend cost reduction and management processes for an organisation 
LO5 Be able to use financial appraisal techniques to make strategic investment decisions for an organisation 
LO6 Be able to interpret financial statements for planning and decision making

Classification of Costs in the Decorative Materials Industry

The assessment considers the business of Arnhold holding ltd which is engaged in the business of supplying of decorative materials which are us3d in homes and residential properties. The company is engaged in production of titles and other interior decorating materials which are used in residential properties. The business classifies the costs of the business for the purpose of on the basis of the products which are produced by the business (Parker and Bryan 2017). The company computes the costs of the business on the basis of the product which is produced by the business (Fullerton, Kennedy and Widener 2013). The cost of sales of the business is shown to be $ 70,703,000 which is shown to be more which is made up of material costs, labour costs and overhead costs of the business. The case study is considered for the business. The management of the company follows absorption costing techniques for the purpose of recording the costs of the business and also ensure that the costs of the business can be used for the purpose of estimating the selling price of the business. The case which is shown in the assessment is related to the business of Arnhold holding ltd which is engaged in the business of materials and other operations such as materials for bathrooms operations. The operating expenses of the business for the year is shown to have increased which is due to the increase in the operations of the business.

The costs which are incurred in a business environment can be effectively classified on basis of various factors which are classification on the basis of nature of the product, process which is followed by the business (Tappura et al. 2013). Another basis of classification is that the decision of the management and the production process which is applied by the business plays a vital role on the basis of the cost classification of the business. The costs of a business can be classified on the basis of the criteria which is shown below:

1. Nature of Expenses: The costs of the business can be classified on the basis the nature of expenses such as labour costs, material costs and overhead costs.
2. Cost Object Relation:The costs of a business can be classified on the basis of whether the costs are direct or indirect in nature.
3. Cost Related to Functions:In some businesses the costs of the business are recognized on the basis of the functions which are performed by the business during the period (Dale and Plunkett 2017). The common functions of the business are sales, marketing, production and operations.
4. Production Process:The type of production process which is followed by business which can be batch process, contract process, joint process.

The business of Arnhold holding ltd utilizes all the concepts for the purpose of classification of costs. The costs of the business are segregated on the basis of direct and indirect costs and also on the basis of how much labour, materials and overheads are incurred by the business for the purpose of producing the final product. The costs are also segregated on the basis of the operations of various departments such as production, sales, marketing.

Costing Techniques in the Decorative Materials Industry - Arnhold Holding Ltd

As per the business conditions and nature of operations of the business, Arnhold holding ltd is engaged in the business of producing decorative materials which are used in buildings and residential property. The company is engaged in the business of producing multiple products and therefore needs to maintain the costs of different products under the same method of costing. Therefore, it is apparent that traditional system of costing is not appropriate for measuring and recording the costs of the business.

The best course of option which is available to the management is to select activity-based costing technique which can effectively relate the costs of the business with the different activities which are undertaken by the business. The multiple products which are offered by the business can be suitably measured using activity-based costing technique which is considered to be most suitable in cases where the business has multiple products to offer to the customers (Mohd, Yazid  and Muhammad Aizzat 2017). The technique allows the business to allocate costs on basis of activity which is undertaken by the business and thereby makes the presentation of costs of the business more accurate in nature.

The costs of a business play a vital role in various decision-making process of the business. One such area where decisions are taken considering the costs of the business is the pricing decisions area. The prices of the products include both the cost component which the business has incurred in making the product and also profit component which is the gains of the business. The costs which are considered contains both fixed and variable costs of the business.

