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Case Report
Case One: Seasonal Changing of Accounting Figures
In the first case, Alistair is blaming Thurasa for continuing to alter and change the figures in the original budget. In short, this case concerns flexible budgeting. To address the issue, we need first to understand what flexible budgeting is, how it is applied, and its advantages and disadvantages.
Flexible Budgeting
Flexible budgeting is an accounting/budgeting technique where the values in the original budgets are readjusted to reflect the actual costs (flexible costs)[footnoteRef:1]. The main intention of flexible budgeting is to ensure the company/project sets realistic targets. [1: Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014. ]
Application of Flexible Budget
To apply flexible budgeting, you need first to identify and separate fixed costs from the budget model. Next, estimate by how much all the variable costs have changed from the original budget. After that, create a budget model in which you include the initial fixed costs and the percentage by which each variable cost has changed[footnoteRef:2]. Finally, prepare a flexible budget using the structure you used to prepare the original budget, but this time, including the values of new variable costs and the original fixed costs. [2: Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014. ]
Advantages of Flexible Budget
The advantages of flexible budgeting include one, it enables the company to set realistic goals. That is because it allows the companies to factor in all the changes in the variable costs; hence, helping them to set feasible subsequent targets[footnoteRef:3]. Besides that, flexible budgeting enables businesses to assess the performance of different departments and increase their efficiency. For example, the labor costs can increase because the human resource department had to hire extra workers to complete a task that could have been completed with the original number of highly experienced workers (which an indication of inefficiency). [3: Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014. ]
Disadvantages of Flexible Budget
The first disadvantage of the flexible budget is closing delays, which arises because the accountant or the person preparing the flexible budget must wait till the end of the financial period before he/she can prepare it[footnoteRef:4]. Besides that, flexible budgeting focuses on variable costs alone and not revenues and fixed costs, yet they are also key components of a budget. [4: Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014. ]
Conclusion
In general, Thurasa was right to change the values in the budget, but she was wrong to do it in the middle of a financial year, since flexible budgets are only prepared at the end of a financial period[footnoteRef:5]. However, if Thurasa prepared her flexible budgets at the end of each financial quarter, that was in accordance with accounting standards. [5: Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014. ]
Case Two: Discounts Resulting in Low Prices
In the second case, Thurasa is concerned that there is a potential bulk buyer who is requesting a huge discount yet he is offering very low prices. Lena is seeing opportunity in the deal because the company will pay less premium fee by ordering the raw material in bulk to cater for the huge demand. Lena, on her part, is concerned that welcoming the new deal will require the company to increase staff-hour, which will translate to the high cost of labor/high production costs.
To address this issue, we need first to acknowledge the fact that the company’s main aim is to make profits, as well as analyze how profits are estimated. In accounting, profits are determined by subtracting total costs from total revenues. Total revenues, on the other hand, are estimated by multiplying prices by quantity sold[footnoteRef:6]. Meanwhile, profit per product is determined by subtracting the production cost per unit from the price. In this case, quantity sold is expected to increase due to bulk buying. However, the price per unit ($200) that the buyer is suggesting is less than the average production cost ($273). Therefore, the company will make a loss of $73 per product. In fact, selling skateboards in bulk (1000 units) is only but adding more problems to the company since it will magnify the loss to $73,000. [6: Needles, Belverd, Marian Powers, and Susan Crosson. Financial and managerial accounting. Nelson Education, 2013. ]
Conclusion
Simply put, Thurasa should advise her colleagues to decline the offer of bulk sale since it will make huge losses for FreeAir Skate Pty Ltd. Instead, it should focus on small clients who are willing to pay $300 price, because that will garner the company a $28 profits[footnoteRef:7]. However, the company can as well focus on bulk buyers who are willing to pay less than $300, but whose prices are not close or below $273. [7: Needles, Belverd, Marian Powers, and Susan Crosson. Financial and managerial accounting. Nelson Education, 2013. ]
Case Three: ABC System of Costing
In the third case, Tom is interested to know why many firms are using the ABC system of costing and he would love to see FreeAir Skate Pty Ltd try it too. To address Tom’s concerns, we need to understand the meaning of the ABC costing system, how it is applied and its advantages and disadvantages.
