ACC203: Activity-Based Costing | Pricing & Possible Plant Closure | Budgeting

Solution Code: 1BCB

Question: Management Accounting Asssignment

This assignment is related to "Management AccountingAssignment" and experts at Grade Saviours successfully delivered HD quality work within the given deadline. Question 1: Activity-based costing East Coast Marine Ltd (ECM) manufactures parts for small marine craft. Over the past decade, ECM’s management has met its goal of reducing its reliance on government contract work to 50 per cent of total sales. ECM is now equally reliant on commercial sales and government contracts. Traditionally, the costs of the Material Handling Department have been allocated to direct material as a percentage of direct material dollar value. This was adequate when the majority of the manufacturing was homogeneous and related to government contracts. Recently, however, government auditors have rejected some proposals, stating that ‘the amount of Material Handling Department costs allocated to these proposals is disproportionate to the total effort involved’. Eloise Smith, the newly hired cost accounting manager, was asked by the manager of ECM’s Government Contracts Unit, Paul Jones, to find a more equitable method of allocating the Material Handling Department costs to the user departments. Her review has revealed the following information: The majority of the direct material purchases for government contracts are high-dollar, low-volume purchases, while commercial materials represent low- dollar, high-volume purchases. Administrative departments such as Marketing, Finance and Administration, Human Resources and Maintenance also use the services of the Material Handling Department on a limited basis but have never been charged in the past for material handling costs. One purchasing manager with a direct phone line is assigned exclusively to purchasing high-dollar, low- volume material for government contracts on an annual salary of $36 000. Employee on-costs are estimated to be 20 per cent of the annual salary. The annual costs of the dedicated phone line are $2800. The components of the Material Handling Department’s budget for the coming year, as proposed by Lindley’s predecessor, follow. Payroll $180000 Employee on-costs 36000 Telephone 38000 Other utilities 22000 Materials and supplies 6000 Depreciation 6000 Direct material budget: Government contracts 2006000 Commercial products 874000 Smith has estimated the number of purchase orders to be processed in the coming year as follows: Government contracts* 80000 Commercial products 156000 Marketing 1800 Finance and Administration 2700 Human Resources 500 Maintenance 1 000 Total 242000Exclusive of high-dollar, low-volume materials. Smith has recommended to Jones that material handling costs should be allocated on a per purchase order basis. Jones realises that the company has been allocating to government contracts more material handling costs than can be justified. However, the implication of Smith’s analysis could be a decrease in his unit’s earnings and, consequently, a cut in his annual bonus. Jones told Smith to ‘adjust’ her numbers and modify her recommendation so that the results will be more favourable to the Government Contracts Unit. Being new in her position, Smith is not sure how to proceed. She feels ambivalent about Jones’ instructions and suspects his motivation may not be in the best interest of ECM. To complicate matters for Smith, the company’s new managing director has asked her to prepare a three-year forecast of the Government Contracts Unit’s results, and she believes that the newly recommended allocation method would provide the most accurate data. However, this would put her in direct opposition to Jones’ directives. Smith has assembled the following data to project the material handling costs over the next three years: The number of purchase orders increases 5 per cent per year. The ratio of government purchase orders to total purchase orders remains at 33 per cent. Total direct material costs increase 2.5 per cent per year. Material handling costs remain the same percentage of direct material costs. Direct government costs (payroll, employee on-costs, and direct phone line) remain constant. In addition, she has assumed that the cost of government material in the future will be 70 per cent of total material. Required:

