Task 1: Cost behaviours and cost classifications
Jason Day, financial controller for Nilstrom Industries, was reviewing production cost reports for the year. One type of costs in these reports continued to bother him- fixed manufacturing overhead such as rental cost of the companies' factories, and some of the electricity and other utility costs. This total fixed manufacturing overhead cost had grown sharply in recent years and is now approaching 30% of total manufacturing cost.
There had been much internal debate as how to report this overhead cost, both internally and externally. The Vice President of Operations, Maria Crane, argued that the current approach to these costs of reporting them as a cost of production, just like direct materials and direct labour should continue. She therefore recommended that this cost be identified as manufacturing overhead and reported as part of inventory costs until sold - saying "I'm not a qualified accountant but from my MBA I remember that all manufacturing costs must go to inventory and be expensed only when sold. To be consistent, this approach also needs to be followed for internal reporting."
Day, however, was unsure and thought that perhaps this cost should be reported as an expense of the current period - and that perhaps Maria Crane had a vested interest in not wishing to do so. He was also unsure why Maria had insisted on increasing production recently even though sales demand had fallen. Others argued that fixed manufacturing overhead be reported differently internally than externally. The president finally had to decide the issue and asked each executive to submit a formal opinion on the matter.
Required - Jason Day approaches you as a trusted advisor to draft some advice for him evaluating the arguments as to how the cost should be accounted for both externally in the financial statements and internally for performance evaluation purposes. He is also keen to understand if there could be any reason why Maria Crane chose to build up inventories. Discuss all relevant points of view, but come to a conclusion as to the most appropriate way to account for fixed manufacturing overhead costs.
Task 2: Understanding Overheads
Cinto Ltd, a distributor of special pharmaceutical products, operates at capacity and has three main market segments:
a) General supermarket chains
b) Pharmacy chains
c) Pharmacist-owned single-store pharmacies.
John Best, the new management accountant of Cinto, reported the following data for 2014:
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Cinto Ltd, 2014
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General supermarket chains
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Pharmacy chains
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Pharmacist-owned single stores
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Cinto Ltd
|
|
Revenues
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$3,708,000
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$3,150,000
|
$1,980,000
|
$8,838,000
|
|
Cost of goods sold
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3,600,000
|
3,000,000
|
1,800,000
|
8,400,000
|
|
Gross margin
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$108,000
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$150,000
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$180,000
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438,000
|
|
Other operating costs
|
|
|
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301,080
|
|
Operating profit
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|
|
|
$136,920
|
For many years, Cinto has used gross margin percentage ((Revenue - Cost of goods sold) ÷ Revenue) to evaluate the relative profitability of its market segments. But John recently attended a seminar on activity-based costing and is considering using it at Cinto to analyse and allocate 'other operating costs'. He meets with all the key managers and several of his operations and sales staff and they agree that there are five key activities that drive other operating costs at Cinto:
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Activity area
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Cost driver
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Order processing
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Number of customer purchase orders
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Line-item processing
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Number of line items ordered by customers
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Delivering to stores
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Number of store deliveries
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|
Cartons shipped to store
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Number of cartons shipped
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|
Stocking of customer store shelves
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Hours of shelf-stocking
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Each customer order consists of one or more line items. A line item represents a single product (e.g. Nurofen Plus tablets). Each product line item is delivered in one or more separate cartons. Each store delivery entails the delivery of one or more cartons of products to a customer. Cinto's staff stacks cartons directly onto display shelves in customers' stores. Currently, there is no additional charge to the customer for shelf-stocking, and not all customers use Cinto for this activity. The level of each activity in the three market segments and the total cost incurred for each activity in 2014 is shown below:
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Activity-based cost data
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Activity level
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Cinto 2014 Activity
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General supermarket chains
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Pharmacy chains
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Pharmacist-owned single stores
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Total cost of activity in 2014
|
|
Orders processed (number)
|
140
|
360
|
1,500
|
$80,000
|
|
Line-items ordered (number)
|
1,960
|
4,320
|
15,000
|
63,840
|
|
Store deliveries made (number)
|
120
|
360
|
1,000
|
71,000
|
|
Cartons shipped to stores (number)
|
36,000
|
24,000
|
16,000
|
76,000
|
|
Self-stocking (hours)
|
360
|
180
|
100
|
10,240
|
|
|
|
|
|
$301,080
|
Required-
1. Calculate the 2014 gross-margin percentage for each of Cinto's three market segments.
2. Calculate the cost driver rates for each of the five activity areas.
3. Use the activity-based costing information to allocate the $301 080 of 'other operating costs' to each of the market segments. Calculate the operating profit for each market segment as a dollar number and a percentage of revenues.
4. Comment on the results. What new insights are available with the activity- based costing information?