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OUA Assignment Cover Sheet Page 1 of 1 Current August 2009 CRICOS Provider No. 00121B
OUA Assignment Cover Sheet
An Assignment Cover Sheet needs to be included at the front of each assignment submitted.
The attachment of this statement on any electronically submitted assignments will be deemed to have the same authority as a signed statement.
Personal details
Student ID: COLAY009
Mr/Miss/Ms/Mrs: MR First name(s): ANDREW EDWARD
Family name: COLE
Address: PO BOX 9043, DEAKIN LPO, ACT 2600
Date of birth: 09-04-1984 Contact phone no: +61 407 384 998
Email: [email protected]
Assignment details
Unit code: ACG24 Unit name: MANAGEMENT ACCOUNTING
Assignment no. 2 Due date: 06-11-2009 11:55:00 PM CDT – 1 WEEK EXTENSION
Assignment topic (as stated in the Unit Information Booklet): CASE STUDY ALTERNATIVE ENERGY SOLUTIONS
Student Declaration I declare the work contained in this assignment is my own, except where acknowledgement of sources is made. I authorise the University to test any work submitted by me, using text comparison software, for instances of plagiarism. I understand that this will involve the University or its contractor copying my work and storing it on a database to be used in future to test work submitted by others. I understand that I can obtain further information on this matter at http://www.unisa.edu.au/ltu/students/study/integrity.asp
Student Signature: ANDREW COLE Date: 06-11-2009
LODGING YOUR ASSIGNMENT
Attach this cover sheet to your assignment and submit via AssignIT on your myUniSA course page.
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ALTERNATIVE ENERGY SOLUTIONS
Activity Based Costing A report on the implementation of ABC at AES
Andrew Cole November 2009
Contents Executive Summary .................................................................................................................................. i
Introduction ............................................................................................................................................ 1
1.0 Implementation of ABC ............................................................................................................... 2
1.1 Limitations ............................................................................................................................... 2
2.0 Analysis of Results ....................................................................................................................... 3
2.1 Profit per Panel ....................................................................................................................... 3
2.2 Profit per Region ..................................................................................................................... 3
3.0 Conclusion ................................................................................................................................... 4
4.0 Recommendations ...................................................................................................................... 5
4.1 Redirection of Marketing Efforts ............................................................................................ 5
4.2 Investigate Expenses in the Southern Region ......................................................................... 5
4.3 Consider Design Changes ........................................................................................................ 5
Bibliography ............................................................................................................................................ 6
Appendix 1 Simple Costing System Using a Single Indirect‐Cost Pool ............................................... 7
Step 1: Identify the products that are the chosen cost objects .......................................................... 7
Step 2: Identify the Direct Costs of the products ................................................................................ 7
Step 3: Select the Cost‐Allocation Bases to Use for Allocating Indirect (or Overhead) Costs to the
Products .............................................................................................................................................. 7
Step 4: Identify the Indirect Costs Associated with Each Cost‐Allocation Base .................................. 7
Step 5: Compute the Rate per Unit of Each Cost‐Allocation Base ...................................................... 7
Step 6: Compute the Indirect Costs Allocated to the Products .......................................................... 8
Step 7: Compute the Total Cost of the Products by Adding All Direct and Indirect Costs Assigned to
the Products ........................................................................................................................................ 8
Appendix 2 Downstream Cost Allocation (Current Costing Method) ................................................ 9
Appendix 3 Profit per Panel (Current Costing Method) ................................................................... 10
Income Statement – Standard Panel ................................................................................................ 10
Income Statement – Deluxe Panel .................................................................................................... 10
Profit Comparison – By Panel ........................................................................................................... 10
Appendix 4 Profit per Region (Current Costing Method) ................................................................. 11
Income Statement – Northern Region .............................................................................................. 11
Income Statement – Southern Region .............................................................................................. 11
Profit Comparison – By Region ......................................................................................................... 11
Appendix 5 Activity Based Costing System ...................................................................................... 12
Step 1: Identify the products that are the chosen cost objects ........................................................ 12
Step 2: Identify the Direct Costs of the products .............................................................................. 12
Step 3: Select the Cost‐Allocation Bases to Use for Allocating Indirect (or Overhead) Costs to the
Products ............................................................................................................................................ 12
Step 4: Identify the Indirect Costs Associated with Each Cost‐Allocation Base ................................ 12
Step 5: Compute the Rate per Unit of Each Cost‐Allocation Base .................................................... 13
Step 6: Compute the Indirect Costs Allocated to the Products ........................................................ 13