Calculate the material handling rate that would have been used by Eloise Smith’s predecessor at EastCoast Marine.
Calculate the revised material handling costs to be allocated on a per purchase order basis.
Discuss why purchase orders might be a more reliable cost driver than the dollar amount of directmaterial.
Calculate the difference due to the change to the new method of allocating material handling costs togovernment contracts.
5 Prepare a forecast of the cumulative dollar impact over a three-year period (based on the coming yearplus 2 more years) of Eloise Smith’s recommended change for allocating Material Handling Department costs to the Government Contracts Unit. Round all calculations to the nearest whole number.
Referring to the standards of ethical conduct for accountants described in Chapter 1:
(a) Discuss why Eloise Smith has an ethical conflict.
(b) Identify several steps that Smith could take to resolve the ethical conflict.
Question 2: Pricing & possible plant closure
Handy Household Products Ltd is a multiproduct company with several manufacturing plants. The Fremantle plant manufactures and distributes two household cleaning and polishing compounds, standard and commercial, under the Clean & Bright label. The forecast operating results for the first six months of the current year, when 100000 boxes of each compound are expected to be manufactured and sold, are presented in the following statement:
Clean& Bright Compounds, Fremantle plant Forecast results of operations for the six-month periodending June 30 (in $'000s)
Sales
Standard $2000
Commercial $3000
Total $5000
Cost of goods sold 1600 1900 3500Gross profit $ 400 $1100 $1500 Selling and administrative expenses: Variable $ 400 $ 700 $1100 Fixed* 240 §QQTotal selling and administrative expenses $ 640 $1060 $1700 Profit (loss) before taxes $ (240) $ 40=$ (200)
*The fixed selling and administrative expenses are allocated between the two products on the basis of dollar sales volume.
The standard compound sold for $20 a box and the commercial compound sold for $30 a box during the first six months of the year. The manufacturing costs are presented in the schedule below. Each product is manufactured on a separate production line. Annual normal manufacturing capacity is 200 000 boxes of each product. However. the plant is capable of producing 250 000 boxes of standard compound and 350000 boxes of commercial compound annually.
Cost per box
Standard Commercial
Direct material $7.00 $8.00 Direct labour 4.00 4.00 Variable manufacturing overhead 1.00 2.00 Fixed manufacturing overhead 4.00 5.00 Total manufacturing cost $16.00 $19.00 Variable selling and administrative costs $4.00 $7.00
The following schedule reflects the consensus of top management regarding the price-volume alternatives for the Clean & Bright products for the last six months of the current year. These are essentially the same alternatives management had during the first six months of the year.
Standard compound Commercialcompound
Alternative prices (per box)
Sales volume (in boxes)
Alternative prices (per box)
Sales volume (in boxes) $18 120000 $25 175000 20 100000 27 140000 21 90000 30 10000022 80000 32 55000 23 50000 35 35000
Handy Household Products' top management believe that the loss for the first six months reflects a tight profit margin caused by intense competition. Management also believe that many companies will leave this market by next year and profit should improve.
Required:

What unit selling price should management select for each of the Clean & Bright compounds for theremaining six months of the year to maximise profit? Support your selection with appropriate calculations.

Independently of your answer to requirement 1, assume that the optimum alternatives for the last sixmonths were as follows: a selling price of $23 and volume of 50 000 boxes for the standard compound, and a selling price of $35 and volume of 35 000 boxes for the commercial compound.

