Accounting System of Cambden Cakes Company - Term Paper Example

Running header: Cost Accounting Student’s name: Instructor’s name: Subject code: Date of submission: 1 Executive summary Cambden Cakes Company is a company specializing in the manufacture of multiple products all of which are supplied to different markets. Of late the company has been experiencing declining profitability. This is an issue of concern to the management. Similarly, the costing system used by the company is not appropriate according to the accountant. This paper looks at both the current cost accounting system as well as the proposed activity based costing system. The paper argues that ABC system is better than the traditional cost accounting system as it leads to more realistic costs and hence avoids under or over costing of the products. In conclusion, the paper urges the management to depart from using the old costing system and adopt the new activity based cost accounting system. Contents Running header: Cost Accounting 1 Executive summary 2 Contents 3 Background 4 Limitations and consequencies 5 The Benefits of the system 7 Calculations 10 Conclusion 16 1. Background The managing director of Cambden a manufacturer and distributor of various cakes is greatly concerned about the company’s performance despite the company’s growth over the years. The main concern is on the recent decline in profits a situation that needs immediate attention. Sales needs to be improved especially on the high margin products. Some of the ways suggested for increasing profitability include increasing of advertising as well as offering discounts to customers on high margin but low volume specialty products among others. Of greater concern to the manager as well as the accountant is the current accounting system. The company uses the traditional cost accounting system that results in increased overhead costs among other short comings. As a result, the accountant is of the view that the company should abandon the traditional costing method for an activity based costing system. The new cost accounting method is expected to greatly improve cost at the company. However, although the managing director also feels that the costing system needs an overhaul, he does not agree with the accountant simply because a lot of cost accounting systems have been introduced in the past without great success. This paper aims at comparing the traditional cost accounting system and the activity based costing method with an aim of convincing the managing director to adopt the activity based costing system. As such, the benefits of implementing the activity based costing as well as the components of such a system have been analyzed. In addition, the paper also looks at what the company needs to put in place for successful implementation of the system. 2. Limitations and consequencies Cambden cakes uses pools all the overheads as one main indirect cost and allocates them using allocation basis of the departments in the determination of total cost. The firm should however allocate the activities and costs associated with each product to each individual cake in order to accurately determine its cost. Cambden cakes may therefore wrongly determine their total costs. This is because the traditional method will reflect maximum profits when indirect costs are low when compared to direct costs. On the other hand, it the firm has high indirect costs as compared to direct costs, this will reflect low profits. Cambdean cakes allocate its overheads to the specific department which are then reallocated to the products. This may result to poor and inaccurate determination of costs. If the cost of the cakes is undervalued, this will result the firm in setting high prices for their cakes. This will in return result to loss of market share especially if the competitors are offering high quality products or substitutes at substantially lower prices. On the other hand, if the firm sets low prices which are below their costs or those that break even, the cakes business may collapse as there will be no retainer earnings to expand or carry on day to day activities. Cambden cakes use a few allocation bases to allocate its overhead costs. Some activities which are essential and which result to further costs may be left. This will result to wrong cost determination. The management accountant will therefore make the wrong decision regarding what type of cake to produce more and that which should be produced in abundance. Cambden cakes do not have all the information required regarding relevant cost. The missing information is relevant when determining costs using the traditional costing method but has little use if the activity based method of cost determination is applied. Although Chris claims that the new specialty lines have high profits margin than the old product lines, the missing information as well use of the traditional method of cost estimation may not reflect the accurate costs of the cakes. Chris’s idea about increasing advertising and offering discounts may only add more costs and cut on the margins. It is therefore advisable for the firm to clearly identify its major activities which constitute unit costs in order before implementing his proposal. 3. Why ABC is more appropriate than the current system Why activity based costing would be more appropriate costing method for Cambden cakes than the existing costing system As earlier stated ABC is an economic model that identifies activity centers in a firm and assigns costs to cost drivers on the basis of the number of activities that occur on several levels unlike the existing systems. Such levels include; -unit level drivers that assume the increase of the inputs for every unit being produced -batch level drivers that assume variation of inputs for every batch being produced -Product level drivers that assume necessity of inputs to support the production of different types of products -facility level drivers that are related to the facility are manufacturing process. As such, the system is completely different from the traditional methods. Activity based costing system would therefore be more appropriate for Cambden cakes than the existing methods due to the following reasons; 1. The system will be more accurate in costing especially with regard to the product line, product end users, and stock keeping units maintained by management, the channel and category that will streamline the flow of Cambden cakes from the company to the consumer. 