Step 7: Compute the Total Cost of the Products by Adding All Direct and Indirect Costs Assigned to
the Products ...................................................................................................................................... 13
Appendix 6 Downstream Cost Allocation (ABC Method) ................................................................. 14
Appendix 7 Profit per Panel (ABC Method) ..................................................................................... 17
Income Statement – Standard Panel ................................................................................................ 17
Income Statement – Deluxe Panel .................................................................................................... 17
Profit Comparison – By Panel ........................................................................................................... 17
Appendix 8 Profit per Region (ABC Method) ................................................................................... 18
Income Statement – Northern Region .............................................................................................. 18
Income Statement – Southern Region .............................................................................................. 18
Profit Comparison – By Region ......................................................................................................... 18
Tables
Table 1 Comparison of Downstream Costs by Region ............................................................................ 5
Table 2 Indirect Costs .............................................................................................................................. 7
Table 3 AES’s Product Costs using the Simple Costing System ............................................................... 8
Table 4 Budget Downstream Costs ......................................................................................................... 9
Table 5 Profit per Panel Downstream Cost Allocation (Current Costing Method) ................................. 9
Table 6 Profit per Region Downstream Cost Allocation (Current Costing Method) ............................... 9
Table 7 Income Statement – Standard Panel (Current Costing Method) ............................................. 10
Table 8 Income Statement – Deluxe Panel (Current Costing Method) ................................................ 10
Table 9 Profit Comparison – By Panel (Current Costing Method) ........................................................ 10
Table 10 Income Statement – Northern Region (Current Costing Method) ........................................ 11
Table 11 Income Statement – Southern Region (Current Costing Method)......................................... 11
Table 12 Profit Comparison – By Region (Current Costing Method) .................................................... 11
Table 13 Indirect Cost Allocation .......................................................................................................... 13
Table 14 AES’s Product Costs using the ABC System ............................................................................ 13
Table 15 Fixed Costs Allocation Rates ................................................................................................... 14
Table 16 Allocated Costs per Panel ....................................................................................................... 15
Table 17 DLH per Territory .................................................................................................................... 15
Table 18 Allocated Costs per Region..................................................................................................... 16
Table 19 Income Statement – Standard Panel (ABC Method) .............................................................. 17
Table 20 Income Statement – Deluxe Panel (ABC Method) ................................................................. 17
Table 21 Profit Comparison – By Panel (ABC Method) ......................................................................... 17
Table 22 Income Statement – Northern Region (ABC Method) ........................................................... 18
Table 23 Income Statement – Southern Region (ABC Method) ........................................................... 18
Table 24 Profit Comparison – By Region (ABC Method) ....................................................................... 18
i
Executive Summary This report investigates Activity Based Costing (ABC) as it may apply at Alternative Energy Solutions
(AES). It was requested by the Managing Director in order to determine whether the current
unexpected profit trends are due to unethical behaviour or an inaccurate costing system.
An ABC system reduces the use of broad averaging in the costing process, which in turn reduces
product cross subsidisation and increases the accuracy of costing data. However, an ABC system
increases accounting effort, as it requires more detailed information and does not meet external
reporting requirements.
The current costing system shows the Deluxe Panel to be more profitable than the Standard Panel,
whereas the Standard Panel is in fact more profitable, as shown by an ABC costing system. As a
result it is recommended the marketing team shift their focus to the Standard Panel.
The current costing system also under reports several expenses in the Southern Region, an error
which is corrected under an ABC system. It is recommended that these expenses be investigated for
possible improvements.
1
Introduction This report is intended to investigate the benefits and disadvantages of implementing an Activity
Based Costing (ABC) system at Alternative Energy Solutions (AES).
AES’s product line consists of two solar panels, the Standard Panel and the Deluxe Panel,
manufactured and distributed throughout two regions in Australia, the Northern Region and the
Southern Region.
The current costing system in use at AES indicates that the Deluxe Panel is more profitable than the
Standard Panel, and as such the marketing team has been concentrating its efforts towards
increasing sales of this model. Sales have improved; however total net profit has not been increasing
as much as expected.
Alicia Green, the Managing Director at AES, is concerned that this trend indicates that either the
current costing system is reporting profitability of these panels incorrectly, or that unethical or
fraudulent behaviour is present in the company. Alicia has requested that an alternative costing
system be investigated and possibly implemented to eliminate the possibility of incorrect costing.
This report includes performance reports, or income statements, comparing the two different
product lines and the two different regions. These reports have been produced using the ABC
system. A set of reports has also been generated using the current costing system for comparison
purposes.