(a) Should management consider closing down the plant's operations until January 1 of the next year in orderto minimise its losses? Support your answer with appropriate calculations.
(b) Identify and discuss the strategic factors that should be considered in deciding whether the Fremantle plantshould be closed down during the last six months of the current year.
Question 3: Budgeting
Hawthorn Leisure Works (HLW) offers tennis courts and other physical fitness facilities to its members. The club has 2000 members. Revenue is derived from annual membership fees and hourly court fees. The annual membership fees are:
Individual $45 Student 30 Family 100
Approximately half the members are 'family', and the remaining memberships are split equally between individuals and students. For the next two financial years, the hourly court fees are $8 and $12, depending on the season and the time of day (prime versus non-prime time). There are 10 courts at each club. The courts are available for 12 hours per day, from 9 am to 9 pm.
The peak tennis season runs from October to April (181 days). During this period, court usage averages from 90 to 100 per cent of capacity during prime time (5 to 9 pm) and from 50 to 60 per cent of capacity during the remaining hours (9 am to 4 pm). Daily court usage during the off-season averages from only 20 to 40 per cent of capacity, and is charged at $6 per hour. All of HLW's memberships expire at the end of September. A substantial amount of the cash receipts is collected during the early part of the tennis season due to the renewal of annual membership fees and heavy court usage. However, cash receipts are not as large in autumn and drop significantly in the winter months.
For the start of the new financial year on 1 October, HLW is considering introducing a new membership and fee structure in an attempt to improve its cash flow planning. Under the new membership plan, only an annual membership fee would be charged, rather than a membership fee plus hourly court fees. There would be two classes of membership, with annual fees as follows:
Individual $300 Family 500
The annual fee would be collected in advance at the time the membership application was completed. Members would be allowed to use the tennis courts as often as they wished during the year under the new plan. All future memberships would be sold under these new terms. A special promotional campaign would be instituted to attract new members and to encourage current members to remain with the club. The annual fees for individual and family memberships would be reduced to $250 and $450 respectively if members pay for their yearly memberships in advance during the two-month promotional campaign.
Hawthorn Leisure Works' management estimates that 70 per cent of the current members will continue with the club, and student members would convert to individual membership. The most active members (45 per cent of the current members) would pay the yearly fee in advance and receive the special fee reduction, while the remaining members who continued would renew memberships in October. Those members who would not rejoin are not considered active (that is, they play five times or less during the year). Management estimates that the loss of members would be offset fully by new members within six months of instituting the new plan. These newmembers would pay a proportional amount of the yearly fee on joining. Furthermore, many of the new members would be individuals who would play during non-prime time. Management estimates that adequate court time will be available for all members under the new plan.
If the new membership plan is adopted, it would be instituted at the start of the new financial year (1 October), which is the start of the tennis season. The special promotional campaign would be conducted during August and September, prior to the start of the new financial year.
Required:
Your consulting firm has been hired to help HLW to evaluate its new fee structure. Write a letter to the club's managing director dealing with the following issues:
Will HLW's new membership plan and fee structure improve its ability to plan its cash receipts? Explain youranswer.
Estimate the effect on sales revenue resulting from the planned change in fee structure for the next financial year, which starts 1 October and ends on 30 September. State any assumptions that you need to make.
Hawthorn Leisure Works should evaluate the new membership plan and fee structure completely before itdecides to adopt or reject it.
(a) Identify the key factors that HLW should consider in its evaluation.
(b) Explain what type of financial analyses HLW should prepare in order to make a complete evaluation.
Explain how HLW's cash management practices may differ from the present if the new membership plan andfee structure are adopted.

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Solution:

Title Management Account Answer 1

East Coast Marine Ltd.
(Amount in A $) 1.
Calculation of the material handling rate that would have been used by Eloise Smith’s predecessor at East Coast Marine
	Payroll			1,80,000
	Employee on cost			36,000
	Telephone			38,000
	Utilities			22,000
	Materials and supplies			6,000
	Depreciation			6,000
	Total			2,88,000	1

	Direct material budgeted costs
	Government contracts			20,06,000
	Commercial			8,74,000
	Total			28,80,000	2

	Material handling rate			(2)/(1)
				10%
2. Calculation of the revised material handling costs to be allocated on a per purchase order basis

	Total material handling costs		2,88,000
less
	direct costs
	Payroll		36,000
	Employee on cost	36000*20/100	7,200
	Telephone		2,800
	Purchase order costs		2,42,000	1

	Total purchase orders		2,42,000	2

	Allocation rate		(1)/(2)
			1%
4. Calculation of the difference due to the change to the new method of allocating material handling costs to government contracts.

Old method
Direct material budgeted costs
Government contracts			20,06,000	1
Material handling rate			10%	2
Total cost		1*2	2,00,600
New method
Direct costs
Payroll		36,000
Employee on cost	36000*20/100	7,200
Telephone		2,800
Total		46,000
Purchase order costs	79860*1	79,860
Total cost		1,25,860

Government contract related purchase orders	242000*33/100	79,860
The new method will reduce the material handling cost to government contracts by
				200600-125860
				74,740
5.
Forecast of the cumulative dollar impact over a three-year period
	Year	1		2		3
Direct material cost ( 2.5% annual increase)		28,80,000	1.025	29,52,000	1.025	30,25,800
Material handling rate		10%
		2,88,000		2,95,200		3,02,580
Direct costs each year
Payroll		36,000		36,000		36,000
Employee on cost	36000*20/100	7,200		7,200		7,200
Telephone		2,800		2,800		2,800
Total		2,42,000		2,49,200		2,56,580
Forecasted purchase orders (5% increase)		2,42,000	1.050	2,54,100	1.050	2,66,805
*Government contract related purchase orders (33% total)**		79,860		83,853		88,046

Allocation to government orders
Direct material cost ( 2.5% increase)		2,42,000		2,49,200		2,56,580
Forecasted purchase orders (5% increase)		2,42,000		2,54,100		2,66,805
		1.00		0.98		0.96	1
Government contract related purchase orders (33% * total)		79,860		83,853		88,046	2