Variable costs can be defined as the costs which changes as the volume of production increases or decreases. Such costs are not constant in nature and can be controlled to an extent by the efforts of the management. The fixed costs of the business are constant in nature and have to be undertaken by the management even if production of the business is nil. When price of a product is set, the business first considers to recover the fixed costs of the business and then the variable costs as variable costs can be controlled and even be reduced by the management. In some cases, as well management uses breakeven analysis to compute the costs of the business (Hilton and Platt 2013). The breakeven analysis is a technique which allows the business the minimum sales amount which is required by the business to cover all the costs of the business. This is known as a no profit, no loss situation

Cost-Based Pricing Strategy for Decorative Materials Industry

Therefore, the costs of the business play an important role in determining the selling price of the product which is to be offered by the business. The cost of the business needs to be recovered for a business or the business will not be able to carry on its operations.

The business which is considered can make improvements in cost and pricing structure of the business by following cost-based pricing strategy which allow the management of the company to exactly know how much cost needs to be covered and also the profits which the business needs to generate over the costs of the business.

The costs of the business can be reduced effectively by following costs reduction strategies which allow a business to reduce its variable costs to some extent and thereby increase the profitability of the business. The business of Arnhold holding ltd needs to consider the same while determining the prices of the products which are to be offered to the general public. The process which can be recommended to the management of Arnhold holding ltd for the purpose of reducing the costs of the business are listed below in details:

1. Focus on more profitable products: The focus of the management of the company should be on products which deliver highest gross profit margin in comparison to other products of the business. In the case of Arnhold holding ltd, the business has multiple products and therefore the management needs to focus on that product which provides them with maximum profitability. This can reduce the costs of the business significantly.
2. Monitoring and Control: Another important measure for reducing the costs of the business is related to exercise of effective monitoring and control of the costs of the business (Estampe et al.2013). This would result in reduction of costs which are avoidable in nature and also the costs which are unproductive to the mainline activities of the business. This will also help the management of the company to keep track of the cash inflow and outflow of the business and also look into the activities and efficiencies of the employees of the business.
3. Setting up new technologies or equipment: The management of the company can make improvement in their technological level or even introduce new equipment in the business which will require one-time investment and reduce the costs of the business from next year onwards. The costs of the business generally decrease when a superior model of equipment or technology is applied by the management of the business as the overall efficiency of the business increases.

Activity based costing practices requires a business to effectively measures the costs of the business on the basis of the activities which are followed by the business. The method is a recently developed method and is gaining popularity in business sector due to its advantages it has over the traditional costing system of a business (Kaplan 2014). As per the situation of Arnhold holding ltd, the company is engaged in production of multiple products which are necessary for meeting the production requirements of the business during the period. The overall usefulness of Activity based costing in a business are shown below in details:

• Accurate Product Costs: By following Activity based costing techniques, the management of the company will be able to effectively ascertain the accurate costs of the business. The main advantage of Activity based costing techniques is that the costs of the business are accurately shown in the costs records of the business (Stefano and Casarotto Filho 2013).
• Information Regarding Cost Behavior: The costs of the business can be effectively analyzed by following Activity based costing of the business. The costs of the business can be analyzed using the method of Activity based costing.
• Tracing the Overhead costs of the business: The overhead costs of the business can be reduced effectively following Activity based costing as the same are traceable in nature (Laguna and Marklund 2013). The management of the company can identify the activity which has generated the overhead costs and accordingly allocate the costs of the business.
• Decision Making Process: The decisions which are taken by the business are based on the structure of the business and therefore when the management has an accurate presentation of the cost information of the business, decisions can be taken effectively by the management of the company.

Moving average is a method which is used for establishing the trends for a given set of data. The data which is considered for this part are shown on a monthly basis. Moving average is used for the purpose of calculating the average points of the data which is available to the business. The above table considers moving average computation for a period of three months (Babu and Reddy 2014). The slope and intercept of the business is computed considering the data and moving averages which are computed and the same is shown to be 89,000.40 and 453,131.24 respectively.