2
1.0 Implementation of ABC An ABC system:
‘provides information to make better decisions. But this benefit must be weighed against the
measurement costs of an ABC system’ (Horngren et al., 2009).
It does this by more accurately assigning costs to products through eliminating the use of broad
averages in the costing process. Rather than costs being allocated to products through one cost
allocation base, costs are allocated to multiple homogenous costs pools, each of which has a single
cost driver. For example, all costs which increase or decrease with (are driven by) the amount of
time a particular machine is run for would be allocated to a single cost pool, and products would be
allocated this cost in proportion to the amount of time their manufacture requires the machine to
be run.
Allocating costs this way eliminates product cross subsidisation, which is where one product that
uses a cost driver proportionately less than another is allocated more than its fair share of the cost
of that driver.
More accurate costing information allows managers to have more confidence when making
decisions on future strategies, such as product mix and marketing plans.
1.1 Limitations In comparison to traditional costing systems an ABC system has several limitations and
disadvantages, including increased effort to produce reports, non‐conformance of reports to
Generally Accepted Accounting Practices (GAAP), and the potential for costs to still be inaccurately
apportioned.
ABC systems require more effort to complete product costing. The use of multiple cost pools
requires managers to allocate costs on a case by case basis, compared with traditional costing where
all costs are allocated to the one pool. This results in an increase to the effort required, and
increases the chance of errors. As this cost allocation procedure is a manual one, requiring
interviews and other input from non‐accounting staff, there is also a possibility that the result will be
manipulated to unfairly place a product or team in a good light.
The layout of an ABC based financial report does not conform to the GAAP (Accounting for
Management, 2008), and therefore cannot be used for external reports. The GAAP requires
manufacturing costs, and only manufacturing costs, to be listed as Cost of Goods Sold (COGS),
whereas ABC can allocate non‐manufacturing costs to the COGS.
Some costs still cannot be apportioned accurately when using an ABC system as the most
appropriate cost driver does not have information available, and the cost of gathering such
information exceeds the potential benefit. This results in an inappropriate cost driver being chosen
for these costs, which may result in an inaccurate cost figure. Given the increased confidence
managers are encouraged to have in ABC costing systems this inaccuracy could result in incorrect
decisions being made.
3
2.0 Analysis of Results Two performance reports, Profit per Panel and Profit per Territory, were produced using the current
costing system (see Appendix 1 to Appendix 4). The same reports were then produced using an ABC
system (see Appendix 5 to Appendix 8).
2.1 Profit per Panel In comparing the Profit per Panel Performance Reports (Appendix 3 and Appendix 7), the ABC
system shows an increase in the manufacturing cost of the Deluxe Panel and a decrease in the
manufacturing cost of the Standard Panel. While the impact of this change is reduced by an opposite
change in the allocation of downstream costs, the ABC system shows the Standard Panel to be
contributing more Net Profit than the Deluxe Panel, whereas the current costing system shows the
opposite.
This change has resulted from the elimination of product cross subsidisation that is occurring using
the current costing system. As the Standard Panel places proportionately less demand on the
additional cost drivers used when implementing the ABC system, the Standard Panel contributes to
the expense of the Deluxe Panel in the traditional costing system.
2.2 Profit per Region In comparing the Profit per Region Performance Reports (Appendix 4 and Appendix 8) no such large
change in Net Profit Contribution is shown. The current costing system correctly identifies the
Northern Region as contributing a larger percentage of the net profits; however the difference is
more pronounced in the ABC system’s performance reports.
The major change that is apparent in the Profit per Region reports is the large increase in expenses
for the Southern Region and the equally large decrease in expenses for the Northern Region. This
highlights the effect the broad averaging previously used had on expense allocation. The cost driver
previously used to allocate downstream expenses was obviously inappropriate, as Sales Dollars has
at best a weak cause‐and‐effect relationship with expenses such as Rent, Depreciation and
Transport.
The change of cost allocation base for expenses between the current costing system and the ABC
system from Sales Dollars to drivers more appropriate for each cost category has again resulted in
the reduction of broad averaging, and product cross subsidisation. This presents a more accurate
comparison of the performance of the two regions.
4
3.0 Conclusion This report has shown that the introduction of an ABC system at AES would result in increased
accuracy in the costing process.
