Beztec Limited: Income Statement, Product Costing And Profitability Analysis

Background

Companies need an accurate product costing systems to track the accurate costs of their operations and to allocate the costs properly by choosing an appropriate unit. The units that are often used for allocation of the overhead costs are machine-hour or labour hour. The selection of an accurate product costing system can represent a manufacturing process represented as profitable and thus offer the scope to the business to continue with the current manufacturing process. Otherwise it will not be possible for a business to continue with manufacturing line having little or no profit margin(DRURY, 2013).

Problems associated with using traditional costing system (used by Beztec)

In the traditional costing system that is often followed by most of the manufacturing business organizations the overhead costs are allocated either on the basis of the direct labour hour consumed or the number of machine hours used. The problem arises with the traditional costing method when the basis of allocation is much smaller than the amount of cost to be allocated.

The problem become more acute with the costing process when due to a small change in the volume of resources consumed leads a huge change in the amount of overhead applied per unit of direct labour hour or machine hour. Thus the issue has become more prominent with the company Beztec that is engaged in manufacturing operation and is having an automated production environment and the amount of overhead cost to be allocated is much higher than the basis that is total machine-hours being used in the operational process(Plank, 2018).

Cost drivers under activity based costing (ABC)

As per the suggestions of Sue smith the Activity Based Costing has been applied where the major cost drivers that are being identified with respect to the product divisions of Lexon

And Protox under Beztec Limited are Soldering (number of solder points),Shipments (number of shipments), Quality control (number of inspections), Purchase orders (number of orders, Machine power (machine-hours), Machine set-ups (number of set-ups).Under the method of activity based costing the total cost with respect to each Activity-cost driver(that are taking place in the organization) has been identified. Then the number of activities that are present under each category of driver has been identified. After that cost per activity has been identified for each division of the business. Finally the sums of the unit cost of the activities are being calculated for each division(Kaplan and Porter, 2011).

Problems associated with using traditional costing system

Cost of each model under ABC costing:

Under the method of ABC costing it can be seen that sums of the unit cost of the activities for Lexon division is $156 where as that of Protox division is $386.Where as the cost of goods  produced and sold per unit under traditional costing system is $627 under Lexon division and $877 under Protox division. So the method of ABC costing has substantially reduced  the cost per unit produced and sold and it is expected that profit margin will improve(Zimmerman and Yahya-Zadeh,  2011).

Gross profit & gross profit percentage for each model under ABC costing

Thus it can be seen that application of the ABC costing method has increased the gross profit margin from 37%(under traditional costing ) to 84% for Lenox division and that of Protox division from 30%(under traditional costing )  to 69%( Rumble, 2012).

Advice to Sue Smith with respect to accounting standard of APES 110 Code of Ethics

The APES 110 Code of Ethics  is issued by the Accounting Professional & Ethical Standards Board Limited (APESB).The code has come in to effect in 1 July 2011.this code of ethics is must be followed by the accountants when they are dealing with accounting operations in Public Interest Entities, partner rotation, non-assurance services, Fees – relative size, compensation and evaluation policies.

Certified accountants in Australia who are working as professional accountants must comply with the requirements of the code of ethics of APES 110.The Australian accounting professional who are practicing even outside Australia are required to comply with this code of ethics to that extent the professional are not prevented from doing so by specific requirements of local laws and regulations.

One of the important requirements of this code of ethics is that the accounting professional must act at the best interest of the public as well as entity in which they are working(Jarillo, 2013).

In the present case scenario the accountant is trying to operate at the best interest of the client as well as public by prescribing the ABC costing method instead of the traditional costing method as ABC costing method will lead to a better method of cost allocation that will be savings of costing and enhancement of profit for the business organization and this in turn will help the business in delivering economic product pricing to the general public. Thus it can be suggested that by advocating the ABC costing technique instead of traditional costing technique the accountant is complying with the basic principle of the code of ethics by acting both at the interest of the organization (in which the accountant is working) as well as public(Martinov-Bennie and Mladenovic,  2015). 

Cost drivers under activity based costing (ABC)

Advice for SUE SMITH:

Thus here the accountant SUE SMITH must convince the CEO Steven Kay that the cost or the activity drivers has been identified and listed on the basis of the detailed analysis of the operation of the business Beztec and therefore the calculation of the activity based costing that are being done are more or less accurate and there is little or no scope of identification of the new activities or cost drivers that can bring a change in the decision of overhead cost allocation.

Moreover SUE SMITH should place the rational in front of CEO that a comparison and calculation between the traditional costing method and the AB C costing method that both the gross profit and gross profit margin has improved for both the divisions of LEXCON and PROTOX under the abc costing method and the loss per unit with respect to both division has declined under ABC costing. Therefore SUE SMITH should stick to the decision of implementing the ABC costing system in the business organization Beztec(Horngren,  2009).

