Managerial accounting is concerned with providing accounting information

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Question 1 (1)

Managerial accounting is concerned with providing accounting information to department managers who direct and control the operations of an internal business. Managerial accounting is also termed as management accounting or cost accounting. It provides the essential data mainly for decision making with which the organizations are actually run. Either small or large organization, it has managers. It is necessary for managers to be responsible in making plans, organizing resources, directing personnel, and controlling operations. Managerial accounting allows them to be informed, make better business decisions and plan department strategies in order to increase revenues while minimizing costs. The accounting department prepares reports for department heads, ensuring detailed cost information is included. Some costs a department manager has control over, while fixed overhead costs leave little room for improvement.

In managerial accounting, there are following types of cost: manufacturing costs, product costs, and period costs. Besides, the costs can also be classified into variable or fixed costs, direct or indirect costs, differential cost, opportunity cost and sunk cost. However, in this case study, we would like to emphasize the four main kinds of costs which are direct costs and indirect costs as well as variable costs and fixed costs.

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Direct costs and indirect costs concern on whether a cost can be traced specifically to a cost subject. Direct costs represent any cost that can be indentified directly on the products itself. Raw materials, labour costs, and manufacturing overheads are the common examples of primary direct costs. Raw material costs refer to the physical materials uses to produce the goods or services; while the labours are the employees directly involved in the production and the manufacturing overheads are the expenses on the facilities and equipments which used in the manufacturing process.

On the other hand, indirect costs include expenses which are incurred outside a company's production process. For instances, office supplies, sales personnel and administration fees are the common indirect costs in a company. The amount of indirect costs should represent a very small proportion of the company's overall expenditures in order to maximize profits. How to know whether a cost is a direct cost or indirect cost? To be clear, we took an example of purchasing eggs. If a raw material of eggs is required for the making of a particular food item, it would be considered as a direct cost; if the eggs would be used in one of several types of baked products made by the manufacturer, it would be classified an indirect cost since it could not be tied specifically to one object.

Relating to the above mentioned, direct costs and indirect costs are either fixed or variable. Fixed costs are the expenses that can be budgeted easily and remain constant, in total, regardless of the changes in activity level of production. Overheads such as depreciation, rent and administrative salaries fall under fixed costs. This is because company still has to pay the fixed costs every month regardless of the amounts produced or sold. Contrastingly, the costs such as raw materials purchases are classified as variable cost due to the changes in the company's production output. Besides, hourly employees' wages are also good example of variable costs because they vary depending upon the number of hours worked and if overtime is involved.

In this case study, the Travel Company has the followings identified possible costs:

Overheads

Classifications

Reasons

Tour directors Salaries

Direct;

Variable

Identified on the services provided

Vary according to the numbers of tours guided

Administrative Salaries

Indirect;

Fixed

Cannot be identified on the services provided

Remain constant regardless the number of tours

Office Rent

Indirect;

Fixed

Not involve in the products provided

Budgeted and remain constant every month

Lighting and Heats

Indirect;

Fixed

Not involve in the products provided

Budgeted expense

Transportation Fee

Direct;

Variable

Involved in providing services to customers

Changes upon the length of tours

Depreciation on Vehicles

Indirect;

Fixed

Cannot be identified directly on the products

Budgeted and remain constant every year

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Advertisement Fees

Indirect;

Fixed

Difficult to be divided on each product that provided

Budgeted expense

Flight Ticket Fees

Direct;

Variable

Identified on the tours provided

Vary regarding to the changes of countries

Accommodation Fees

Direct;

Variable

Identified on the tours provided

Changes according to the places of tours

Dining Expenses

Direct;

Variable

Included in the tours provided

Changes according to the preferences of customers

Telephone Charges

Indirect;

Fixed

Difficult to divided on each tour that provided

Budgeted expense

Question 1 (2)

Under managerial accounting, we learnt five parts of cost accounting system: (1) an input measurement basis, (2) an inventory valuation method, (3) a cost accumulation method, (4) a cost flow assumption, and (5) a capability of recording inventory cost flows at certain intervals. These five parts and the alternatives under each part are summarized in the below diagram. Note that many possible cost accounting systems can be designed from the various combinations of the available alternatives, although not all of the alternatives are compatible. Selecting one part from each category provides a basis for developing an operational definition of a specific cost accounting system.