Implementing an ABC bases system at AES would reduce the use of broad averaging in product
costing, therefore reducing product cross subsidisation. This would increase the accuracy of the
performance reports. The limitations and disadvantages of an ABC system, such as increased effort
required to complete product costing, the need to produce separate reports for internal and
external (GAAP) reporting, and the still present possibility of inaccurate costing, are outweighed by
this benefit.
The ABC performance reports produced for this report have highlighted several inaccuracies the
current costing system has. The current system under costs the production of the Deluxe Panel, and
over costs the production of the Standard Panel. The current system also incorrectly allocates
downstream expenses to the regions.
5
4.0 Recommendations
4.1 Redirection of Marketing Efforts The ABC costing system has shown the previously held belief that the Deluxe Panel returns more net
profit per dollar than the Standard Panel to be false. The Standard Panel returns 59 cents for each
dollar of sales, compared to the Deluxe Panel which only returns 40 cents.
For this reason it is recommended that the marketing team redirects their efforts to focus more on
the Standard Panel than the Deluxe Panel. Increased marketing of the Standard Panel is likely to
result in increased net profit, even if total sales remains at the current level.
4.2 Investigate Expenses in the Southern Region With the more accurate assigning of expenses that the ABC system delivers it is apparent that the
Southern Region spends proportionately more on two expense categories, Distribution and
Transportation, and Warehousing and Handling, than the Northern Region.
As Table 1 shows, Distribution and Transportation accounts for 5 cents on the dollar more in the
Southern Region than in the Northern Region, as does Warehousing and Handling. While some
variance is to be expected none of the other expense categories vary by more than 1 cent on the
dollar. Indeed it would be expected that these expenses be higher in the Northern Region, given the
greater distances involved.
Northern Region Southern Region Cost % of Sales Cost % of Sales
Sales $ 575 000.00 100.00% $ 695 000.00 100.00% Warehousing and Handling 83 500.00 14.52% 141 000.00 20.28% Distribution and transportation 24 846.88 4.32% 71 153.12 10.24% Administration 2 444.44 0.42% 3 055.56 0.44% General Marketing 7 616.00 1.32% 3 584.00 0.52% Table 1 Comparison of Downstream Costs by Region
Although there may be a valid reason for this discrepancy there is no obvious one, therefore it is
recommended that expenses in the Southern Region be investigated. An investigation is likely to
discover the reason for the discrepancy, and may uncover improvements that could result in a
reduction of these expenses.
4.3 Consider Design Changes One advantage of an ABC system is greater understanding of the costs associated with
manufacturing products. Armed with this new information on the costs associated with each process
AES should investigate potential improvements to each process.
Any reduction in the cost of a process, without a resultant reduction in efficiency or quality, should
result in an increase in net profit.
6
Bibliography Accounting for Management, 2008, Activity Based Costing GAAP and External Reports, viewed 3
November 2009,
<http://www.accountingformanagement.com/activity_based_costing_external_reports.htm>.
Horngren, C.T. et al., 2009. Cost Accounting, 13th edn. Upper Saddle River: Pearson Education.
7
Appendix 1 Simple Costing System Using a Single Indirect‐Cost Pool
Step 1: Identify the products that are the chosen cost objects AES identifies the 800 Standard Panels and the 500 Deluxe Panels budgeted for construction during
the month as the cost objects
Step 2: Identify the Direct Costs of the products AES identifies the direct costs as the Prime Costs (Direct Manufacturing and Direct Labour)
consumed during the production process for the chosen cost objects. Line 3 in Table 3 lists the Prime
Costs on both a Per Unit and a Total basis for the Standard and Deluxe panels.
Step 3: Select the Cost‐Allocation Bases to Use for Allocating Indirect (or
Overhead) Costs to the Products Factory Overheads at AES are allocated to panels using the cost driver of direct labour hours. The
total budgeted direct labour hours for the month is 2 400 (1 500 for the Standard Panels + 900 for
the Deluxe Panels).
Step 4: Identify the Indirect Costs Associated with Each Cost‐Allocation Base As only a single indirect cost pool is in use at AES, all indirect costs for the month are totalled as
shown in Table 2.
Overhead Budgeted Monthly Cost Indirect Labour $ 34 000Equipment Costs 82 000Equipment Setups 100 000Production Orders 80 000Material Issues 56 000Quality Control 10 000General Overhead 67 000Total 429 000Table 2 Indirect Costs
Step 5: Compute the Rate per Unit of Each Cost‐Allocation Base
$ 429 000
2 400
$ 178.75
The indirect cost‐allocation rate is $178.75 per direct labour hour.