*(1)(2)**		79,860		82,236		84,671
Direct costs each year
Payroll		36,000		36,000		36,000
Employee on cost	36000*20/100	7,200		7,200		7,200
Telephone		2,800		2,800		2,800

Total variable cost allocation		1,25,860		1,28,236		1,30,671.40

Calculation of cumulative dollar impact

Direct material cost ( 2.5% increase		28,80,000	1.025	29,52,000	1.025	30,25,800
Government material cost (70% of material cost)		20,16,000		20,66,400		21,18,060	1
Material handling rate		10%					2
Material handling cost		2,01,600		2,06,640		2,11,806	a
Total variable cost allocation		1,25,860		1,28,236		1,30,671.40	b
Net reduction a-b		75,740		78,404		81,134.60

3 Purchase orders might be a more reliable cost driver than the dollar amount of direct material as all these costs are related to the purchase order. Also the purchase order determines the resource consumption rather than the size of the order. 6 a Referring to the standards of ethical conduct for accountants described in Chapter 1:

Eloise Smith has an ethical conflict as she is bound by the rules set in this regard for the management accountants to be competent enough to provide proper, accurate, timely information for decision making to the management and make recommendations accordingly.
She should conduct herself as expected of a management accountant without prejudicing her ethical duties.
She ought to act in the best interests of the profession.
Therefore, she ought to disclose all relevant information regarding the government contract in order to enable the users to make informed judgements and decisions.

6 b the steps she should take are

Following established rules and regulations of the company in the regard of the matter.
Discussing the matter with her superior or where this is not possible (where the superior is also involved in the unethical conduct) to the next level in hierarchy up to the board of directors for quick resolution.
Obtaining Objective advice from a professional colleague or senior outside the engagement for better understanding of the alternative courses of action available in this case.
If nothing works, she may resign from the assignment after submitting the clear reasons to the appropriate level in the company.

Answer 2

Handy Household products
For the first six months of the year
Expected output					1,00,000					1,00,000

Using the contribution approach , the following results are obtained
Alternatives available
Price per box S			Sales volume				*Total revenue (Pricevolume)**					*Variable costs( volume16)**				Price per box C			Sales volume				*Total revenue (Pricevolume)**			*Variable costs( volume21)**
18			1,20,000				21,60,000					19,20,000				25			1,75,000				43,75,000			36,75,000
20			1,00,000				20,00,000					16,00,000				27			1,40,000				37,80,000			29,40,000
21			90,000				18,90,000					14,40,000				30			1,00,000				30,00,000			21,00,000
22			80,000				17,60,000					12,80,000				32			55,000				17,60,000			11,55,000
23			50,000				11,50,000					8,00,000				35			35,000				12,25,000			7,35,000
Costs per box under each alternative									S				C
Direct material									7				8
Direct labour									4				4
Variable manufacturing overhead									1				2
Variable selling and administrative costs									4				7
Total per unit variable cost									16				21
Fixed manufacturing overhead									4				5
Total per unit fixed cost									4				5
Calculation of contribution under each alternative
Contribution = Revenue less variable costs
Total revenue S				Total revenue C					Variable costs S				Variable costs C				Contribution S							Contribution C
21,60,000				43,75,000					19,20,000				36,75,000				2,40,000							7,00,000
20,00,000				37,80,000					16,00,000				29,40,000				4,00,000							8,40,000
18,90,000				30,00,000					14,40,000				21,00,000				4,50,000							9,00,000
17,60,000				17,60,000					12,80,000				11,55,000				4,80,000							6,05,000
11,50,000				12,25,000					8,00,000				7,35,000				3,50,000							4,90,000

													Contribution is maximum @ $ 22 per box price for S
													Contribution is maximum @ $ 30 per box price for C
													Total contribution at these prices would be $ 13,80,000
													These are the prices at which the company will make maximum profits after providing for fixed cost
													Profit made at selected prices
															Contribution S						Contribution C
															4,80,000						9,00,000
less						fixed costs									3,20,000						5,00,000
															80,000*4						5*100000
less						fixed selling and administrative expenses									1,30,909.09						1,09,090.91
															120/220*240000						240000-130909.09
						Profit									29,090.91						2,90,909.09
						Total profit									3,20,000