On the basis of the slope and intercepts which are computed in the table above, the forecasted sales for the month of January and February can be computed effectively and the same is shown in the table below:

Cost Reduction Strategies in the Decorative Materials Industry

The forecasted sales of the business for the month of January and February is shown to be $ 1,343,135.29 and $ 1,432,135.69. The methodology which is applied for calculating the moving average of three years is that the forecasted sales is taken for three months period and then the average for the same is considered. The average is considered to compute the moving average and on the basis of the estimate of moving average slope and intercepts are computed as shown in the table above.

A budget plays a vital role in the organization in the process of planning and coordinating with different departments regarding the role such departments need to play. The master budget is the main budgets which considers all aspects of the business and appropriately plans for the different activities which are undertaken by the business (Warren, Reeve and Duchac 2013). The management of companies needs link the master budget of the business with the corporate strategies of the business so that the ultimate goals of the business are given the emphasis and the activities and resources of the business are directed towards achieving the goals of the business.

The budget sample is shown above which show different expenses which are incurred by the business during the period. The actual performance of the business is also shown in the budget which is prepared above showing comparison between the financial information. The sales of the business are shown to be $ 4,399,907 as per budgeted estimates. The profit margin for the business is shown to be 73% as per the budgeted estimates of the business. The net profit is also budgeted to be $ 406,404 for the year during the period.

The budgets can also be used for the purpose of monitoring the activities of the business and ensure that the same are being followed considering the objectives and goals of the business. The good practice which can be followed by the management in budgeting are the application of standard costing requirements of a business. The master budgets are used by businesses to set standards for costs and revenues of the business and also estimate the profits which the business is going to earn during the period. The standards the can be used by businesses to analyze the performance of the business in terms of the standards which is set by the business. This also enables the management to evaluate the variances in performance which is the difference between actual and standard performance of the business. The management can the investigate as to the reasons for the variances to occur in the first place. This promotes monitoring and control practices in the business.

Computation of Moving Averages

Table: (Variance Report)

Source: (Created by Author)

The above table shows an analysis of the budget which is prepared considering the standards figures and also the actual performance of the business during the period. The sales and gross profit margin of the business is shown to be favorable as per the table above, but certain expense of the business is shown to be adverse and even the total expense of the business is shown to be adverse.

The variances which are shown in the table above are significant in nature as the most of the variances are seen in the expenses which are incurred by the business during the period. The business had to incur higher costs than what was expected by the management of the company and therefore the profitability of the business is severely affected due to such results. The cause behind such a variance can be identified to be the unplanned expenses which are incurred by the business and also the inflationary pressures which are felt by the business during the period.

The practice of budgeting allows businesses to effectively deal with the forecasting practices of the business regarding to revenue and expenses of the business. Budgets can also be used alongside with standard costing practice which is considered to be a good practice (Draheim 2013). The budgets of the business can deeply benefit from the standard costing practice of the business (Joshua and Mohammed 2013). The standard costing practices allows the management to identify the variances of the business and effectively show the variances of the business. The standard costing practice which is applied on a business can help businesses to control and monitor the expenses and revenue of the business and identify the gap between standard sets and the actual results of the business.

The above table shows the computation of net present value, payback period analysis and also computation of Accounting Rate of Return.

Internal Rate of Return of the business refers to the rate of return which is used by businesses to ascertain whether the projects which are undertaken by the business are profitable in nature or not. The internal rate of return technique is known to produce accurate results about the investments which the business. The Internal Rate of Return must be higher than the overall cost of capital of the business in order to ascertain whether the project which is undertaken by the management of the company is profitable or not (Harris 2017). The Internal Rate of Return of a project is the ideal required rate of return which the business anticipates from a project. The Internal Rate of Return of a project is also considered to be one of the most relevant and accurate form of investment appraisal techniques which is available to the management.

Sales Forecasting

NPV Analysis

The investments appraisal techniques which are available to the business are listed below in details. The advantages of net present value of the business are explained below in details:

• The technique of NPV gives emphasis to the concept of time value of money and therefore the results which are obtained are appropriate and relevant.
• The computation of NPV of the project can help the business to effectively consider the after-cash flows and before cash flow of the business.
• The method NPV considers both profitability and risks of the business.
• The NPV of the business are helpful in maximizing the value of the business.

