The Entity’s Background: Jefferson Multi Media Inc. Is a production company that provides services to recording artists. The company has two main divisions: the audio division and the video division. The audio division is charged with executing all necessary procedures to finalize the recording process. For example, the company records the artists, adds special effects, develops concepts and designs, and finally promotes artist relations to ensure that artists are satisfied with the services provided by the company.
To finalize the audio production process, the company’s audio division produces the final work in a arm Of audio cassettes, computerized disks, and digital sound tracks, which are transferred to the video division if necessary. Key Issues: Two years ago, a divisional cost accounting system was adopted by Jefferson Multi Media Inc. The Audio Division of Jefferson Multi Media Inc. Is one of the company’s largest divisions and among the first to implement the new cost system.
In this new cost system, Division General Managers are required to monitor and evaluate their division’s cost structure and expenses. Adam King, General Manager of the Audio Division, had some concerns regarding the Division-Based Cost Accounting System (DABS). This cost method was based on a standard costing unit each division could use to measure its overall costs. In particular, for the Audio Division, this cost method used a completed product as the basic cost calculation.
To calculate an average cost per product, the DABS collected the direct costs on the Divisional Cost Report (DOC), and then other central office costs were allocated, such as depreciation, administration and insurance costs. The bases for these allocations were designed to distributing these costs to the different divisions of the company. After all these costs were allocated, the average cost per unit loud be calculated by dividing the division’s total costs by the unit of activity.
In the case of the Audio Division, the unit of activity was a completed product, such as Cad’s, digital sound tracks, and audio cassettes. Mr.. King was interested in improving the cost control methods for his division as he felt the average per product cost was not accurate, because the type of products may varied depending on other factors such as recording hours, special effects used, and other costs related to the time spent with the recording artist. He suggested the current accounting system to be revised taking in inconsideration these factors. One of the main issues was that Mr..
King believed the actual costs for his produces division was not accurate and misrepresented, as some of the resources needed for most of its products were not considered. As a result, he could not rely in this data to prepare his forecasting and budgeting for the year. In order to address this issue, Mr.. Abbot, the Controller, suggested that the DABS for Audio should be based on product distinctions and divided into three categories: cassettes, Cad’s, and Dust’s (Product Type-Based System). In addition, overhead costs would be allocated to the product categories. This new cost system may help Mr..
King in his budgeting and forecasting efforts. Even though Mr.. King agreed this method was more accurate in reflecting the unit costs for the Audio division; he was still concerned on some continuing problems such as amounts of recording studio hours, special effect hours, between others, which should have varied depending on the artist needs and experience. In conclusion, still the product-type cost system was not an accurate measure. Finally, Mr.. King started experimenting with a cost system based on level of services received, which he believed reflected costs more accurately.
He classified the division costs according to the type of service provided (Service Based System): recording studio, special effects, concept/design, and artist relations. With the assistance of Mr.. Abbot, they allocated the indirect costs to the four types of services. Mr.. King was satisfied with the outcome of this third cost System, as he believed it reflected the different resources provided allowing him to locate and manage costs problems in the division more efficiently. On the other hand, Mr.. Abbot was worried that this accounting system may not work or the other divisions because this cost system was too complicated to be implemented.
Furthermore, the utilization units for their various resources could not be applied to all the company’s divisions. The main key issues for this case would be to determine the unit cost for the Audio division’s three products. In addition, it would be necessary to decide which would be the best cost system between the three suggested, to be applied to the Audio division, based on the General Manager’s needs, and that reflects accurately the cost per unit of the division’s products taking into consideration the types of services the Audio division provides.
Finally, after the three costs systems are evaluated and one has been determined to work best for the Audio division, it is necessary to suggest ways to improve the cost system. The main goal would be not only to decide on the best cost method that reflects an accurate cost per unit for the division’s products and provides reliable information to the division’s General Manager for his monitoring, planning, and controlling activities, but also to be able to be implemented efficiently among the other divisions of the company. Solution: The administrators and managers at Jefferson Multi Media, Inc. Eave come up tit three different ways to allocate costs to its product lines. A combination of all three methods will assist the company’s management to decide the total cost of production per product(s) and division(s). We agree with the way the cost per division is being calculated. However, we propose a different way to allocate indirect cost per product based on the number of hours calculated for each product and an estimate of the number of units needed for special effects, concept/design, and artist relations related to each product.
Based on the calculations provided by Mr.. King, we used the cost per hour or unit hon. on the Resource-Based Cost Report to calculate the costs of each resource by product line. Once we had the cost resource-based, we calculated a percentage for Cassettes, CDC, and Digital Sound Tracks (DUST). The percentage was applied to the ‘dendrite costs allocated from central office”, shown on the product-type cost report, for each of the previously mentioned products. When we got the indirect costs, we noticed that DUST absorbed most of those costs, which increased from $53,227 to $105,590.
DUST requires a lot more of recording studio hours, extensive special effects, new concept design, and continued artists relations. When comparing the indirect costs for Cassettes and CDC calculated using the Product Type-Based and the Service- Based systems, we noticed that both products’ indirect costs decreased by using the Service-Based system. Cassettes require less recording studio hours, moderate special effects, none modification to the concept and design used in a prior recording received, and minimal artists relations.
