MANAGEMENT ACCOUNTING REPORT 2

Introduction

Cost or management accountants are often tasked with the noble task of advising management on costs incurred in the manufacturing of products. As such, the management is able to utilize the information to make price decisions, profit margins as well as the production levels that optimize resources and other elements. To achieve this objective, various methods can be exploited to the discretion of the management. For instance, the cost calculation of Android01, has been subjected to Factory Space cost allocation method as well as allocation of costs using labor. Once the cost allocation method has been settled on, it becomes possible to determine the mark-up that should be added on the costs to give the full price of a unit of Android01. Allocation of joint costs should be prioritized to ensure that Min X and Mini Y get shall get apportioned a fair share of the costs they incurred. 

Production of products should be in designed in such a manner that allows the company to reap the most profit using the least resources. On this, the company should thus seek to optimize profits rather than to maximize profits. According to Horngren et al., (2002), there exist a stack difference between profit maximization and profit optimization. When it comes to profit maximization, Horngren et al., (2002) explains that profit maximization simply entails the widening of profit margins as much as possible using a variety of techniques such as increasing the selling price, use of inexpensive resources including finance as well as exploiting the advantage of economies of scale. Profit maximization can easily lead to loss of business since quality of products as well as competitive forces are easily disregarded. On the other hand, profit optimization aims at extracting profits from the right channels. With profit optimization, a company often aims at cutting down on unnecessary costs while at the same time, ensuring that the quality of products is reminiscent to the prices charged. It, therefore, means that with profit optimization, profits are rationalized to ensure that a company is able to enhance its going concern as well as remain sustainably competitive. 

The following steps have been adopted to solve the above highlighted management accounting aspects of Android01, Mini X, and Mini Y. 

• Step 1 involves the allocation of fixed costs between two products. 
• Step 2 requires the allocation of costs using the activity-based cost allocation method
• Step 3 requires the determination of costs and consequently profits to be earned from a product using the mark-up pricing approach. 
• Step 4 is about finding out the appropriate production level that will maximize profits 
• Step 5 is a question of budgeting for costs under different manufacturing levels 
• Step 6 is a profit determination problem with the knowledge gathered in the above preceding steps. 

STEP 1

Two products, Android01 and Processor01 share some production facilities. As such, there is need to allocate such costs to each of the products independently. The management has decided that Android01 should shoulder 30% of the fixed costs while Processor01 should take up the other part of the cost. Fixed overheads do not fluctuate substantially making them easy to work with. Fixed costs include rent, depreciation, insurance, utilities like power and administrative salaries among others depending of the specific nature of the operations of a company. The costs under the fixed costs category will not be affected by changes in the activity levels of a company. In this case, fixed costs had to be allocated using factory space as well as using labor. 

When it comes to calculating the total cost for producing one unit of Android01, the following steps were taken. First, calculation of fixed costs, variable costs and remaining costs attributable to Android01. Two methods were used in the calculation; the first method allocated costs using Factory Space while the second method allocated costs using labor. 

The following table summarizes the calculations 

	Allocation Using Factory Space ($)	Allocation using Labor ($)
Fixed Costs	20,000	20,000
Variable Costs	20,000	26,667
Other Costs	25,000	25,000
TOTAL COSTS	65,000	71,667

As it can be seen from the analysis, allocation it can be confidently said that when costs are allocated using Factory Space, the costs are $6,667 lower as compared to when labor is used to allocate costs. The difference is mainly because of variable costs. Both factory space and labor are fixed costs centers and they absorb fixed costs in the manner described by Yazdifar (2003). Factory space method utilizes 30% of the variable costs while labor uses 40% of the variable costs. This effectively means that the Factory Space allocation method ultimately yields less allocated variable costs. 

STEP 2

In Step 1, variable costs have been absorbed using fixed cost absorption method. In Step 2, we are required to break away from the approach and allocate costs using the activity-based approach. The activity based costing approach assigns overheads costs into the direct costs identified earlier. The approach’s objective is according to Cooper and Kaplan (1988), is to map out and do away with products that are not profitable and at the same time lower the prices of products that are overpriced. The other objective of the approach is to completely bring down processes that are not effective and help in making the same product at a better yield. In this case, the management is interested in knowing how well the assembly process (the activity) can absorb overheads and the process has been completed with satisfaction. 

