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Crow's Nest Springs face two main problem first increased overhead if they expand their area and second they faced to deliveries' unhappiness in result of expanding routes and pressure to meet difficult delivery schedules.
Although company management is responsible for planning, directing, and controlling operation effectively, they need make decision about one of the important type of information related to company's cost. As long as we start some question rise as follow:
How can we control the cost?
What costs are involved in making a products or providing a service?
What impact will have cost reduction on company production?
Can we reduce the cost and make more sale?
Is there different among cost and expense?
Answered to these question can help management to understand enough the cost purpose and its association with different part in company. In addition recognizing manufacturing cost that include direct labor cost, direct material cost, and manufacturing overhead which is all measuring, recording, and reporting by cost accounting system can help management to make better decision.
Cost report by accounting system allocate to activity cost pool by different method which are job order cost system, process cost system and activity based cost.
Accurate cost allocation to production is one of the motivation that top management chose best cost allocation method to assign cost to firm's production.
Question Two (6 marks)
Describe some alternative ways to allocate corporate overhead.
There are two type of cost accounting system to allocate cost to product: traditional methods which are
Process cost system company
Job order cost system company
And recent cost accounting system is activity based cost system.
The Traditional Costing System
The traditional costing systems utilize a single, volume-based cost driver. This is the reason why the traditional product costing system distorts the cost of products. In most cases this type of costing system assigns the overhead costs to products on the basis of their relative usage of direct labor. For this reason traditional cost systems often report inaccurate product costs.
Job order cost system
The job order cost system is used when products are made based on specific customer orders. Each product produced is considered a job. Costs are recognized based on job. Services rendered can also be considered a job. For example, service companies consider the creation of a financial plan by a certified financial planner, or of an estate plan by an attorney, unique jobs. The job order cost system must capture and track by job the costs of producing each job, which includes materials, labor, and overhead in a manufacturing environment. To track data, the following documents are used:
Job cost sheet. This is used to track the job number; customer information; job information (date started, completed, and shipped); individual cost information for materials used, labor, and overhead; and a total job cost summary
Process Cost System
Some companies have same or very similar products that are not made to order and are produced in large volumes. They continually process their product, moving it from one function to the next until it is completed. In these companies, the manufacturing costs incurred are allocated to the reasonable functions or departments within the factory process rather than to specific products. Examples of products that companies produce continuously are cereal, bread, candy, steel, automotive parts, chips, and computers. Companies that refine oil or bottle drinks and companies that provide services such as mail sorting and catalog order are also examples of continuous, homogeneous processing.
Activity Based Costing (ABC)
The underlying assumption of activity based costing is entirely different from that of conventional costing systems. The conventional costing system assumes that products cause costs. Activity based costing systems have activities as the fundamental cost objects. Activity based costing systems also assumes that activities cause costs and that cost objects create the demand for activities.
Activity based costing is a different approach and improves control of overheads by a cost/cause relationship, that are activity and cost. The system is flexible enough to relate costs to customers, processors, management responsibility and not just products.
As the name suggests, activity based costing is a system that focuses on activities as the basic cost objects and uses the costs of these activities as building blocks for compiling the costs of other cost objects. The use of an activity based costing system can also help a company to develop a way to analyze and justify manufacturing cycle-time improvements.
Question Three (5 marks)
Which allocation system would you choose? If implemented, what effects do you believe it's implementation would have upon Crow's Nest Springs' distribution operations?
Based on our consideration we choose Activity Based Cost system because:
Activity-Based Costing (ABC) arose in the 1980s from the increasing lack of relevance of traditional cost accounting methods. The traditional cost accounting methods were designed around 1870 - 1920 and in those days industry was labor intensive, there was no automation, the product variety was small and the overhead costs in companies were generally very low compared to today. However, from the 1960s - particularly 1980s - this changed rapidly. For these reasons, and more, traditional cost accounting has been called everything from 'number 1 enemy of production' and questions whether it is 'an asset or a liability' have been raised.
The question of course is whether ABC has overcome these deficiencies or not? It has. In fact, ABC has been called one of the most important management innovations the last hundred years.
So what is really the difference between ABC and traditional cost accounting methods? Despite the enormous difference in performance, there is three major differences:
cost accounting it is assumed that cost objects consume resources whereas in ABC it is assumed that cost objects consume activities.
Traditional cost accounting mostly utilizes volume related allocation bases while ABC uses drivers at various levels.
Traditional cost accounting is structure-oriented whereas ABC is process-oriented.
We chose activity based cost because ABC acknowledges that you cannot manage costs, you can only managed what is being done and then costs will change as a consequence. In traditional cost accounting, however, the underlying assumption is that costs can be managed, but as most managers have found out the hard way - managing costs is almost impossible.
The benefit of the ABC mindset is that it opens up for a much wider array of measures when it comes to improving productivity. By investigating systematically what is being done, i.e. the activities, one will not only be able to identify surplus capacity if it occurs, but also lack of capacity and misallocation of capacity. A result of this might be that costs are cut the traditional way, but it might as well lead to a reallocation of capacity to where it is most needed which will yield high productivity more effectively than the traditional way.
Quarterly Total Profit and Loss Statements for Crow's Nest Springs Three Distribution Centres ($000)
Staff and administration
Question Four (11 marks)
Calculate net profit for the three DCs using an overhead allocation based on total subscriptions and compare these results with those found under the present system.
Quarterly Profit and Loss Statements for Crow's Nest Springs Three Distribution Centers ($000) Allocation Base
Subscription fee revenue
Staff and administration
Quarterly Total Profit and Loss Statements for Crow's Nest Springs Three Distribution Centres ($000) Allocation Base
Subscription fee revenue
Staff and administration
In order to compare the two systems it is necessary to understand the working of both systems. The problem in many businesses using traditional overhead allocation is that their overhead expenses or operating expenses don't cleanly tie to products or services. Without good allocation of overhead or operating expenses, businesses can't accurately determine which products make money and which don't.
Costing systems are information systems. They require a specific type of information such as direct labor hours and units produced, to be of value. It is from the input data that product costs and other information are determined according to the specific costing system defined methodology. The results obtained would depend on the costing system used, since the same input data could be used in different ways. In this case the traditional costing system or an activity based costing system.
Question Five (2 marks)
How does total profit of Crow's Nest Springs Ltd compare across the original allocation and the new allocation scheme?
Quarterly total profit of Crow's Nest Springs Ltd
Original allocation New allocation
Net profit 566.7 2419
As we can see in Quarterly total profit of Crow's Nest Springs Ltd profit based on current allocation system is 566.7 and based on new system that we implement is 2419 .