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Activity Based Costing for Beztec Ltd

ACC200 term 2 2018 Assignment

Beztec Limited produces two models of Printers: the Lexon, which Beztec has produced since 2014 and sells for $990; and the Protox, a newer model introduced in 2016 that sells for $1254. Based on the following income statement for the year ended 31 December 2017, senior management at Beztec have decided to concentrate marketing resources on the Protox model and to begin to phase out the Lexon model because the Protox generates a much bigger operating profit per unit.

Beztec Limited
Income statement for the financial year ended 31December 2017

LexonProtoxTotal
Revenues$23 760 000 $7524 000 $31 284 000
Cost of goods sold15 048 000 5 266 80020 314 800
Gross margin8 712 0002 257 20010 969 200
Selling and administrative expense6 996 000 1 613 7008 609 700
Operating income$1 716 000 $643 500$2 359 500
Units produced and sold24 0006 000
Operating income per unit sold$71.50$107.25


Details for cost of goods sold for Lexon and Protox are:



LexonProtox
CostsTotalPer unitTotalPer unit
Direct materials$5 491200$228.80$3 854 400$642.40
Direct production laboura475 20019.80277 20046.20
Machineb3 801 600158.40475 20079.20
Total direct$9 768 000$407.00$4 606 800$767.80
Production overheadc$5 280 000$220.00$660 000$110.00
Total cost of goods sold$15 048 000$627.00$5 266 800$877.80


Lexon requires 1.5 hours per unit and Protox  requires 3.5 hours per unit. The direct production labour rate is $13.20 per hour.

bMachine costs include lease costs of the machine, repairs and maintenance. Lexon requires 8 machine-hours per unit and Protox requires 4 machine-hours per unit. The machine-hour rate is $19.80 per hour.

Production overhead costs are allocated to products based on machine-hours at the rate of $27.50 per hour.

Beztec’s management accountant, Sue Smith, is advocating the use of activity-based costing and activity-based management and has gathered the following information about the company’s production overhead costs for the year ended 31December 2017.


Activity-cost-driver quantities
Activity-cost driver (driver quantity)Total activity costsLexonProtoxTotal
Soldering (number of solder points)$1 1657251 333 125433 1251 766 250
Shipments (number of shipments)1 064 25018 2254 27522 500
Quality control (number of inspections)1 534 50063 22523 96387 188
Purchase orders (number of orders)1 176 12090 113123 727213 840
Machine power (machine-hours)71 280198 00018 000216 000
Machine set-ups (number of set-ups)928 12518 00015 75033 750
Total production overhead$5 9400 000



After completing her analysis, Smith shows the results to Steven Kay, the CEO of Beztec. Kay does not like what he sees. ‘If you show headquarters this analysis, they are going to ask us to phase out the Protox line, which we have just introduced. This whole costing stuff has been a major problem for us. First, Lexon was not profitable and now Protox.

      ‘Looking at the ABC analysis, I see problems. First, we do many more activities than the ones you have listed. If you had included all activities, maybe your conclusions would be different. We can’t afford to phase out either product, please alter the costs produced by the ABC system.’

Smith knows that her numbers are fairly accurate. As a quick check, she calculates the profitability of Lexon and Protox using more and different activity drivers. The set of activities and activity rates she had used results in numbers that closely approximate those based on more detailed analyses. She is confident that headquarters, knowing that Protox was introduced only recently, will not phase out Protox. She is also aware that a sizeable portion of Kay’s bonus is based on division revenues. Phasing out either product would adversely affect his bonus. Still, she feels some pressure from Kay to do something. She asks for your advice.

Required

1. Discuss the importance of accurate product costing. In your discussion you should highlight the problems associated with using traditional costing system which Beztec has been using. 

2. Calculate the cost driver rates for the various activities identified in the activity-based costing (ABC) system.

3. Calculate the cost of each model under activity based costing.

4. Complete a profitability analysis by calculating the gross profit and gross profit percentage per unit for both models under ABC system. 

5. Advise Smith on how she should respond to Kay’s suggestion that she alter the costs produced by the ABC system. You should discuss APES 110 Code of Ethics for Professional Accountants.

6. Using a predetermined overhead rate to allocate overhead cost will most probably result in over/under allocation of overhead coats. Explain why this may happen and three ways to dispose the amount of over/under applied overhead costs.

Answer

ACTIVITY-BASED COSTING


Executive summary

Beztec Ltd is the Australian company head office situated in Adelaide. In the recent time, the company spread their business to all over the Australia. Now a day the company’s head office is situated in the Perth and Melbourne. Despite of being a large business sector, the company raised the issue regarding their financial data maintenance. The company did not follow the perfect path of accounting governed by the IFRS. The company violated the rules of ethics while maintaining the records. The accounting professional suggested them to how the organisation conducts the operation of activity-based costing.