Causes of over and under allocation of overhead cost while predetermined overhead rate is used

In a traditional costing method where a predetermined overhead rate  are used as a  basis of allocation of the overhead cost  there is every possibility of over and under allocation of costing that can be discussed with the help of the following example.

Let as assume that in business-X there are two divisions; division-A, division-B., The division-A is a high value product line and the division-B is a low value product line. The business-X has estimated that total machine hours of 20,000 units will be used and the estimated overhead cost to be used is $2,000,000. In such a situation the predetermined rate that will exist in the organization is $100 per machine hour. Thus if this predetermined overhead rate is applied then in case of division-A the total overhead cost to be applied is $150,000(assuming the division is using a total machine hours of 1500 units).

Again as per the predetermined rate division-B the total overhead cost to be applied is $50,000 (assuming the division is using a total machine hours of 500 units).Thus it can be seen that being a high value division, division-A has required $150 per machine hour and being a low value division-B requires $90 per machine hour(Cai et al.,2009).

According to this rate Division-A will account for the overhead cost of ($150*1500machine hours) =$ 2, 25,000 and Division-B will account for the overhead cost of ($90*500machine hours) =$ 45,000. Thus it can be seen that when the predetermined overhead rate of $100 per machine hour has been used then an under absorption or allocation of cost have occurred in case of the high value division or Division-A  and an over allocation of cost have occurred in case of low value division of Division-B(Noreen et al., 2014).

Cost of each model under ABC costing

Thus in case of fixed pre-determined overhead rate 8% of the total overhead cost has been allocated to the high valued division-A & 3% of the total overhead cost has been allocated to the high valued division-B.

But in case when the different rate  of overhead cost has been applied to Divisions-A & Division-B as per the requirement of the divisions then it can be seen that 11% of the total overhead cost has been allocated to division-A and 3% of the total overhead cost has been allocated to division-B.

Thus it can be seen that a clear under allocation of cost has occurred in case of Division-A and over allocation of cost has occurred in case of Division-B when the fixed predetermined overhead rate has been applied.

Three ways of disposing over and under application of over head allocationThe following method or ways can be applied for the disposition of the under or over application of over head cost:

Dynamic ABC costing method:

In this .method the business should identify the cost drivers as well as the number of activities as well as total overhead cost to be allocated to that cost driver just from the scratch for every new accounting period so that the business can use a changing overhead rate per activity instead of a predetermined overhead rate with respect to the each cost driver .This procedure will definitely help the business to dispose the over and under application of over head with respect to the listed drivers of cost being freshly identified in each new accounting periods as per the changing requirements of the business.

The other method of disposing the over or under application of overhead is “closed out to cost of goods sold”. Under this method the balance of the manufacturing overhead is being closed out to the cost of goods sold account (Walther and Skousen, 2009).

The third method of disposing the under or over applied manufacturing overhead is the allocation of the balance overhead between work in process (WIP), finished goods and cost of goods sold in proportion to the overhead applied during the current period

Conclusion:

The discussion and calculations of the assignment suggests that it is quite inappropriate to use a fixed overhead rate which is determined well is advance for the different divisions or product lines of the organization that are operating in different scales of operations(Garrison et al.,2010). The use of a predetermined over rate often leads to over and under application of costs for the different division of the organization and also affects the profit margin of the organization. In such a situation the best option that is available to the accountant of an organization is the use of activity based costing where the identification of cost drivers and overhead rates should vary from one accounting period to another with the changing business activity

Reference:

Cai, J., Liu, X., Xiao, Z. and Liu, J., 2009. Improving supply chain performance management: A systematic approach to analyzing iterative KPI accomplishment. Decision support systems, 46(2), pp.512-521.

DRURY, C.M., 2013. Management and cost accounting. Springer.

Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.

Horngren, C.T., 2009. Cost accounting: A managerial emphasis, 13/e. Pearson Education India.

Jarillo, J.C., 2013. Strategic networks. Routledge.

Kaplan, R.S. and Porter, M.E., 2011. How to solve the cost crisis in health care. Harvard Business Review, 89(9), pp.46-52.

Martinov-Bennie, N. and Mladenovic, R., 2015. Investigation of the impact of an ethical framework and an integrated ethics education on accounting students’ ethical sensitivity and judgment. Journal of Business Ethics, 127(1), pp.189-203.

Noreen, E.W., Brewer, P.C. and Garrison, R.H., 2014. Managerial accounting for managers. New York: McGraw-Hill/Irwin.

Plank, P., 2018. Introduction. In Price and Product-Mix Decisions Under Different Cost Systems (pp. 1-5). Springer Gabler, Wiesbaden.

Rumble, G., 2012. The costs and economics of open and distance learning. Routledge.

Walther, L.M. and Skousen, C.J., 2009. Managerial and cost accounting. Bookboon.

Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.

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