Assignment: Accounting Practices for Managers
Tasks:
• Examine the case below and then...
o Calculate the amount of overhead allocated to small and large advertising campaigns under existing methods.
o Apply activity-based costing to calculate the cost per cost driver for each of the cost pools.
o Use the costs per cost driver to calculate the activity-based overhead applicable to small and large campaigns.
o Calculate the percentage to be added to direct advertising costs to recover overhead costs under activity-based costing.
Merit-o-cracy PLC is a specialist advertising agency. It has been long-established but is experiencing difficulties in winning new business. The Chief Executive believes that its pricing methods are leading to the loss of large customer advertising campaigns while it is consistently winning smaller business.
Merit-o-cracy costs work for pricing purposes on the basis of direct advertising costs (i.e. space or time purchased from newspapers, radio and TV) plus 100%. The 100% is intended to cover all the overheads of the business, which run at $2 million per year. It does not include any profit margin. This budget cost comprises:
Creative staff $500,000
Production staff $750,000
Administrative & support staff $300,000
Rental and associated costs $450,000
Merit-o-cracy classifies its advertising campaigns as either small or large. Of the 350 campaigns the agency wins, about 325 are classified as small. A typical small advertising campaign incurs direct advertising costs of $4,000 each (and therefore is allocated $4,000 of overheads under current methods). The other 25 advertising campaigns are large and incur direct advertising costs of $28,000 each.
Merit-o-cracy's accountant has heard of activity-based costing. After speaking to the management team, she has gathered information on the most common causes of costs. She believes that creative staff costs are linked to the number of advertising campaigns the agency competes for. Production staff costs are related to the number of advertising campaigns the agency wins. Administrative and support staff costs are related to the number of customers the agency has. Rental and associated costs are people-based and as a similar number of staff is employed in each of the three departments, the costs should be equally shared.
The accountant has also collected data on the activity levels in each of the three departments over the budget period. These are:
Creative
• 800 advertising campaigns the agency bids for
• 400 of these are bids for large campaigns and 400 for small campaigns
Production
• 350 advertising campaigns the agency wins
• 325 of these are small campaigns and 25 large campaigns
Admin & support
• 400 customers the agency services
• 300 of these are customers with small campaigns and 100 have large campaigns
OVERHEAD COSTS ALLOCATED UNDER CURRENT METHODS
Small campaigns - $4000 x 325 = $1,300,000
Large campaigns - $28,000 x 25 = $700,000
ACTIVITY BASED COSTING - COST PER COST DRIVER
CREATIVE - $500,000/800 = $625
PRODUCTION - $750,000/350 = $2142.88
ADMIN & SUPPORT - $300,000/400 = $750
ACTIVITY BASED OVERHEAD
CREATIVE
Small campaigns - 400 x $625 = $250,000
Large campaigns - 400 x $625 = $250,000
PRODUCTION
Small campaigns - 325 x $2142.88 = $696,436
Large campaigns - 25 x $2142.88 = $53,572
ADMIN & SUPPORT
Small camapaigns - 300 x $750 = $225,000
Large campaigns - 100 x $750 = $75,000
TOTAL OVERHEARD COST BASED ON ACTIVITY BASED COSTING - Add totals from Activity Based Overhead.
Small campaigns - $946,436
Large campaigns - $153,672
**SMALL CAMPAIGNS - Overhead comes to $946,436 based on Activity Based Costing. In order to cover the overhead based on this amount, 73% ($946,436/325=$2912/$4000x100=73%) should be added to the direct advertising costs
**LARGE CAMPAIGNS - Overhead comes to $153,672 based on Activity Based Costing. In order to cover the overhead based on this amount, 22% ($153,672/25=$6146/$28,000x100=22%) should be added to the direct advertising costs.