8
Step 6: Compute the Indirect Costs Allocated to the Products AES has budgeted to use a total of 2 400 hours of direct labour hours, 1 500 of those for the
Standard Panels (1.875 hours each), and 900 for the Deluxe Panels (1.8 hours each), as shown in Line
3 of Table 3. Table 3 also shows the calculated Indirect Cost Allocation on a per unit and total basis;
$ 268 125 ($ 178.75 per direct labour hour x 1 500 direct labour hours) for the Standard Panels, and
$ 160 875 ($ 178.75 per direct labour hour x 900 direct labour hours) for the Deluxe Panels.
Step 7: Compute the Total Cost of the Products by Adding All Direct and
Indirect Costs Assigned to the Products The total manufacturing costs of the Standard and Deluxe Panels are calculated simply by adding the
Prime Costs to the calculated Indirect Costs Allocated, as shown in the final line of Table 3.
Standard Panels (800) Deluxe Panels (500) Total Per Unit Total Per Unit
Direct Labour Hours 1 500 1.875 900 1.8Indirect Costs Allocated $ 268 125 $ 335.15625 $ 160 875 $ 321.75Prime Costs 200 000 250.00 150 000 300.00Total Costs 468 125 585.15625 310 875 621.75Table 3 AES’s Product Costs using the Simple Costing System
9
Appendix 2 Downstream Cost Allocation (Current Costing Method) Downstream Costs are categorised into Warehouse and Handling, Distribution and Transport,
Administration and General Marketing, as shown in Table 4.
Warehousing and Handling Receiving 500 shipments @ $ 95.00 $ 47 500 Pricing and Tagging 1 300 panels @ $ 130.00 169 000 Packing 160 orders @ $ 50.00 8 000 $ 224 500Distribution and transportation Rent 2 territories @ $ 6 000 12 000 Depreciation 2 territories @ $ 4 500 9 000 Transportation – Variable 500 shipments @ $ 140.00 70 000 Transportation – Fixed 5 000 96 000Administration Credit and Collection – Variable 100 accounts @ $ 25.00 2 500 Credit and Collection – Fixed 3 000 5 500General Marketing Advertising – Variable 160 orders @ $ 20.00 3 200 Advertising – Fixed 8 000 11 200Table 4 Budget Downstream Costs
Downstream costs are allocated to Panels and Territories for the two reports on the basis of sales
dollars per panel/territory.
For the Profit per Panel comparison report, the Standard Panel is allocated 56.6929%
($ 720 000 / $ 1 270 000) of the costs, and the Deluxe Panel the balance of 43.3071%
($ 550 000 / $ 1 270 000).
Total Standard Panel Deluxe Panel 100% 56.6929% 43.3071%
Warehousing and Handling $ 224 500 $ 127 275.56 $ 97 224.44Distribution and transportation 96 000 54 425.18 41 574.82Administration 5 500 3 118.11 2 381.89General Marketing 11 200 6 349.60 4 850.40Table 5 Profit per Panel Downstream Cost Allocation (Current Costing Method)
For the Profit per Region comparison report, the Northern Region is allocated 45.2756%
($ 575 000 / $ 1 270 000) of the costs, and the Southern Region the balance of 54.7244 %
($ 695 000 / $ 1 270 000).
Total Northern Region Southern Region 100% 45.2756% 54.7244$
Warehousing and Handling $ 224 500 $ 101 643.72 $ 122 856.28Distribution and transportation 96 000 43 464.58 52 535.42Administration 5 500 2 490.16 3 009.84General Marketing 11 200 5 070.87 6 129.13Table 6 Profit per Region Downstream Cost Allocation (Current Costing Method)
10
Appendix 3 Profit per Panel (Current Costing Method)
Income Statement – Standard Panel
Sales 800 units @ $ 900 $ 720 000.00 Less: Cost of Goods Sold 800 units @ $ 585.15625 468 125.00 Gross Profit 251 875.00 Less: Expenses Warehousing and Handling $ 127 275.56 Distribution and transportation 54 425.18 Administration 3 118.11 General Marketing 6 349.60 191 168.45 Net Profit 60 706.55 Table 7 Income Statement – Standard Panel (Current Costing Method)
Income Statement – Deluxe Panel
Sales 500 Units @ $ 1 100 $ 550 000.00Less: Cost of Goods Sold 500 Units @ $ 621.75 310 875.00Gross Profit 239 125.00Less: Expenses Warehousing and Handling $ 97 224.44 Distribution and transportation 41 574.82 Administration 2 381.89 General Marketing 4 850.40 146 031.55Net Profit 93 093.45Table 8 Income Statement – Deluxe Panel (Current Costing Method)
