ESSAY ON ZENRE TECHNOLOGY: ANALYSIS OF COSTING SYSTEM
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The purpose of this report is to identify the
actual cost for Robin and King models by using Activity-Based Costing System.
The information that has been provided in preparing this report includes the
income statement, direct materials and labour used, machine costs per hour and
the manufacturing overhead other than machine costs. Zenre Technology
manufactures two types of television, namely Robin which was being produced
since 2004 and King which was only introduced in 2007. Based on the analysis
performed, the company should concentrate on the Robin model since it is more
profitable as compared to the King model which is incurring losses. Therefore,
the King model should be phased out or find a way to improve efficiency to
ensure that it is profitable. It is advised that Zenre Technology should adopt
the Activity-Based Costing System in order to obtain more precise costing
information on their products. This will aid in the elimination of wasteful use
of resources which results in an increase in productivity.
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2.0 Introduction
This report is prepared for the evaluation of
Activity-Based Costing (ABC) system in determining the costs of various
products manufactured by Zenre Technology and to deduce if the said system
should be implemented. In this report, we analyse the information given and
compare between the two costing systems. In addition, the differences between
the two systems are clearly outlined and the effects of the ABC system are
evaluated based on the cost of the models produced. The definition of ABC would
be the refinement of the costing system by recognising the individual tasks
used in the production process as cost objects.
2.1 Weaknesses of the current costing system
In the case examined, it is found that Zenre
Technology uses a traditional costing system, also known as the plant wide
costing system. The common characteristic of these systems is that they
allocate direct costs to the cost object and allocate indirect costs based on a
single plant wide cost allocation base. In the case of Zenre Technology, they
calculate the overhead cost using machine hours, etc. The weakness of using a
single cost pool, where the cost is allocated based on the machine hours used
may result in inaccurate costs, which may lead to the inability of the company
to provide accurate costing in a multi-product company (Rac & Petkovics
1990, p.748). This may result in the overcosting or undercosting of a product.
In addition the weakness of the traditional costing system is that it also does
not include non-manufacturing costs (Traditional Costing System 2006) such as
administration costs (building security, rent etc.).
3.0 Activity-Based Costing (ABC) System
3.1 Principle
Activity-Based Costing (ABC) system is one of
the many types of costing systems available for businesses to use. It refines a
costing system by identifying individual activities that are required to
produce both Robin and King models as their fundamental cost objects (Horngren,
Datar, Foster, Rajan & Ittner 2009, p.170). Cost pools for each activity
identified are set up for the purpose of assigning overhead costs based on its
costs driver. The following are the activities carried out by the company with
its cost allocation base as well as their respective cost hierarchy.
Activities Cost Allocation Base Cost Hierarchy
Soldering Number of Solder Point Output-unit
Level Shipments Number of Shipments Batch Level
Quality Control Number of Inspections Batch
Level
Purchase Orders Number of orders Batch Level
Machine Power Machine-hours Output-unit Level
Machine Setup Number of Setups Batch Level
3.2 Benefits
Activity-based costing (ABC) system allows Zenre
technology to further improve on its accuracy in the process of costing for
both Robin and King models. ABC system better assists in the process of
refining the assignment of indirect costs to cost objects as it breaks up the
indirect cost pool into finer pools of costs with different allocation bases
(Horngren et al 2009). Thus, ABC system concentrates on the cost pertaining to
each activity instead of focussing on a single cost pool used in traditional
costing to prevent product overcosting and undercosting. Moreover, ABC system
accurately represents the consumption costs as it does not assign costs of idle
capacity to its products (Rac & Petkovics 1990, p.750). Inaccurate and
misleading cost data may constitute to erroneous impression of a product’s
profitability. Also, ABC is particularly helpful in identifying business
activities which are non value adding as it provides financial and
non-financial information about activities and cost objects (Gunasekaran 1999,
p.118). Last but not least, the system aids in the process of benchmarking
which constitutes to quality control system (Chen, Firth & Park 2001).
4.0 Calculations
ACTIVITY
Total Activity Cost
Cost-Allocation Base
ROBIN
KING
Soldering
(number of solder points)
$942,000
= $942,000/1,570,000
= $0.60
= $0.6 x 1,185,000
= $711,000
= $0.6 x 385,000
= $231,000
Shipments
(number of shipments)
$860,000
= $860,000/20,000
= $43
= $43 x 16,200
= $696,600
= $43 x 3,800
= $163,400
Quality control (number of inspections)
$1,240,000
= $1,240,000/77,500
= $16
= $16 x 56,200
= $899,200
= $16 x 21,300
= $340,800
Purchase orders (number of orders)
$950,400
= $950,400/190,080
= $5
= $5 x 80,100
= $400,500
= $5 x 109,980
= $549,900
Machine power (machine-hours)
$57,600
= $57,600/192,000
= $0.30
= $0.3 x 176,000
= $52,800
= $0.3 x 16,000
= $4,800
Machine setups (number of setups)
$750,000
= $750,000/30,000
= $25
= $25 x 16,000
= $400,000
= $25 x 14,000
= $350,000
TOTAL
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$ 1,639,900
ACTIVITY-BASED COSTING SYSTEM
Unit Cost = +Direct Material+Direct
Manufacturing Labor+Machine Cost
ROBIN = + $208 + $18 + $144
= $513.64
KING = + $584 + $42 + $72
= $1,107.98
Gross Margin per unit = Selling Price - Unit
Cost
ROBIN = $900- $513.64
= $386.36 per unit
KING = $1,140-$1,107.98
= $32.02 per unit
Gross Margin Percentage per unit =
ROBIN =
= 42.93%
KING =
= 2.81%
5.0 Analysis
Based on calculations as shown above, Zenre
Technology should continue with the production of Robin model and discontinue
with the production of King model. There are 3 main reasons to justify our
statement. Firstly, the unit cost for Robin model is cheaper than that of King
model. According to the traditional costing system (simple costing system), the
unit costs of Robin and King models are $570 and $798 respectively. The ABC
system shows that the unit costs for both the models are $513.64 and $1,107.98
respectively (shown in 4.0 calculations). It is shown here that Robin models
are overcosted where as King models are undercosted.