2. The process will better assist in understanding the overheads concept- the allocation of common business resources as they get used by specific product lines and their relation to specific cost drivers. 3. Unlike the existing costing method which uses unitary costing, the new activity based method will make use of, marginal or unitary cost. As such, over costing or under costing of processes can always be avoided. In addition, the system will be of particular importance in helping Cambden in identifying as well as earmarking the matters that are a burden on the firm- the wasteful non value adding activities. The Benefits of the system Unlike the existing methods, the new activity based system will mimic the actual processes of the business since the appropriation of common pool resources will always take place in the same way as common resources are used in the firm. In addition, the new system will help in the benchmarking process which will be an integral part of the quality control system. Based on all of the above benefits, the new system will not only improve how costing is done at Cambden but also lead to increased profitability for the firm. This is because the non profitable activities will be avoided and areas that need improvement identified and corrective actions implemented. Activity Based Costing (ABC) is the determination of products total cost based on the activities required to manufacture a given product. ABC system has various advantages over the traditional system being used and could help mitigate the problems associated with the current system. The ABC costing system will result to accurate determination of costs as well as a detailed and clear breakdown of indirect costs. The cake firm will therefore be able to determine the cost of producing each individual type of cake as well as the cost per unit. The firm will therefore be able to tell whether the prices set are profitable or not. The ABC system will also enable the company to determine which type of cake have the highest profitability as well those will low margins and little contribution. This will enable the company to determine which type of cake to allocate most resources for example machine hours. This will also enable the firm to make informed decisions regarding the price setting of the cakes manufactured. Cambden cakes will be able to control the overhead costs when they adopt ABC system. This mostly holds because the entity produces a wide variety of cakes. The costs that are traced to the activities in the organizations are reflected in the prices of the goods and services. Customers are therefore charged for such activities accurately. ABC system will enable Cambden cakes to analyze and determine unit cost rather than just analyzing the total cost. This will enable the management accountant as well as the management to understand their overheads and make informed decisions. The ABC system will also enable the firm to show visible waste as well as non-value adding activities. The cake company may therefore be able to outsource, cutback or eliminate these activities that are less profitable and concentrate on the most profitable once in order to raise profits. These may eliminate the dangers Charles might have regarding the risk of non continuity. The adoption of ABC system will enable a firm to respond quickly to changes in overheads. Such changes should quickly be reflected in the prices in order to maintain profitability as well as the market share. The current system that is used by the firm may not be appropriate to adjust to changes in the increase in overheads. ABC system will also enable Cambden cakes to improve their product quality as well as the product design. When ABC method of cost determination is used, the firm is able to streamline its activities and improve on those that are beneficial to the product and customers in terms of product design as well as the quality. The ABC system will enable Cambden to coordinate and implement other modern management practices such as Just In Time (JIT) and Total Quality Management (TQM). This will also improve budgetary control in the firm and lead to optimum utilization of recourses. Calculations Table 5 Mixing centre costs and recourse drivers – 2010 Cost category source $cost resource driver Wages 45000 number of employees Building costs 8000 floor space Depreciation 10000 machine hours Indirect materials 5000 direct labour hours Energy 16000 kilowatt hours used Other 3000 number of employees Total conversion costs 87000 Wages = 15/100×300000 =$45000 Building costs = 500/5000×80000 =$8000 Depreciation = 1000/10000×100000 =$10000 Indirect materials = 50/500×50000 =$5000 Energy = 10000/250000×400000 =$16000 Other = 15/100×20000 =$3000 Total = $87000 The costs associated with mixing amount to $87000, ie $950000 –$ 863000= $87000 Table 3 List of Activities for the Factory - 2010 Activity $ Cost Activity Driver Prepare Annual Accounts 5,000 None Available Senior Management Costs 18,300 None Available Process Receivables 15,000 # Invoices Process Payables 15,000 # Purchase Orders Program Production 28,000 # Production Schedules Process Sales Orders 20,000 # Sales Orders Dispatch Sales Orders 21,500 # Dispatches Develop and Test Products 20,200 # New Products Set up Scales 7800 # Batches Weigh Ingredients 4100 # Batches Load Mixers 14850 # Batches Operate Mixers 47500 # Kilograms Clean Mixers 8500 # Batches Move Mixture to Filling 4250 # Kilograms Clean Trays 20,000 # Trays Add Ingredients 92,000 # Packets of Cakes / Pastries Fill Trays 16,000 # Packets of Cakes / Pastries Move to Baking 8,000 # Trays Setup Ovens 50,000 # Batches Bake Cakes / Pastries 346,000 # Batches Move to Packing 40,000 # Trays Pack Cakes / Pastries 80,000 # Packets