2
In the second case ; the profit made under the given alternatives would be
Price per box S		Sales volume						*Total revenue (Pricevolume)**						*Variable costs( volume16)**				Price per boxC		Sales volume3		*Total revenue (Pricevolume)4**			*Variable costs( volume21)**
23		50,000						11,50,000						8,00,000				35		35,000		12,25,000			7,35,000

Calculation of contribution under the alternative
Total revenue S		Total revenue C						Variable costs S						Variable costs C				Contribution S		Contribution C
11,50,000		12,25,000						8,00,000						7,35,000				3,50,000		4,90,000
								Profit made at selected prices
								Contribution S						Contribution C
								3,50,000						4,90,000
less		fixed costs						2,00,000						1,75,000
								50000*4						5*35000
		Fixed selling and administrative expenses						1,41,176						98,824
								50/85*240000						240000-141176
		Profit						8,824						2,16,176
		Total profit						2,25,000
3.		Decision to shut down or continue

		Calculation of the cost of shutdown
											Variable costs S					Variable costs C
	Savings in variable costs										12,80,000					21,00,000
	Fixed costs										-10,00,000					-17,50,000
	Savings										2,80,000					3,50,000
	Total savings										6,30,000
less	Fixed selling and administrative expenses										2,40,000
	Total shutdown savings										3,90,000
* Savings in variable costs have been calculated on the basis that the volume calculated in 1 giving maximum profits would have been produced if the plant was not shut down
* Fixed costs have been charged for full capacity
*Fixed selling and administrative expenses would still be incurred being fixed in nature
The savings from shut down in aggregate are $ 3,90,000
The profit on continuing is $ 3,20,000
So it is an apt decision to shut down in this case

2 b the strategic factors that should be considered in deciding whether the Fremantle plant should be closed down during the last six months of the current year primarily include:

Considering the impact on future prospects for the company. The loyal customers of the company may switch over to other alternatives.
The impact on the employees of the company may have to be considered under sustainability reporting which is much stressed on in the current scenario. Temporary shutdown may impact the cost of living in huge way.
In reality , agreements with the trade union may contain a clause warranting the payment of wages in case of temporary shutdown , in which case the profits from shut down may be much lower.
The suppliers of the company may switch over to other alternatives, in which case, new suppliers may have to be negotiated with higher prices of raw materials pushing up the overall cost of the product. Alternatively, supplier clauses may contain regular supply clause. In this case, disposal or storage of the material received may involve further costs.
Restoration of the manufacturing plant may involve further costs.

Answer 3 The Managing Director Hawthorne Leisure Works Subject: Evaluation of New fee structure

The new membership plan and fees structure, if adopted , will definitely improve the clubs ability to plan its cash receipts owing to the following reasons

- It will enable the management by alerting them in advance when to borrow funds and when to make arrangements for the effective utilization of excess funds in a short term investment or financing opportunity as the case may be.
- The net operating cash flow arrived at after deducting the budgeted cash expenses against the revenue will be clearly outlined by the approach. The management will thus find it easier to manage its investment and financing cash flows in a better manner. (Cmaa,2016)
- The new system will not only accelerate the overall cash inflows but make it possible to invest surplus cash to earn a good rate of return.
- The system will also help to maintaining an optimal level of cash that is neither excessive nor deficient.
- It will help to plan disbursements wisely in advance.
- It will result in a decrease of the cash receipt cycle by reducing the time for collection. The system will also increase customer satisfaction by rewarding customers making early payment at a discounted price
- It will also aid the cash flow forecasting to a considerable extent.(Exinfm,2016)

Sales revenue resulting from the planned change in fee structure for the next financial year, which starts 1 October and ends on 30 September will increase as presented