Introduction 

 Beztec Ltd is the electronic appliance company in the Australia, head office situated in the Adelaide. The company raises the issue regarding maintenance of the improper cost sheet, which is directly linked with the consumer’s goods and services. The improper maintenance of the cost and accounting analysis the price of the goods and services rose immensely. The CEO of the company Mr. Steven Kay also looking for the appropriate approach which deserves the company        

1. Accurate product costing and   impacts in Beztec Ltd 

Product costing is an approach to ascertain the cost associated with managerial accounting. It intends to determine the cost of a unit of production. In past, managers of Beztec Limited focused on optimization of the production. This approach helps to determine the cost of each production elements. The product costing should be recorded as a closing inventory for the unsold goods. It charges on the cost of goods sold, cost of sales and unveils as an expense in the financial statement of the company. This approach helps to reduce the cost of each element of the production material, which contributes the company to spawn the profitability without increasing the price of goods and services.

Beztec Limited in Australia included the some imperfect materials while calculating the cost of each element, which raises the value of items in the market. As a result, it might affect negatively on the profitability of impending growth. Beztec Limited expresses the desire to strengthen the financial market by pairing up with Lexon and protox. In this regard, the analysis of cost was predicted wrongly while calculating. The highlighting portion of the Lexon and Protox are improper to ascertain of labour hour, machine overhead, repair and maintenance costs which disclose the imperfect ascertainment of the cost it might be caused to the loss of the company.  

2. Calculation of activity based accounting 

Beztec Limited prepared the cost analysis statement with the wrong prediction which left an impact on the cost driver of the each element of the statement. The cost driver triggers a change in the cost of an activity. The cost driver also can be used in activity-based costing system to point out the cause of overheads.

Activity-based costing

Activity-based costing allocates costs for items used in the production process. Grossman (2014) narrated that this system targets to reduce the cost of each item, even though it is not necessary for the every organisation. This approach determines the perfect cost analysis, which may be increased or decreased. This system is operated by the cost drivers of the product costing. The cost drivers control the work hours of direct labour, number of machine hour worked, number of return inwards, number of change in elements and the number of goods sold. The Lexon & Protox made an error while determining the cost through the cost driver. In this regard, the company ensures the wrong cost analysis of machine hour rate, labour hour rate, repair, and maintenance. 

The perfect cost analysis approach should be adopted by the Lexon. The wrong presentation of the cost statement suppresses the actual cost by the $ 126,720. As a result, it might be shown the false income in the cost statement.

3. Analysis of items under activity-based costing  

The activity-based cost system refers to the relationship between costs, overhead activities and manufactured products. Through this method, it assigns indirect cost as per the costing rules rather than the traditional method. Some costs are difficult to ascertain by this method such as management expenses, office salaries, and miscellaneous expenses. For this reason, this method has found to be applied in the manufacturing sector.

Shoup (2017) praised that a factory machine requires a periodic maintenance. This maintenance ensures the cost that needs to be allocated to the products produced by the machinery. Therefore the cost drivers are used as a equipment to distribute the cost among the elements. The cost driver has an impact on allocating the overhead expenses. Internal management uses the cost drivers in the determination of the product price. That's why it has a direct impact on the profitability and operations of an entity.  The cost data given by the Lexon and Protox are imperfect because of the inclusion of lease value and repair & maintenance cost into the machine value. The inclusion of the lease value hikes the cost per unit. The firm or the business organisation has to maintain the repair and maintenance account separately as per the accounting rules stated by the IFRS.  The repair and maintenance is a well-balanced technique of the machinery. 

The repair and maintenance are directly connected to the usage of the machinery. The Protox and Lexon need to clarify the quantity of usage of machinery and show separately from the cost accounting system. The lease of the machinery defines a contract between lessee and lessor. The property owner of the assets gets the payment from the lessee for the usage of the assets. The company must add the lease acquisition value to the assets. The Lexon and Protox add the entire lease value to the asset value; they might show the lease value separately except lease acquisition value. The lease value of the assets is deducted from the value of the assets while calculating the depreciation. If Lexon and prtox charge the depreciation to the financial statement then the lease values are liable to deduct.

4. Ascertain the gross profit & gross profit percentage 

Gross profit is the direct income of the company arise from the direct source such as revenue, gross profit defines the company's efficiency in using its labour and supplies. The approach considers variable costs, that fluctuate with the output such as material, labour, sales, inventories, the utility of production sites and shipping etc. The gross profit percentage describes the profitability of the organisations. Namazi (2016) stated that higher gross profit percentage denotes the higher profitability. The gross profit percentage is arisen by using the formula (Gross Profit/ Turn over)*100. Durán & Durán (2018) narrated that the gross profit percentage is closely monitored over the time to see how the possible factors are impacting the profitabilities. Similarly, the decline in the gross profit percentage strongly indicates that the market is becoming more competitive, and the management should take the necessary steps to sustain the gross profit margin. 