ABC System of Costing
Activity Based Costing (ABC) system is an accounting technique used by firms to precisely allocate overhead to tasks that actually need it. It is mostly used to reduce the overhead costs, and maximize the use of the available overhead[footnoteRef:8]. ABC system of costing is ideal for complex manufacturing companies that have multiple production machines, products, and interconnected processes that are not easy to separate. On the contrary, the ABC system of costing is less useful in a simplified production setting. [8: Aldogan, Mehtap, A. David Austill, and Mehmet C. Kocakülâh. "The excellence of activity-based costing in cost calculation: case study of a private hospital in Turkey." Journal of Health Care Finance 41, no. 1 (2014). ]
Application of ABC System of Costing
To use ABC costing system, you must first identify the cost that you intend to minimize. For example, if you want to minimize distribution costs, you identify costs such as the cost of fuel and not research expenses[footnoteRef:9]. The second step is loading the secondary cost pools, which are costs that do not directly support the production of the products. For example, security costs are secondary costs since they only help the production process by presenting thefts. The third step is to load the primary cost pools, which include all factors (such as the cost of raw material) that contribute directly to the production process. The next step is to locate the activity drivers, I.e., current tools and techniques used to allocate primary and secondary costs. Finally, use the activity drivers to allocate primary and secondary costs best on necessity. [9: Aldogan, Mehtap, A. David Austill, and Mehmet C. Kocakülâh. "The excellence of activity-based costing in cost calculation: case study of a private hospital in Turkey." Journal of Health Care Finance 41, no. 1 (2014). ]
Advantages of ABC System of Costing
The first advantage is that ABC system tracks all the costs of activities and enable you to tell whether or not activity costs exceed the industry’s standards; thus, allowing you to respond by employing necessary measures. Besides that, the ABC costing system enables you to tell which customers garner you the highest profits by analyzing things like Product Return Handling from each customer. Thirdly, the ABC system enables the company to identify the cheapest distribution means/strategy; hence, cutting the cost of distribution. Fourthly, the ABC system allows the company to determine whether it should outsource or produce itself, depending on the costs associated with the two options. Finally, the ABC system enables the company to properly set the prices and profit margin of each product line.
Disadvantages of the ABC System of Costing
The first demerit of ABC is that it is expensive to install and manage it. Also, the installation of the ABC system can take as long as years. Thirdly, ABC System uses data from multiple departments which expose it to a risk of erroneous allocation, especially if the data have errors[footnoteRef:10]. Next, ABC system depends entirely on the data collected on the first time, which renders it ineffective when the original data changes with time. Moreover, the ABC system requires keeping massive data, which can be hard to maintain, plus it does not account/factor in unused time in the production. [10: Aldogan, Mehtap, A. David Austill, and Mehmet C. Kocakülâh. "The excellence of activity-based costing in cost calculation: case study of a private hospital in Turkey." Journal of Health Care Finance 41, no. 1 (2014). ]
Conclusion
Since FreeAir Skate Pty Ltd’s is a manufacturing company whose production involves complex steps, it is recommendable that it adopts ABC system because it will enable it to allocate its overhead effectively.
Case Four: Variable versus Absorption Costing
In the fourth case, Lina is concerned that the company has to decide to use variable costing or absorption costing. To address her concern, we need to define the two costing techniques, how they are applied, and their advantages and disadvantages before finally making the decision.
Definitions
Variable Costing: Variable costing, also known as direct costing, is an accounting technique that recognizes variable overhead manufacturing costs as the product costs[footnoteRef:11]. Here both manufacturing and non-manufacturing costs (fixed costs) are not included in product costs. [11: ]
Absorption costing: Absorption costing, also known as full costing, is an accounting method that recognizes both fixed and variable overhead manufacturing costs[footnoteRef:12]. That is, product cost includes all variable and fixed manufacturing costs such as factory overhead, direct materials, and direct labor. [12: Drury, Colin M. Management and cost accounting. Springer, 2013. ]
Advantages
Variable Costing: There are multiple benefits of using variable costing. However, the main one concerns the fact that it excludes fixed costing. Well, a company usually incurs fixed costs whether or not it conducts its operations. As a result, variable costing discourages the management from focusing on fixed costs while making critical decisions since there is nothing they can do about it. Instead, it encourages them to focus on variable costs since those are the only costs that the company can regulate/control.