(Amount in $)
At present
Number of members		2,000
Annual membership fees per head
Individual		45
Student		30
Family		100
Total revenue from annual fees
200050%100				1,00,000
100050%45				22,500
100050%30				15,000
				1,37,500
Number of courts		10
Hourly fees		8
		12
Availability of courts		12
Number of hours available in a day		12*10		120
Peak season		October to April		181 days
Prime time usage		90 to100%		4 hours
Non Prime time usage		50 to 60%		7 hours
Total revenue in peak season
Prime time usage
Pessimistic		181481090%		52,128
Optimistic		18148*10		57,920
Moderate		52128+57920/2		55,024
Non Prime time usage
Pessimistic		1817121050%		76020
Optimistic		1817121060%		91224
Moderate		76020+91224/2		83,622
Total revenue in peak season
Optimistic				1,49,144
Pessimistic				1,28,148
Moderate				1,38,646
Off season
Usage		20 to 30%		at 6 per hour
Pessimistic		1841161020%		24,288
Optimistic		1841161030%		36,432
Moderate		24288+36432/2		30,360
* 365-181 days = 184 days
Total fees		(Peak +off season)		Old plan	New plan	Increase
Optimistic				3,23,076	6,45,000	3,21,924
Pessimistic				2,89,936	6,45,000	3,55,064
Moderate				3,06,506	6,45,000	3,38,494
New plan
Number of members	2,000
Annual membership fees per head
Individual	300
Family	500

Discounted fee rate per head for fees received in August and September
Individual	250
Family	450
Members continuing
70%*2000	1,400
Members not Continuing
30%*2000	600
Total revenue from annual fees
Individual	100050%300		1,50,000
Members availing discount
(assumed family)	45%2000450		4,05,000
New members	60030050%		90,000
(assumed half year joiners and all students)
			6,45,000

The following assumptions were made:

Three estimates of revenue i.e. pessimistic, optimistic and moderate have been used on the basis of the % given to estimate sales renew under the old plan.
All members availing discount in August and September are assumed to be family.
All new members are assumed to have joined in the half year and half cost has been apportioned accordingly.
All new members are assumed to be students for the ease of calculation.
The club will be open for all 365 days of the year including holidays. 181 days will be peak season and the balance will be allotted to off season.

Evaluation the new membership plan and fee structure

The key factors requiring consideration before the new plan is adopted are:

The membership plan and fee structure of similar clubs in the area is a very important factor to be considered as a better plan by the competitor in terms of lower rates, discounts or better faculties to compensate for increased rates could result in loss of membership.
The next factor to consider is the sustainability of the new plan in terms of adaptability, increased resource usage, employee requirement and similar factors.
Some members may resist the change so due notice, understanding and guidance to members before hand would be important to implement the plan successfully.
Where the members perceive the new plan as costing them higher, they may need to be convinced about the propriety of the plan or be compensated with additional services in one form or the other.

The following financial analysis techniques will help in the evaluation process:

In order to determine the suitability and profitability of the new plan, ratio analysis of key figures in the financials of the company like revenue, costs, and cash flows will help to extrapolate and compare the club’s past performance against the expected future performance. For example, profitability ratios like return on owner’s funds,return on assets , net profit, operating profit will help to determine the profitability of operations. Other efficiency, solvency and liquidity and cash flow ratios can also be used for the analysis. (Investopedia, 2016)
Cash flow analysis of the historical and planned financial, operating and investment flows will be useful for the evaluation.
A discounted cash flow (DCF) analysis may also assist for the coming 3 to 5 years to help form an idea of the attractiveness of the new plan; Net present value (NPV), payback period, IRR and other capital budgeting techniques will not be of much use here as cash flows are involved and secondly no information on any additional capital investment, cost of capital or cash outflow is provided.

HLW's cash management practices may differ from the present if the new membership plan and fee structure are adopted in the following ways:

- With the consolidated and surplus cash under the new plan, after providing for the year’s operating costs like maintenance, salaries, depreciation and financing costs for the club; the surplus balance can be used for financing new better facilities for the club. Alternatively, the surplus may be used of investment to generate a return. An opportunity cost analysis may be useful in this area.
The funds may also be used for marketing and advertising to secure more members for the club.
Most importantly, with major cash receipts expected in the months of August and September; proper, accurate and validated recording of the receipts would be very important. Proper authorization and separation of duties of the cashier and the recorder would be important from the internal control perspective to avoid misappropriation and fraud related to the funds.
Responsibility for recording and cash receipts would need to be fixed.
It will be important to carefully chalk out then list of members who have already paid under the new plan.
The bank reconciliation statement will be mandatory to tally the receipts with the amounts deposited in the bank.
Cash disbursement ought to be properly authorized, sanctioned, approved and then disbursed.
Retaining financial record of receipts under the old plan may be important under the statutory laws for the minimum stipulated period.

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