Cost Accounting System

From what we can see in this case study, the Travel Company uses pure historical cost system. As the diagram shown below, in a pure historical cost system, only historical costs flow through the inventory accounts. Historical costs, sometimes known as actual costs, refer to the costs that have been recorded. However, in order to determine the cost of a goods or service requires many cost allocations. For instances, the Travel Company allocates the cost of fixed assets to time periods, and allocates certain indirect overheads to length of tours. Since there are many alternative allocation methods, (e.g. straight line or reducing balance depreciation), the calculated cost of a tour simply represents an attempt to approximate the true cost.

Pure Historical Costing

The pure historical cost accounting is the situation in which accountants record revenues, expenditures and asset acquisitions or disposals at the historical costs. Under generally accepted accounting principle (GAAP), historical costs are required in all financial statement items be based upon original cost. They are the actual amounts of money or value that received or paid in the transactions, but not fair market values. In this case, the Travel Company purchased vehicles to operate its business. This transaction is recorded on the balance sheet at its historical cost. It is not recorded at fair market value that might be higher or lower than the original cost.

Nevertheless, nothing is perfect. Such method, over a period of time has been subject to many criticisms. Obviously, as it only interested in cost allocations (the acquisition cost of an asset) and does not recognise the current market value. Where there is an acquisition cost of an asset or it depreciates in the following years, it ignores the possibility that the fair market value of that asset may be higher or lower than it expects.

In addition, the Travel Company uses activity based costing (ABC) as an inventory valuation method. This technique was developed to provide more accurate product costs by tracing costs through activities. In other words, costs are traced to activities (activity costing) and then these costs are traced, in a second stage, to the products that use the activities. The concept of ABC is illustrated in the diagram below.

Activity Based Costing (ABC)

Inventory

Under activity-based costing (ABC), overhead costs are allocated to products on the basis of the resources consumed in each activity relating to the design, production, and distribution of particular products. Costs are assigned to homogeneous cost pools that represent specific activities. The allocation of these costs to products is attempted through appropriate cost drivers. Cost drivers are transaction-related and volume-related, which represent the causes of costs incurred in specific activities. Table below represents certain overheads in the Travel Company.

Activity-Based Costing

Activities

Cost Drivers

Repairs, maintenance

Repair hours or machine hours

Depreciation

Cost of an asset

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Handling Charges

Number of tours provided

Personnel management

Number of employees served

Transportation Fees

Miles driven

Number of tours guided

Billings

Lines typed or bills processed

Selling costs

Proportionate to sales in dollars

Administrative costs

Proportionate to sales in dollars

Disbursing

Number of checks issued

Apart from that, the Travel Company uses job orders as the cost accumulation. Cost accumulation refers to the manner in which costs are collected and identified with specific customers, jobs, batches, orders, departments and processes. In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the work is done to the customer's specifications. As a result, each job tends to be different. Job order costing is used since the Travel Company accepts the customized tours by teachers. With this, the costs incurred in the tours provided are identified by specific orders from different customers.

Costs flow through the inventory accounts by the job in a job order cost system which represents an example of specific identification. In the Travel Company, we can know that the requirements of the tours determine the timing of the cost flows. Simple orders tend to move through the system faster than more complex jobs.

At my point of view, I personally select the activity based costing as the best among all the cost accounting system due to the higher accuracy costing of all activities to be obtained throughout the business. Moreover, it enables accounting users to have better understanding on the overheads incurred in the company. In other words, it is easier to identify the causes where the high or low costs are being incurred. Besides, it utilizes unit cost rather than just a total cost and hence, helps in future product planning, pricing determination and etc.