When Android01 is subjected to the more accurate ABC method of allocating costs, it yields a higher cost per unit for Android01, which is $46,600. By producing 300 units of Android01, and 500 units of Processor01, it effectively means that Android01 will absorb 43% of the entire activity (assembly). Using this approach, the management can be convinced that increasing production will automatically lead to a reduction in the total cost. 

The method, as mentioned by Homburg (2001) can significantly lead to exploitation of economies of scale if there are more units of Android01 to be produced. This means that the assembly line can be made more efficient by utilizing it more and as such, costs will go down significantly. This is the efficiency that Cooper and Kaplan (1988) were talking about. As such, there will be a tendency to reduce the price of the commodity in the market since there will be less costs with more volumes. 

STEP 3

Step 3 is simply concerned with the concept of finding the right prices to charge customers for the product. In this regard, there are many methods of determining the price to be paid by the customers. To handle this step, the mark-up pricing approach has been selected. Mark-up is essentially the quotient of costs and the selling price of a good. It is often added to the costs to get the final price to be paid. Given the total costs incurred in the manufacturing process of a product derived using various methods, the mark-up approach is used to add on profits on the cost to get price. 

The mark-up (cost-plus) method is simple to apply and it is preferable since it makes pricing more consistent and predictable across various goods (Baker, 2013). The method has led to the conclusion that the company will make gross profits of $18,900 per each unit of sold Android01 when the price is $81,900. The figure has been arrived at by adding a profit that is equivalent to 30% of the cost. The management is often at liberty to change the mark-up ratio depending on the performance of the product in the market with competition and other relevant factors. The cost-plus method is easy to use and it reduces the worry of determining pricing like it can be seen in the previous two steps where pricing has not been done but instead focus has been given to total costs. 

Our company is a going concern. To sustain the concept, the firm needs to have sustainable profits. The concept is valuable since it serves the concept of going concern by rewarding shareholders. Profits are also the means that the shareholders increase their wealth and as such, there should be sufficient and convincing methods of arriving at these profits. 

STEP 4

In the introduction, I discussed the concept of profit maximization and profit optimization. Step 4 requires that there be established production levels that uses the least costs but gives the highest return. This is the optimum profit. Optimum profits do not necessarily mean the highest profits. Revenues can be high yet not optimum as affirmed by Hart and Nisan (2017). At different production levels, the difference between costs and revenues differ. A producer should settle on that production level that has given the biggest difference between costs and revenues. The company should not be focused solely on sales volumes but should find that point that offers an equilibrium between costs and revenues.  

When the contribution of the various production levels is done, it is found out that a production output of 300 units provides the highest contribution. This settles the question, “how much should we produce?” From the table below, we can see that the profits are increasing with increase in number of units until after 300 units. At this point, diseconomies of scale set in and start eating into profits. 

Number of Units	Variable Cost-per-Unit ($)	Sale Price-per-Unit ($)	Profit
200	60,000	70,000	2,000,000
250	54,000	66,000	3,000,000
300	48,000	64,000	4,800,000
350	46,000	59,000	4,550,000
400	45,000	52,000	2,800,000

From the analysis above, it can be seen that high sales volumes do not equate to profits. From the other steps, particularly Step 2, it was advocated that high production volumes are better since they help the organization to draw advantages of economies of scale. The same ‘good’ effect is cancelled out by an increase in variable costs. Because of this conflicting status, the management should employ other methods that balance volumes, costs, and profits by optimizing profits rather than maximizing revenue/profit. The management accountant should advice the production manager and the sales manager to adjust production and sales to 300 units until something is done to the diseconomies of scale.

STEP 5

This step is involved with the development of a production budget for the production of Mini Y. From prior analysis, the management has provided the production budget for the month of 2018. The task at hand involves the development of a budget for the month of May which had different production levels. At the same time, it should be remembered that fixed costs do not change with changing activity levels. As a result, some of the costs will not change due to the anticipated increase in the production level. However, some overheads change with changing production levels, for instance, components costs and labor costs. 

From the description, it has been shown that Mini Y has five cost centers out of which two are variable (Component Cost and Labor Cost). When calculating the budget for May which has 200 extra units, it is important to factor in the extra cost for these 200 units. Only the variable costs will change. When the changes in variable costs have been affected, the total budget for the month of May is $54 million. 

In conclusion, Mini Y’s increase in production means that there will be a definite increase in some of the cost drivers especially those that are variable as described by Emmanuel et al., (1990). In this regard, labor and rent are affected by the 200 extra units that have been produced. 