Secondly, Robin model has a higher gross margin
percentage than King model. Based on the traditional costing system, gross
margin for Robin and King models are 36.67% and 30% respectively (Refer to
Appendix A). On the other hand, ABC system shows that Robin model has a gross
margin percentage of 42.93% while King model has a mere 2.81% (Refer to
Appendix B). Gross margin percentage is defined as the percentage that a
company retains as gross profit from the selling price.
Lastly, with reference to Appendix C, the
operating income derived from Robin model is $121.36 but for King model, it is
-$212.48. Therefore, Robin model results in a profit but King model makes a
loss. Operating income is calculated by the deduction of selling and
administrative expenses from the gross margin.
Therefore, Zenre technology should continue with
Robin model and discontinue with King model.
6.0 Accuracy and Limitations of an ABC System
The accuracy of ABC system lies in the
determination of the actual cost driver as the cost-allocation base of each
activity. Mason was concern about the cost drivers used in Nader’s
determination of the costs to assign to each of the allocation bases. Nader had
used number of setups and number of inspections as allocation bases but Mason
suggested that if Nader were to use setup hours and inspection hours instead,
the conclusion derived would be different. Hence, the use of proper cost driver
is vital in the measurement of the system’s accuracy.
Also, the number of activities included affects
the accuracy of ABC system. Some activities are not considered to be
economically feasible in the process of television production. For instance,
the amount of screws needed to assemble the television parts. Therefore, as not
all of the activities can be determined, the total costs calculated would not
be fairly accurate as well.
The limitations of ABC system is that the data
collection process for this system is very time consuming. Besides, the cost to
implement and maintain ABC system is high, resulting in high capital
expenditure in the long-run. Furthermore, the implementation of ABC system is
not easy as some organisations may be highly resistant to change. Lastly, ABC
system is a transparent system which some managers may not approve of as they
would prefer to keep some things out of the view of the company owners.
7.0 Ethical Issues
With reference to the case at hand, there
appears to be a conflict between two parties, James Nader, Zenre’s Controller
and Sandy Mason, the divisional president. The reason for this conflict is the
disagreement with the type of allocation bases to be used to evaluate costs in
production of the models and the method of application. This is due to Mason’s
desire to lower costs in order to reflect a higher profit as her bonus is
affected by profit. In the current situation it is the question of ethical
standards that would affect the company’s profitability, and therefore Nader
must make his decision based on competency, credibility and integrity.
With the application of the ABC system, there
may be unfavourable consequences, but Nader should report the exact information
to the relevant parties as the issue is jeopardising the future of the company.
Therefore, Nader should uphold the values of integrity and credibility of his
profession as an accountant to report the actual results. Even if Nader faces
the risk of losing his job, he should enforce his accountability to the firm
and disclose the true cost numbers to the company.s essay is an example
of a student's work
There are several suggestions that Nader should
do in response to his supervisor - Masion’s instructions. The first would be to
report the situation to the immediate manager above his supervisor (Horngren et
al 2009, p.42). If the manager seems to be in the loop of the same opinion,
then the next option would be to report to the CFO or the CEO or equivalent and
explain the dilemma and its effect on the future of the company. If assuming
the CEO is involved too, then Nader would have to seek advice from the IMA
Ethics Counsellor so that he would have a clear view of the possible courses of
action that he could take (Horngren et al 2009, p.43). Lastly, Nader would also
be advised to consult his legal attorney in relation to the ethical dilemma he
is experiencing at his workplace.
Financial Objectives – Measures
Some related links are shown below;
Financial Objectives – Measures
8.0 Conclusion
Zenre Technology manufactures two television
models, Robin an older product and King, a newer model introduced in 2007.
However, James Nader, Zenre’s financial controller decided to incorporate the
ABC system which resulted in less that savoury results in the costing which
lowered profits compared to the existing traditional costing system. Therefore,
it is recommended that Zenre Technology discontinue the production of King
model, or research on a more cost efficient way to produce the products, and
implement the ABC system in the corporation.
9.0 Appendix
Appendix A
TRADITIONAL Costing Sytem
Gross Margin per unit =
1. ROBIN =
= $330
2. KING =
= $342
Gross Margin percentage per unit =
1. ROBIN =
= 36.67%
2. KING =
= 30.00%
Appendix B
Traditional Costing System
ABC System
Robin
36.67%
Robin
King
30.00%
King
Gross Margin Percentage for both costing systems
Appendix C
Traditional Costing System
ABC System
Robin
King
Robin
Operating Income ($)
1,430,000
390,000
19,800,000 – (513.64 x 22,000) – 5,830,000 =
2,669,920
Number of Units Sold
22,000
4000
22,000
Operating Income/unit ($)
65.00
97.50
2,669,920/ 22,000 = 121.36
Total Operating Income of both costing systems
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