Profit Comparison – By Panel
Standard Panel Deluxe Panel
Sales $ 720 000.00 $ 550 000.00COGS 468 125.00 310 875.00Gross Profit 251 875.00 239 125.00Expenses 191 168.45 146 031.55Net Profit 60 706.55 93 093.45 Gross Profit Percentage 34.9826% 43.4773% Net Profit Percentage 8.4315% 16.9261% Net Profit Contribution 39.4711% 60.5289% Table 9 Profit Comparison – By Panel (Current Costing Method)
11
Appendix 4 Profit per Region (Current Costing Method)
Income Statement – Northern Region
Sales Standard Panel 150 units @ $ 900 $ 135 000.00 Deluxe Panel 400 units @ $ 1 100 440 000.00 $ 575 000.00 Less: Cost of Goods Sold Standard Panel 150 units @ $ 585.15625 87 773.44 Deluxe Panel 400 units @ $ 621.75 248 700.00 336 473.44 Gross Profit 238 526.56 Less: Expenses Warehousing and Handling 101 643.72 Distribution and transportation 43 464.58 Administration 2 490.16 General Marketing 5 070.87 152 669.33 Net Profit 85 857.23 Table 10 Income Statement – Northern Region (Current Costing Method)
Income Statement – Southern Region
Sales Standard Panel 650 units @ $ 900 $ 585 000.00 Deluxe Panel 100 units @ $ 1 100 110 000.00 $ 695 000.00 Less: Cost of Goods Sold Standard Panel 650 units @ $ 585.15625 380 351.56 Deluxe Panel 100 units @ $ 621.75 62 175.00 442 526.56 Gross Profit 252 473.44 Less: Expenses Warehousing and Handling 122 856.28 Distribution and transportation 52 535.42 Administration 3 009.84 General Marketing 6 129.13 184 530.67 Net Profit 67 942.77 Table 11 Income Statement – Southern Region (Current Costing Method)
Profit Comparison – By Region
Southern Region Northern Region
Sales $ 575 000.00 $ 695 000.00COGS 336 473.44 442 526.56Gross Profit 238 526.56 252 473.44Expenses 152 669.33 184 530.67Net Profit 85 857.23 67 942.77 Gross Profit Percentage 41.4829% 36.3271% Net Profit Percentage 14.9317% 9.7759% Net Profit Contribution 55.8239% 44.1761% Table 12 Profit Comparison – By Region (Current Costing Method)
12
Appendix 5 Activity Based Costing System
Step 1: Identify the products that are the chosen cost objects AES identifies the 800 Standard Panels and the 500 Deluxe Panels budgeted for construction during
the month as the cost objects
Step 2: Identify the Direct Costs of the products AES identifies the direct costs as the Prime Costs (Direct Manufacturing and Direct Labour)
consumed during the production process for the chosen cost objects. Line 3 in Table 14 lists the
Prime Costs on both a Per Unit and a Total basis for the Standard and Deluxe panels.
Step 3: Select the Cost‐Allocation Bases to Use for Allocating Indirect (or
Overhead) Costs to the Products The 6 selected cost‐allocation bases are as follows:
Direct Labour Hours
Machine hours
Setups
Orders
Requisitions
Inspections
Step 4: Identify the Indirect Costs Associated with Each Cost‐Allocation Base The 7 Overhead Cost categories used by AES are allocated to the 6 selected Cost‐Allocation Bases as
show in Table 13.
13
Step 5: Compute the Rate per Unit of Each Cost‐Allocation Base
Calculations for each cost‐allocation base are shown in Table 13.
Cost‐Allocation Base Total Cost Quantity Cost RateDirect Labour Hours General Overhead $ 67 000 Indirect Labour 34 000 $ 101 000 2 400 $ 42.08Machine hours Equipment Costs 82 000 82 000 65 000 1.26Setups Equipment setups 100 000 100 000 3 000 33.33Orders Production Orders 80 000 80 000 1 200 66.67Requisitions Material Issues 56 000 56 000 500 112.00Inspections Quality Control 10 000 10 000 200 50.00Table 13 Indirect Cost Allocation
Step 6: Compute the Indirect Costs Allocated to the Products Table 14 shows the calculation of indirect costs allocated to products by multiplying the budgeted
quantity of each cost‐allocation base with the budgeted indirect cost rate calculated in step 5.