STEP 6

It is essential for our company to allocate the joint costs between Mini X and Mini Y. To begin with, joint costs are incurred when a company manufactures two or more products. Allocating joint costs is a necessary activity that is undertaken for the following reasons. 

• Financial reporting. Financial reporting in any company makes more sense when products are allowed to be independent of each other. For instance, when reporting the value of inventory, there is need to separate two products that are as a result of one manufacturing process. External financial report consumers are interested in the value of products not how they were made and it is sufficing and legal to provide this information to them when it is due. 
• Pricing of products. Companies manufacture inventory so that such inventory can give value after being sold. Selling has a price. To determine the price of products that are a consequence of one manufacturing process, joint costs need to be allocated so that the management can determine the total product costs. When the costs are expensed with reference to a particular product, then the pricing decision can be made. It is not possible to determine the profit level of a product if there is insufficient information with regards to costs of such products. 
• Contract justification. When undertaking a contract, reimbursement will be on the basis of costs incurred. When joint costs are involved, it is necessary to have the costs allocated so that they can be justified for reimbursement. 
• Insurance settlement. When a dispute or an insured risk arises, for instance, when a warehouse catches fire and there is need to provide the value of merchandise in the store, joint costs need to be allocated to ensure that the costs are met by the insurer. 
• Litigation. During a court process, documentation to support the claims especially where two or more products are involved, allocation of joint costs becomes useful. This scenario becomes inevitable if a company is the plaintiff or the defendant. Allocation of costs is necessary so that the court can know the dollar amounts in dispute.

According to Deevski (2016), there are various means of allocating joint costs. First, Deevski (2016) explains that cost accountants can approach the problem from the approach of utilizing market based data, for instance, revenues as a basis for allocation. Here, an accountant can settle down on information either the sales value split-off method, or the net realizable value method (NRV) (Deevski,2016). The second approach utilizes the physical measures, for instance, weight, physical quantity count, or volumes of the products in question. When it comes to Mini X and Mini Y, costs have to be allocated using market based data, specifically the relative sales value of the two products. 

When allocating joint costs on the basis of sales value, the sales value for Mini Y and Mini X are first expressed as percentages of their total sales value and then the percentage multiplied by the total joint costs. The joint costs for Mini Y and Mini X are thus $1,560,460.65 and $1,439,539.35 respectively. The profit attributed to Mini Y is $31,159,540.00 

In conclusion, after considering various costing methods it can be recommended that the company adopts the cost-plus method. It is more precise and accurate. When it comes to Mini Y, production levels should be maintained at 300 units to ensure that profits are maximized. Due to the nature of Mini Y having variable and fixed costs in it cost mix, it follows that the more the products manufactured, the higher the costs incurred especially due to variable costs. The same effect is offset by economies of scale. According to Kropf and Sauré (2014), only through calculations can the equilibrium production point be produced. 

In conclusion, through the steps above, it has been possible to allocate costs to their respective cost centers using various methods, for instance, using factory space, labor, and the activity based costing. The markup approach has been used to determine the profits in the production of a Android01. Budgeting has been done when production levels change. Finally profit levels have been determined. 

References

Baker, M. J. (2014). Marketing strategy and management. Palgrave Macmillan.

Deevski, S. (2016). Cost Allocation Мethods for Joint Products and By-products. Retrieved from http://www.unwe.bg/uploads/Alternatives/deevski_br1_2016-6.pdf

Emmanuel, C., Otley, D., & Merchant, K. (1990). Accounting for management control. In Accounting for Management Control (pp. 357-384). Springer, Boston, MA.

Hart, S., & Nisan, N. (2017). Approximate revenue maximization with multiple items. Journal of Economic Theory, 172, 313-347.

Horngren, C. T., Bhimani, A., Datar, S. M., Foster, G., & Horngren, C. T. (2002). Management and cost accounting. Harlow: Financial Times/Prentice Hall.

Homburg, C. (2001). A note on optimal cost driver selection in ABC. Management Accounting Research, 12(2), 197-205.

Cooper, R., & Kaplan, R. S. (1988). Measure costs right: make the right decisions. Harvard business review, 66(5), 96-103.

Kropf, A., & Sauré, P. (2014). Fixed costs per shipment. Journal of International Economics, 92(1), 166-184.Yazdifar, H. (2003). Management accounting in the twenty‐first‐century firm: a strategic view. Strategic Change, 12(2), 109-113.