(1601 words)

Question 2 (a)

S&W

Income Statement for the year ended 31 December 2009

Bolts Piston Valves Total

RM RM RM RM RM RM

Sales Revenues 960,000 440,000 1,400,000

Less: Variable Production Costs

Materials 400,000 160,000 560,000

Labours 120,000 80,000 200,000

Variable Overheads 40,000 14,000 54,000

560,000 254,000 814,000

Gross Margin 400,000 186,000 586,000

Less: Variable Overheads

(WK1) Delivery Transport 71,000 13,000 84,000

Contribution 329,000 173,000 502,000

Less: Fixed Overheads

Administration 78,000 78,000 156,000

Marketing Expenses 36,000 36,000 72,000

(WK1) Delivery Transport 42,000 42,000 84,000

(WK2) Factory Rent 60,000 40,000 100,000

(WK3) Depreciation 34,000 30,000 64,000

250,000 226,000 476,000

Net Profit 79,000 (53,000) 26,000

====== ====== ======

Workings:

(WK1) Delivery Transport

Units Variable (50%) Fixed (50%) Total

Bolts

(RM960,000/ RM0.8) 1,200,000 RM 71,000 RM42,000 RM113,000

Piston Valves

(RM440,000/ RM2) 220,000 RM 13,000 RM 42,000 RM 55,000

__________ ___________ ___________ ____________

1,420,000 RM 84,000 RM84,000 RM168,000

========= ========== ========== ===========

(WK2) Factory Rent

Ratio Expenses

Bolts 3 RM 60,000

Piston Valves 2 RM 40,000

_________

RM100,000

========

(WK3) Depreciation (Straight line method over 5 years)

Costs Scrap Value Depreciation per year

Bolts RM170,000 NIL RM 34,000 (RM170,000/ 5 years)

Piston Valves RM150,000 NIL RM 30,000 (RM150,000/ 5 years)

Question 2 (b)

Based on the marginal costing statement in (a), bolts division shows a net profit of RM79,000 while piston valves division make a loss of RM53,000. The loss that made in piston valves division might due to the high in fixed overheads. Obviously, the sales revenue is unable to cover the overheads incurred in the division. Nevertheless, the overall net profit gives a positive figure of RM26,000; yet there is still room available for improvement.

In order to maximize the profits, management has either to maximize sales or to minimize costs. From my point of view, I personally think that the company should reduce their fixed expenses such as administrative and marketing expenses. For instance, they can choose to advertise its products via cheaper marketing channels such as the flyers or internet. In addition, the company can reduce the price or give promotions in order to boost the sales. With this great combination, the company will derive a favourable net profit.

Question 2 (c)

S&W

Income Statement for the year ended 31 December 2010

Bolts Piston Valves Total

RM RM RM

Option 1- Increase Price

Sales 946,000 504,000 1,450,000

Less: Variable Costs 616,000 285,600 901,600

Contribution 330,000 218,400 548,400

Less: Fixed Costs 260,000 240,000 500,000

Net Profit 70,000 (21,600) 48,400

====== ====== =======

Option 2 - Reduce Price

Sales 1,170,000 432,000 1,602,000

Less: Variable Price 840,000 326,000 1,166,000

Contribution 330,000 155,600 485,600

Less: Fixed Costs 260,000 240,000 500,000

Net Profit 70,000 (84,400) (14,400)

======== ======= ========

Workings:

High Low Method:

Bolts:

Sales (units) Total Costs

High 1,500,000units RM1,100,000

Low 1,100,000units RM 876,000

400,000units RM 224,000

========== ==========

Piston Valves:

Sales (units) Total Costs

High 240,000units RM566,400

Low 210,000units RM525,600

30,000units RM 40,800

========== ==========

Variable cost = Total cost/ Sales (units)