The disadvantages of the NPV are listed below in details:

• The computation of NPV of the business is very difficult to use and also complex in nature.
• The NPV method in cases of Mutually exclusive projects which are not equal in nature.
• In cases where the projects have unequal life , NPV fails to provide accurate estimates for the business.

Payback Period Analysis

The strength and weakness of using payback period analysis are listed below in details:

• Payback period analysis allows businesses to effectively analyze the projects of the business and effectively make comparison between the same.
• The initial cash flow requirements of the business can be planned effectively using the payback period analysis of a business and also establish the duration of the project of the business (Adair et al.2013).

The weaknesses of using Payback period analysis are listed below in details:

• The method does not appropriately portray the profitability aspect of the business in case of projects which are long term in nature.
• The method is not considered to be as accurate as the NPV analysis or Internal Rate of Return analysis of the business.

Accounting Rate of Return Analysis

The advantages of Accounting rate of return are listed below in details:

• The computation of Accounting rate of return considers only the information which are available from accounting records and therefore there is an ease of access for the same.
• The Accounting rate of return method effectively measures the profitability aspect of the project as the analysis from the point of view of accounting information.

The disadvantages of Accounting rate of return is shown in the points given below:

• The method of Accounting rate of return ignores the concept of time value of money.
• The method also ignores the cash flow from investments which are generated by the business.

The analysis of the investment appraisal technique which are applied by the management of the company on the projects of the business reveal that Project A is more profitable in nature in comparison to Project B. The NPV which is computed in the above table shows that the estimates for Project A is shown to be $ 5,112 which is more than Project, B estimates which suggest that Project A is more profitable in nature. In addition to this, the payback period and accounting rate of return of Project A is shown to be more favorable in comparison to Project B and therefore the Project A needs to be suggested by the management of the company.

The post appraisal audit of the business helps the management of the business to take decisions regarding the investments which are undertaken by the business during the period. The management with the help of post audit appraisal techniques identify the performance of the project and determine whether the same is being done as per the expectation of the management of the business (Coleman et al. 2013). If the project is not performing as per the expectation of the management of the company than the same can be stopped or alternative course of action can be selected by the management.

The management of the company needs to decides what type of investment source which the business want to undertake for the purpose of financing the projects of the business. The sources of finance which are to be considered by the business are shown below:

• Equity Capital: The management has the option to select equity-based capital for the purpose of accumulating funds which are associated with the business. The management can issue shares to the public in order to raise the capital which is required by the business for the project. The basic advantage which is associated with equity share capital are that it does not create a charge on the asset of the business and the business also does not need to bear any fixed rate of dividend for the same (Giovannini et al.2015). Another advantage is that these sources are permanent source of capital and only needs to be repaid at the time of liquidation. The disadvantage which is associated with equity shares are that there is a risk of overcapitalization as the shares are not redeemable. The ownership of the business is segregated which is also a limitation and hampers decision-making process.
• Debt Capital: The debt capital of the business is another option where the business can take loans from the banks in order to finance the projects of the business. The advantages of using debt capital of the business is that the ownership remains intact and the decision-making process is quick. Debt capital present a leverage effect which can lead to improvements in the business. The disadvantage of using Debt capital is that the capital source creates a burden on businesses to pay a fixed rate of interest. Theses sources often create charges on assets of the business.
• Bank Loan: Bank loan is another important source of capital for the business and the same can be used for the purpose short term financing as well as long term financing requirements of the business. The advantages of utilizing bank loan is that it is very easy to access and the business can get appropriate amount of loans. The disadvantage of using bank loans can be related to the burden which is to incurred and also the risk factor is also high.