Step 7: Compute the Total Cost of the Products by Adding All Direct and
Indirect Costs Assigned to the Products The total manufacturing costs of the Standard and Deluxe Panels are calculated simply by adding the
Prime Costs to the calculated Indirect Costs Allocated, as shown in the final line of Table 14.
Standard Panels (800) Deluxe Panels (500)
Total Cost Total Cost Quantity Total Unit Quantity Total Unit Prime Costs $ 200 000 $ 250.00 $ 150 000 $ 300.00 Indirect Costs Direct Labour Hours 1 500 63 125 78.90 900 37 875 75.75 Machine Hours 30 000 37 846 47.31 35 000 44 154 88.31 Setups 2 000 66 667 83.33 1 000 33 333 66.67 Orders 400 26 667 33.33 800 53 333 106.67 Requisitions 250 28 000 35.00 250 28 000 56.00 Inspections 100 5 000 6.25 100 5 000 10.00 Total Indirect Costs 227 305 284.13 201 695 403.15 Total Costs 427 305 534.13 351 695 703.15 Table 14 AES’s Product Costs using the ABC System
14
Appendix 6 Downstream Cost Allocation (ABC Method) Downstream Costs are categorised into Warehouse and Handline, Distribution and Transport,
Administration and General Marketing.
Downstream costs are allocated to Panels and Territories for the two reports on the basis of their
cost drivers, with fixed costs such as Rent and Depreciation using Direct Labour Hours as their cost
drivers as they have no root cause driver.
The costs using Direct Labour Hours as a driver are outlined in Table 15, with the Rate per Direct
Labour Hour calculated by dividing the total fixed cost by 2 400 (the budgeted number of Direct
Labour Hours for the month).
Cost Total Rate Rent $ 12 000 $ 5.00Depreciation $ 9 000 $ 3.75Transportation $ 5 000 $ 2.08Credit and Collection $ 3 000 $ 1.25Advertising $ 8 000 $ 3.33Table 15 Fixed Costs Allocation Rates
As the advertising budget is determined as a discretionary cost per each customer’s order, but is
charged by advertising centimetres which are used disproportionately for the different products and
regions, advertising centimetres is selected as the cost driver for advertising. The rate to be allocated
per advertising centimetre is determined as follows:
$ 20 160 $ 8 000
500
$ 11 200
500
$ 22.40
Therefore the cost‐allocation rate for Advertising is $ 22.40 per Advertising Centimetre.
As the Credit and Collection budget is determined as a discretionary cost per each account sold, but
is charged by clerical items which are used disproportionately for the different products and regions,
clerical items is selected as the cost driver for Credit and Collection. The rate to be allocated per
clerical item is determined as follows:
$ 25 100 $ 3 000
900
$ 5 500
900
$ 6.11
15
Therefore the cost‐allocation rate for Credit and Collection is $ 6.11 per Clerical Item.
For the Profit per Panel comparison report the costs are allocated as shown in Table 16.
Standard Deluxe Quantity Cost Quantity Cost Warehousing and Handling Receiving $ 95.00 / Shipment 300 $ 28 500.00 200 $ 19 000.00 Pricing & Tagging $ 130.00 / Panel 800 104 000.00 500 65 000.00 Packing $ 50.00 / Order 100 5 000.00 60 3 000.00 Total Warehousing and Handling 137 500.00 87 000.00 Distribution and Transport Rent $ 5.00 / DLH 1500 7 500.00 900 4 500.00 Depreciation $ 3.75 / DLH 1500 5 625.00 900 3 375.00 Transportation Variable $ 140.00 / Shipment 300 42 000.00 200 28 000.00 Fixed $ 2.08 / DLH 1500 3 125.00 900 1 875.00 Total Distribution and Transport 58 250.00 37 750.00 Administration Credit and Colltn. $ 6.11 / Item 500 3 055.56 400 2 444.44 Total Administration 3 055.56 2 444.44 General Marketing Advertising $ 22.40 / CM 100 2 240.00 400 8 960.00 Total General Marketing 2 240.00 8 960.00Table 16 Allocated Costs per Panel
For the Profit per Territory comparison report first the number of Direct Labour Hours per Territory
must be calculated. This calculation is shown in Table 17.
Region Standard Deluxe Total DLH Quantity DLH Quantity DLH
Total 800 1 500.00 500 900.00 2 400Northern 150 281.25 400 720.00 1 001.25Southern 650 1 218.75 100 180.00 1 398.75Table 17 DLH per Territory
16
For the Profit per Region comparison report the costs are allocated as shown in Table 18.