Thus, changes in the gross profit percentage may be caused by the change in the amount of fixed cost and number of unit produced. The variation of the gross profit percentage defines the contribution portion, which eliminates all fixed cost from the gross profit. Variable cost included in the calculations and the contribution margin tends to be a better measure of performance.  The gross profit percentage of Lexon is 36.6667% and for Protox percentage is 30 percentage by using the formula (Gross Profit/ Revenue)*100. The following percentage denotes that the Lexon company occupies the better market position rather than the Protox. The gross profit percentage per unit for both the company is tantamount to the market conditions. The higher gross profit percentage of Lexon denotes better uses of the variable of productions. The both the companies must reveal the lease value separately in the books of account except accruing cost of the lease value.

5. Analysis of ethics code & its application to Beztec ltd.

The code of ethics helps the professionals to perform their professional duties in an ethical manner. Laviana et al. (2016) asserted that a code of ethics may outline the mission, vision, and value of the organisations. The ways the professionals deal with the corporate problems by maintaining ethical standard are stated in the rulebook based on the organisation's core values.  A code of ethics channelized the rules for the professionals that how to maintain the professionalism.  For every business and organisations the ethical standard sets the rule for their performances to prevent the corporate violations. Employees usually undergo for the formal training to learn the rule of conduct. 

Individual workers, professional will be penalized in case of failure to meet the requirements of business ethics. Miluzzo, Caceres & Chen (2015) narrated that accountants are an integral part of a company as they are bound to show the true and fair view of the financial statement to the investors, employees, and the managers without being provoked. Accounting ethics is the preliminary field were the accountant may follow the ethical rules regarding maintenance of the account, maintenance of cost, income tax return and auditing. Akhavan, Ward, & Bozic (2016) stated that due to the diverse change in the corporate world the accounting ethics also upgraded. The question has arisen about the ethical standard whether the rules applied or not while conducting the cost analysis. 

In this regard, the Lexon and Protox have applied the code of ethics to concrete the financial base except for the lease value. The lease value has charged into the value of a machine that may lead to suppression of profit due to the higher value of per unit of cost. The companies must follow the ethical approach to retain the profitability percentage. In some other cases, it might be difficult for the professional to maintain the professionalism while conducting the duty and performance but the organisation and company must be serious in this regard.  The CEO of the Beztec Ltd Mr. Steven kay must be reminded while producing the product that the lease value always keep away from the value of the assets. The repair and maintenance accounts should be operated separately. The inclusion of the repair and maintenance accounts may hike the per unit cost. This is irrelevant to the cost accounting.    

6. Discussion of under/over-absorption of overhead 

The over and under absorption of the overhead defines the difference between the budget cost and actual cost. The over absorption rate refers to the cost incurred above the budget and under absorption overheads define the cost incurred less than budget. The differences between the over and under the absorption rate are charged to costing profit & loss statement.  The differences occurred generally due to the wrong estimation of the expenses. As a result, the actual expenses may be substantially more or less to the budget. If the organisation fails to predict the performance budget the company may face the difficulties to equalize the difference between the budget value and actual value.

Beztec Ltd needs to maintain the budget for the comparison with the actual performance. The absence of the budget plan fails the organisation to check the internal efficiency. At first beztec Ltd need to maintain the budget programme for each and every section of the production unit. In this regard, the absence of budget plans the accountant and the professionals are failed to analyse the performance. Hence it can also be assumed by the experts that the given records belong to the initial year. The seasonal fluctuation is also responsible for the over/under the overhead. Under this approach, the difference between the actual and estimated cost is charged to the 3 parts of cost accounting such as work in progress, cost of finished goods and cost of sales. The supplementary rates are also used to compute the under/ over-absorption of overhead.

Conclusion 

Beztec Ltd is an electric appliance company in Australia. The company has an issue with the cost recording purpose. The company did not follow the proper way to maintain the cost records. The accounting professionals advised the organisation to follow the ethical principle in order to carry out the cost scrutiny of production elements. Beztec Ltd included the lease value of the assets which pertain to a violation of ethical norms. Lease value should be recorded according to the manner of IFRS. Lease value always deducted from the asset value for calculates the depreciation amount. The wrong adopted approach of the organisation affected the gross profit percentage. The gross profit percentage of the company unveils the weakness of cost management.

Beztec Ltd has the issue regarding the preparation of the budget. The company doesn’t have any budget record which creates barriers to calculate the self-efficiency. The company must prepare the budget before the actual production process. It will help the organisation to sustain the profitability.    

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