CDC require the least of all recording studio hours, none special effects, extensive modifications to prior concept/design, and minimal artists relations. The cost accounting method-based on levels of services brings greater advantages hen allocating indirect costs to production. A more accurate allocation of this cost is brought to the administrators of the company so they can better assess the different managerial strategies. There is going to be a greater relationship between the products and the costs associated to each product. This method will allow Mr..
King to observe how the resources used affect the products so he could make better conclusions when analyzing budgeted numbers and actual results by division and product. The number of resources that were budgeted and the resources that were actually allocated to each reduce could easily explain any difference in costs. This method can also have a few disadvantages when implementing it across the board. The method could be a bit too complicated for all divisions to use. The method uses estimates that need to be re-assessed constantly in order to assure that the company is properly allocating indirect costs.
It was questionable by Mr.. Abbot the fact that some divisions might not be able to come up with utilization units for their numerous resources. As a conclusion, we have better predictions of what the cost for each product could be by having a more accurate method of allocating indirect costs. The total costs per product resulted in increases and decreases among them triggered by the service- based system. The following were the changes on costs that occurred: cassettes’ total cost decreased by 2. 21%, CDC’ total cost decreased by 3. 41%, and Dots’ total cost increased by 6. 2%. Nevertheless, cassettes remain to be the most costly product among the three selected by Mr.. King. The total cost to produce twenty two products remains at $28 million, out of which $1. 06 million pertains to cassettes. We believe that the cost accounting system that Mr.. King created is appropriate to the company. We think the system should be implemented to all divisions and look for similar alternatives when a division can’t develop utilization units for different resources. The management team and the president of the firm should feel comfortable with the idea that Mr..
King brought to resolve the reporting issue by product and division. We learned how important it is for a company to properly scum late and allocate costs for management decision-makings. Destined Brass Products Co. The Entity Background: Destined Brass Products Co. Is a manufacturing company specializing in custom order brass products. The company has three product categories: valves, pumps and flow controllers. The Same machines Were used for all three products categories, and an engineering department was created to design pumps and flow controllers.
Destined purchased brass components from its foundry suppliers who agreed to just in time delivery. Destined machined the components to the customers’ specifications, and the products were packed and shipped as completed. Destined was being undercut by its competitors in the pumps market, and the managers had to sacrifice their 35% margin standard to remain competitive and sustain production volume. The managers had trouble understanding why competitors were able to price their pumps at such low cost, and remain profitable. A meeting was held to determine what could be changed to price products more profitably.
Peggy, the accountant for Destined, suggested that the company switch to a more modern cost allocation approach to better estimate cost allocated to each product line. Roland Guider, President of Destined, asked Peggy about the more modern cost allocation system she had suggested last month. Roland had initially been apprehensive about the system because he feared that it would consume more resources to maintain, ND would cause a discontinuity is his historical data. Under the traditional approach, cost is based on measurements of direct and indirect cost, and on certain assumptions regarding the sales and production activity.
Each unit is allocated material cost and labor cost. Material cost are based on the prices paid for the brass components, and labor cost are based on the standard time for runs labor times the labor pay rate of SSL 6 per hour. Overheard costs are then allocated to each unit in a two stage process. The first step of Destines traditional system is to allocate overhead to production. The next step is to allocate the total overhead cost assigned to production on a production-labor cost basis. In this system, $4. 39 of overhead is allocated for each $1. 00 of run labor cost.
The problem with this approach is that pumps are absorbing more of the overhead cost which is causing Destines margins to shrink in this product line. Peggy analyzed overhead cost and suggested a new system be implemented. Peggy commented that material related overhead should be allocated to each product based on the cost of material. The reason for this is because material handling does not have any relationship to the labor cost of machining. The next step of this new system is to remove set-up labor cost from total overhead and allocate it to each product line.
Although this is a small amount Of overhead for Destined production activities, the cost Of set ups also had no relationship whatsoever to the total labor cost of a production run. Lastly, Peggy suggested that the company use machine hours instead of labor dollars as the basis for allocating remaining factory overhead. The reason for this is because expenses for machines are probably more than double the cost of labor. Under the new, more modern cost allocation approach, the prices for each reduce line changed dramatically.
For example the revised standard cost for pumps was reduced to more than 34. 00 below current cost figures. A major reason for this is that pumps did not consume any engineering hours, which is a major component of overhead cost. It seems that pump sales were subsidizing the cost of flow controllers. It was noted that even with a 12. 5% price increase, there was no new competition in this market. The reason for this is that competitors understood the amount of engineering resources that flow controllers would consume, and decided to not enter this product segment.
John noted that Destined spends one half of engineering efforts on flow controllers alone. It did not matter whether Destined used direct labor dollars or machine hours to allocate the engineering cost because flow controllers were not currently being allocated enough of the engineering cost which it was responsible for incurring. In reality, flow controllers should have absorbed most of the overhead cost which they weren’t under the traditional approach. More components were needed for each finished unit, and more labor was required for the flow controllers.