Assignment 1: Discussion—ABC or Activity-Based Costing
In your readings this module, you were introduced to Activity-Based Costing or ABC. It is a method used to determine a reliable predetermined benchmark for the allocation of overhead costs to the products produced based on their activity levels. In this discussion, we will work a case study on ABC together. For your initial response, attempt to answer the questions yourself and post all the required items into the Discussion Area. You may want to post some elements during different days so the class can work this problem together. Then in your response postings, help each other with misunderstandings or miscalculations.
- Examine the case below and then…
- Calculate the amount of overhead allocated to small and large advertising campaigns under existing methods.
- Apply activity-based costing to calculate the cost per cost driver for each of the cost pools.
- Use the costs per cost driver to calculate the activity-based overhead applicable to small and large campaigns.
- 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:
- 800 advertising campaigns the agency bids for
- 400 of these are bids for large campaigns and 400 for small campaigns
- 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
By Saturday, August 5, 2017, post your initial response to the Discussion Areabelow. Through Wednesday, August 9, 2017, review and comment on at least two peers’ responses on two different days. Your response should be thorough and address all components of the posted question in detail, include citations of all sources, where needed, according to APA style, and demonstrate accurate spelling, grammar, and punctuation
Assigned questions for Module 4 are:
Q9-1: What type of information system includes both financial and non-financial information and can be presented graphically relative to targets?Q9-2: What type of information system provides holistic information across multiple business activities?Q9-3: Explain the concept of reporting on a horizontal perspective.Q9-4: Why is information systems design and control important?Q13-1: Williams, a professional services firm has overhead of £625,000. It operates three divisions and an accountant’s estimate of the overhead allocation per division is 38% for Division 1, 22% for Division 2 and 40% for Division 3. The divisions respectively bill 4,100, 1,950 and 3,300 hours. Calculate the business-wide overhead recovery rate and the cost centre overhead recovery rate for each division.Q13-2: Randy’s Components uses an activity based costing system for its product costing. For the last quarter, the following data relates to costs, output volume and cost drivers. If set-up costs are driven by the number of production runs, what are the correct set-up costs for each product?
Q13-3: What is the difference between absorption costing and ABC costing?Q13-4: The main proposal made by Cooper & Kaplan in their article “How cost accounting distorts product costs” is best described as? (The article can be found as Reading A on page 390 of your textbook.)Q14-1a: The projected net cash flows for an investment are (in £’000):
Y0: -950 Y1: 130 Y2: 200 Y3: 330 Y4: 270 Y5: 180
What is the net present value of the investment, assuming a 7% cost of capital and a 950 initial investment. What is the NPV when we change the cost of capital to 8% and have a 850 initial investment? Have a 9% cost of capital and a 825 initial investment? Or have a 6% cost of capital and a 900 initial investment?
Q14:-1b: Given the cash flow in the prior question (14a) and for the $900 initial investment, what is the IRR of the cash flows?Q14-2: General Sales is considering three alternative investment proposals but can only accept one of these. The investments and cash flows are shown below:
General uses discounted cash flow techniques to evaluate its investments, using a cost of capital as specified above. Compare for each alternative investment the Net present value, Profitability index, and the Internal rate of return. Which of the three investment proposals would you prefer and why?