Bolts = RM224,000/ 400,000 units

= RM0.56 per unit

Piston = RM40,800 / 30,000 units

=RM 1.36 per unit

Total cost = (units * Variable cost) + Fixed cost

Bolts: 876,000 = (1,100,000 * RM0.56) + Fixed cost

Fixed Cost = RM876,000 - RM616,000

= RM260,000

Piston Valves: RM 525,600 = (210,000 * RM 1.36) + Fixed cost

Fixed cost = RM525,600 - RM285,600

= RM240,000

Option 1

Option 2

Bolt

Piston Valves

Bolts

Piston Valves

Units

1,100,000

210,000

1,500,000

240,000

Sales (RM)

946,000

504,000

1,170,000

432,000

Variable cost (RM)

616,000

285,600

840,000

326,400

Fixed Cost (RM)

260,000

240,000

260,000

240,000

Question 2 (d)

Bolts

Option 1 - Increase Price

Option 2 - Reduce Price

(i) Contribution per unit (WK1)

RM 0.30

RM 0.22

(ii) Breakeven point (units) (WK2)

866,667 units

1,181,818 units

(iii) Margin of Safety ratio (WK3)

26.9%

26.9%

(WK1) Option 1:

Contribution = Sales - Marginal cost

= RM946,000-RM616,000

= RM330, 000

Contribution per unit = RM330,000/ 1,100,000 units

= RM0.30

Option 2:

Contribution = RM1,170,000 - RM840,000

= RM330,000

Contribution per unit = RM330,000/ 1,500,000 units

= RM0.22

(WK2) Option 1:

Breakeven point (units) = Fixed cost/ Contribution per unit

= RM260,000/ RM0.30

= 866,667 units

Option 2:

Breakeven point (units) =Fixed cost/ Contribution per unit

= RM260,000/ RM0.22

= 1,181,818 units

(WK3) Option 1:

Margin of safety ratio = [(expected sales - breakeven sales) / Breakeven sales] x 100%

= [(RM946,000 - RM745,333*) / RM745,333] x 100

= 26.9%

*Breakeven sales: 866,667 units x RM0.86= RM745,333

Option 2:

Margin of safety ratio = [(expected sales - breakeven sales) / Breakeven sales] x 100%

= [(RM1,170,000 - RM921,818*) / RM921,818] x 100

= 26.9%

*Breakeven sales: 1181818 units x RM0.78 = RM921,818

Question 2 (e)

Option 1 - Increased Price

Bolts: Contribution to sales ratio = Contribution/ Sales x 100

= (RM330,000/ RM946,000) x 100

= 34.9%

Piston Valves: Contribution to sales ratio = Contribution/ Sales x 100

= (RM218,400/ RM504,000) x 100

= 43.3%

Question 2 (f)

Bolts division

Based on marginal costing statement in (a), it shows that bolts division is making a net profit of RM79,000. While the management suggested the option 1 - to increase price; and option 2 - to reduce price, it ends up showing a same net profit of RM70,000 as in (c). Opposite with the sales revenues, which it shows the option 2 is generating higher sales of RM 1,170,000 compared to option 1's of RM946,000. Meanwhile, if the company uses the original costing plan, the sales is RM960,000. From what we can see above, reducing the cost per unit of Bolts is definitely boosted the sales (Option 1 - 1,100,000 units and 1,500,000 units - option 2). In conclusion, the management should reduce the price in order to attract customers to purchase the product.

Piston Valves division

Based on the marginal costing statement in (a), it shows that piston valves division is making a loss of RM53,000. Unlike bolts division, while the management suggested to increase price, the loss is obviously minimising to RM21,600. On the other hand, there will be higher loss of RM84,400 if the management chose to reduce price of the piston valves. As a conclusion, in this division, the company can boost its sales by increasing the price, and hence, minimising the loss in the production.