The annual reports of the Esprit Holding ltd for the year 2017 shows that the overall revenue of the business is shown to have reduced for the year 2017 and the same is shown to be HK$ 15,942 million. The revenue has reduced which can be taken as a negative sign for the business. The gross profit of the business is shown to have reduced from the last year analysis which shows a decline in operational capacity of the business. The business has incurred losses during the year which is shown to be HK$ 106 million which is before taxation amount. The business gains tax credit during the year and therefore the profit is shown to be HK$ 67 million which has improved significantly during the year.

Master Budget and Corporate Strategy

An analysis of the ratio in relation to profitability of the business is shown in the figure demonstrated below:

The gross profit margin of the business is shown to be 51.62% for the year 2017 and the same is shown to have improved from previous year analysis. The net profit margin is also shown to have improved which is a positive sign for the business. The profitability ratios of the business shows improvements which suggest that the business is on the verge of improvement.

The profitability of the business can be further be improved by following an effective internal control system which focuses on improving the costs structure of the business. In addition to this, proper monitoring and supervision policies are to be applied by the management of the company for the purpose of reducing the costs which are associated with the business.

Reference

Adair, A., Downie, M.L., McGreal, S. and Vos, G., 2013. European valuation practice: Theory and techniques. Taylor & Francis.

Babu, C.N. and Reddy, B.E., 2014. A moving-average filter based hybrid ARIMA–ANN model for forecasting time series data. Applied Soft Computing, 23, pp.27-38.

Coleman, C., Crosby, N., McAllister, P. and Wyatt, P., 2013. Development appraisal in practice: some evidence from the planning system. Journal of Property Research, 30(2), pp.144-165.

Dale, B.G. and Plunkett, J.J., 2017. Quality costing. Routledge.

Draheim, D., 2013. Towards total budgeting and the interactive budget warehouse. In Innovation and Future of Enterprise Information Systems (pp. 271-286). Springer, Berlin, Heidelberg.

Estampe, D., Lamouri, S., Paris, J.L. and Brahim-Djelloul, S., 2013. A framework for analysing supply chain performance evaluation models. International Journal of Production Economics, 142(2), pp.247-258.

Fairwoodholdings.com.hk. 2018. Financial Reports. [online] Available at: https://www.fairwoodholdings.com.hk/eng/investor/financial_rep2.jsp [Accessed 30 Sep. 2018].

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2013. Management accounting and control practices in a lean manufacturing environment. Accounting, Organizations and Society, 38(1), pp.50-71.

Giovannini, A., Mayer, C., Micossi, S., Di Noia, C., Onado, M., Pagano, M. and Polo, A., 2015. Restarting european long-term investment finance. A Green Paper Discussion Document, London.

Harris, E., 2017. Strategic project risk appraisal and management. Routledge.

Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.

Joshua, O. and Mohammed, N.A., 2013. Budget Target Setting and Effective Performance Measurement in Nigerian Hospitality Industry. Journal of Finance and Economics, 1.

Kaplan, R.S., 2014. Improving value with TDABC. Healthcare financial management, 68(6), pp.76-84.

Laguna, M. and Marklund, J., 2013. Business process modeling, simulation and design. CRC Press.

Mohd Yazid, A., KR, J. and Muhammad Aizzat, Z., 2017. Characterisation of Activity Based Costing on Remanufacturing Crankshaft. International Journal of Automotive and Mechanical Engineering (IJAME).

Parker, J. and Bryan, P., 2017. Landscape management and maintenance: a guide to its costing and organization. Routledge.

Stefano, N.M. and Casarotto Filho, N., 2013. Activity-based costing in services: literature bibliometric review. SpringerPlus, 2(1), p.80.

Tappura, S., Sievänen, M., Heikkilä, J., Jussila, A. and Nenonen, N., 2015. A management accounting perspective on safety. Safety science, 71, pp.151-159.

Warren, C., Reeve, J.M. and Duchac, J., 2013. Financial & managerial accounting. Cengage Learning.