Absorption costing: Again, there are multiple advantages of absorption costing. However, the major one is the fact that it incorporates both fixed and variable costs. In accounting, profits are estimated by subtracting revenues from the sum of fixed and variable costs. Therefore, the fact that the absorption costing method recognizes both fixed and variable costs as product costs makes it an ideal method for making profit-related decisions[footnoteRef:13]. [13: Drury, Colin M. Management and cost accounting. Springer, 2013. ]
Disadvantages
Variable Costing: The main disadvantage of variable cost concerns the fact that it totally overlooks the effect of fixed costs on production costs. In reality, although the fixed overhead does not contribute a lot in product production, it has a significant impact[footnoteRef:14]. Therefore, assuming that fixed overhead should totally not be included in the overall product costs is illogical. [14: Drury, Colin M. Management and cost accounting. Springer, 2013. ]
Absorption Costing: The main disadvantage of absorption costing is that it is not ideal for helping the management to decide whether or not a company should make or outsource since such decisions rely purely on variable costs[footnoteRef:15]. [15: Drury, Colin M. Management and cost accounting. Springer, 2013. ]
Conclusion
Based on the above analysis, FreeAir Skate Pty Ltd should use absorption costing since it is more realistic in making profit related decisions (it considers both fixed and variable costs).
Case Five: High Costs
In the fifth case, Tom is concerned that FreeAir Skate Pty Ltd is incurring extremely high costs. He is, therefore, considering postponing the annual routine servicing of the production machines. To address his concerns, we need first to dispute his suggestion before recommending the effective methods of minimizing costs.
Postponing Annual Servicing Of the Production Machine
Yes, postponing the annual servicing of the production machine will reduce FreeAir Skate Pty Ltd’s production costs significantly. However, that decision may have huge collateral damage that may cost the company even more. For example, the machine may incur serious mechanical damage due to skived servicing; hence, costing the company much more in repair.
Strategies to Reduce Costs
The first option that FreeAir Skate Pty Ltd can use to reduce its costs is to retrench some of its part-time employees and consider outsourcing (that is if outsourcing is cheaper than internal production)[footnoteRef:16]. Besides that, the company can use highly-advanced, energy-efficient production techniques that consume less power. [16: Eldenburg, Leslie G., Susan K. Wolcott, Liang-Hsuan Chen, and Gail Cook. Cost management: Measuring, monitoring, and motivating performance. Wiley Global Education, 2016. ]
Case Six: Declining Sales
In the fifth case, Thurasa is concerned that FreeAir Skate Pty Ltd will not meet its sales targets and so, she is suggesting increasing bonuses to attract more sales. Well, to address her concern, we must first dispute her suggestion before recommending better ways of promoting sales.
Offering More Bonuses
Well, offering more bonuses may enable the sales team to hit their targets. However, it is more likely to prevent FreeAir Skate Pty Ltd from hitting its profit targets. Simply put, increasing bonuses reduces the price per skateboard; hence, minimizing its[footnoteRef:17] per product profits (profit per product=price-cost per product). [17: Babaei, Mahmoudreza, Baharan Mirzasoleiman, Mahdi Jalili, and Mohammad Ali Safari. "Revenue maximization in social networks through discounting." Social Network Analysis and Mining 3, no. 4 (2013): 1249-1262. ]
Strategies to Increase Sales
Bibliography
Aldogan, Mehtap, A. David Austill, and Mehmet C. Kocakülâh. "The excellence of activity-based costing in cost calculation: case study of a private hospital in Turkey." Journal of Health Care Finance 41, no. 1 (2014).
Babaei, Mahmoudreza, Baharan Mirzasoleiman, Mahdi Jalili, and Mohammad Ali Safari. "Revenue maximization in social networks through discounting." Social Network Analysis and Mining 3, no. 4 (2013): 1249-1262.
Drury, Colin M. Management and cost accounting. Springer, 2013.
Eldenburg, Leslie G., Susan K. Wolcott, Liang-Hsuan Chen, and Gail Cook. Cost management: Measuring, monitoring, and motivating performance. Wiley Global Education, 2016.
Needles, Belverd, Marian Powers, and Susan Crosson. Financial and managerial accounting. Nelson Education, 2013.
Stone, Debra. "Cost Accounting Systems: A Holistic View from the Top." In Proceedings of Global Interdis-ciplinary Business-Economics Advancement Conference (GIBA), Clearwater Beach, Florida, USA, pp. 94-102. 2014.
Xie, Karen, and Young-Jin Lee. "Social media and brand purchase: Quantifying the effects of exposures to earned and owned social media activities in a two-stage decision making model." Journal of Management Information Systems 32, no. 2 (2015): 204-238.