Northern Southern Quantity Cost Quantity Cost Warehousing and Handling Receiving $ 95.00 / Shipment 100 $ 9 500.00 400 $ 38 000.00 Pricing and Tagging $ 130.00 / Panel 550 71 500.00 750 97 500.00 Packing $ 50.00 / Order 50 2 500.00 110 5 500.00 Total Warehousing and Handling 83 500.00 141 000.00 Distribution and Transport Rent $ 5.00 / DLH 1 001.25 5 006.25 1 398.75 6 993.75 Depreciation $ 3.75 / DLH 1 001.25 3 754.69 1 398.75 5 245.31 Transportation Variable $ 140.00 / Shipment 100 14 000.00 400 56 000.00 Fixed $ 2.08 / DLH 1 001.25 2 085.94 1 398.75 2 914.06 Total Distribution and Transport 24 846.88 71 153.12 Administration Credit and Colltn. $ 6.11 / Item 400 2 444.44 500 3 055.56 Total Administration 2 444.44 3 055.56 General Marketing Advertising $ 22.40 / CM 340 7 616.00 160 3 584.00 Total General Marketing 7 616.00 3 584.00Table 18 Allocated Costs per Region
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Appendix 7 Profit per Panel (ABC Method)
Income Statement – Standard Panel
Sales 800 units @ $ 900 $ 720 000.00 Less: Cost of Goods Sold 800 units @ $ 534.13 427 305.00 Gross Profit 292 695.00 Less: Expenses Warehousing and Handling $ 137 500.00 Distribution and transportation 58 250.00 Administration 3 055.56 General Marketing 2 240.00 201 045.56 Net Profit 91 649.44 Table 19 Income Statement – Standard Panel (ABC Method)
Income Statement – Deluxe Panel
Sales 500 Units @ $ 1 100 $ 550 000.00Less: Cost of Goods Sold 500 Units @ $ 703.15 351 695.00Gross Profit 198 305.00Less: Expenses Warehousing and Handling $ 87 000.00 Distribution and transportation 37 750.00 Administration 2 444.44 General Marketing 8 960.00 136 154.44Net Profit 62 150.56Table 20 Income Statement – Deluxe Panel (ABC Method)
Profit Comparison – By Panel
Standard Panel Deluxe Panel
Sales $ 720 000.00 $ 550 000.00COGS 427 305.00 351 695.00Gross Profit 292 695.00 198 305.00Expenses 201 045.56 136 154.44Net Profit 91 649.44 62 150.56 Gross Profit Percentage 40.6521% 36.0555% Net Profit Percentage 12.7291% 11.3001% Net Profit Contribution 59.5900% 40.4100% Table 21 Profit Comparison – By Panel (ABC Method)
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Appendix 8 Profit per Region (ABC Method)
Income Statement – Northern Region
Sales Standard Panel 150 units @ $ 900 $ 135 000.00 Deluxe Panel 400 units @ $ 1 100 440 000.00 $ 575 000.00 Less: Cost of Goods Sold Standard Panel 150 units @ $ 534.13 80 119.69 Deluxe Panel 400 units @ $ 703.15 281 356.00 361 475.69 Gross Profit 213 524.31 Less: Expenses Warehousing and Handling 83 500.00 Distribution and transportation 24 846.88 Administration 2 444.44 General Marketing 7 616.00 118 407.32 Net Profit 95 116.99 Table 22 Income Statement – Northern Region (ABC Method)
Income Statement – Southern Region
Sales Standard Panel 650 units @ $ 900 $ 585 000.00 Deluxe Panel 100 units @ $ 1 100 110 000.00 $ 695 000.00 Less: Cost of Goods Sold Standard Panel 650 units @ $ 534.13 347 185.31 Deluxe Panel 100 units @ $ 703.15 70 339.00 417 524.31 Gross Profit 277 475.69 Less: Expenses Warehousing and Handling 141 000.00 Distribution and transportation 71 153.12 Administration 3 055.56 General Marketing 3 584.00 218 792.68 Net Profit 58 683.01 Table 23 Income Statement – Southern Region (ABC Method)
Profit Comparison – By Region
Southern Region Northern Region
Sales $ 575 000.00 $ 695 000.00COGS 361 475.69 417 524.31Gross Profit 213 524.31 277 475.69Expenses 118 407.32 218 792.68Net Profit 95 116.99 58 683.01 Gross Profit Percentage 37.1347% 60.0754% Net Profit Percentage 16.5421% 8.4436% Net Profit Contribution 61.8446% 38.1554% Table 24 Profit Comparison – By Region (ABC Method)