of Cakes / Pastries Inspect Pastries 2,500 # Pastries Warehousing 65,500 # Packets of Cakes / Pastries $950,000 Set up scales (2/15×48000) + (5/100×8000) + (0/1000×10000) + (20/100×5000) + (0/10000×16000) =$7800 Weigh ingredients (1/15×48000) + (5/100 ×8000) + (0/1000×10000) + (10/100×5000) + (0/10000×16000) =$4100 Load mixers (4/15×48000) + (10/100×8000) + (0/1000×10000) + (25/100×5000) + (0/10000×16000) =$14850 Operate mixers (5/15×48000) + (50/100×8000) + (1000/1000×10000) + (30/100×5000) + (10000/10000×16000) =$47500 Clean mixers (2/15×48000) + (20/100×8000) + (0/100×10000) + (10/100×5000) + (0/10000×10000) =$8500 Move mixture to filing (1/15×48000) + (10/100×8000) + (0/100×10000) + (5/100×5000) + (0/10000×10000) =$4250 b) Cambden cakes total product cost Under the original costing system Sponge cake $ Danish $ total cost$ Direct materials 250000 32000 282000 Direct labour 250000 50000 300000 Indirect materials 41667 8333 50000 Energy 333333 66667 400000 Depreciation 83333 16667 100000 Other 16667 3333 20000 Total cost 975000 177000 1152000 Product Cambden cakes total cost Under the revised ABC system Activity sponge cake $ Danish $ total cost $ Process receivables 1500 450 Process payables 1200 600 Program production 2800 1400 Process sales order 2000 500 Dispatch sales order 4300 1290 Develop and test products 202 808 Set up scales 780 390 Weigh ingredients 410 205 Load mixers 1485 742.5 Operate mixtures 7125 950 Clean mixtures 850 425 Move mixture to filing 4250 85 Clean trays 2500 500 Add ingredients 11500 1150 Fill trays 2000 200 Move to baking 1000 200 Set up ovens 5000 2000 Bake cakes/pastries 34600 17300 Move to packing 5000 1000 Pack cakes/ pastries 5000 1000 Inspect pastries 0 500 Warehousing 8187.5 818.75 Direct materials 250000 32000 TOTAL 351689.5 64414.25 Process receivables Sponge cake $ Danish $ 500/5000×15000 150/5000×15000 =1500 =450 Process payables 200/2500×15000 100/2500×15000 =1200 =600 Program production 100/1000×28000 50/1000×28000 =2800 =1400 Process sales order 400/4000×20000 100/4000×20000 =2000 500 Dispatch sales order 500/2500×21500 150/2500×21500 =4300 =1290 Develop and test products .05/5×20200 0.2/5×20200 =202 =808 Set up scales 100/1000×7800 50/1000×7800 =780 =390 Weigh ingredients 100/1000×4100 50/1000×4100 =410 =205 Load mixers 100/1000×14850 50/1000×14850 =1485 =742.5 Operate mixtures 30000/200000×47500 4000/200000×47500 =7125 =950 Clean mixtures 100/1000×8500 50/1000×8500 =850 =425 Move mixture to filing 30000/200000×4250 4000/200000×4250 =4250 =85 Clean trays 2000/16000×20000 400/16000×20000 =2500 =500 Add ingredients 100000/800000×92000 10000/800000×92000 =11500 =1150 Fill trays 100000/800000×16000 10000/800000×16000 =2000 =200 Move to baking 2000/16000×8000 400/16000×8000 =1000 =200 Set up ovens 100/1000×50000 50/1000×50000 =5000 =2500 Bake cakes/pastries 100/1000×346000 50/1000×346000 =34600 =17300 Move to packing 2000/16000×40000 400/16000×40000 =5000 =1000 Pack cakes/ pastries 100000/800000×80000 10000/800000×80000 =10000 =1000 Inspect pastries =0 10000/50000×2500 =500 Warehousing 100000/800000×65500 10000/800000×65500 8187.5 818.75 6. Causes of the differences between the costs of the two products a) Using the traditional cost accounting system The differences between the two costing systems arises form the differences in the amount of each product being manufactured. This in turn causes the differenc3e in the amount of various costs incurred in manufacturing each of the products for example; the cost of labor is different in each case owing to the amount of each product that is being manufactured. The differences can also be attributed to the differences in the cost of materials required in the manufacture of each of the products. b) Under the new ABC costing system, the cost of the two products is also noted to be different. This is associated with the difference in the number of activities and cost centers associated with each product. Similarly, the level of activity difference is a major cause the differences in the cost of the two products. There is a huge difference in the cost of the two products when the two methods of costing are compared. The difference is associated to the following reasons; i) We have used cost drivers at various levels in the new activity based cost accounting method as opposed in the traditional cost accounting method which was mainly volume based. ii) The number of processes in the new cost accounting method are a major determinant of cost unlike the traditional costing method which mainly was a structure oriented method. 7. Successful implementation of the system Cambden cakes needs to consider the following issues to ensure a successful implementation of the ABC system. Availability or recourses The cake firm requires considering its resources when implementing this system. ABC is expensive to implement for the firm and therefore they should set apart some funds to introduce and maintain the system. Scrutiny of activities The firm needs to properly and accurate determine all the activities that are value adding to the product. Other non value adding activities should be eliminated in order to pass relevant and fair prices to the customers. This can also be used to analyze the costs and come up with correct pricing. Record keeping and information Cambden cakes needs to keep record of all the activities carried out in the firm in order to implement a successful ABC costing system. Availability of all the relevant data will facilitate high quality decision making. Moreover, all the cost centers as well as cost centers should be identified in order to capture all the data. The management accountant should also look for all information regarding the cakes from the finance department, marketing and procurement department in order to fully scrutinize all the activities and set prices that will result to substantially high margins. Continuous review and taking corrective action. Cambden cakes limited need to constantly review their ABC system in order to ensure that all the activities are carried out as required. Any variance should be investigated and relevant corrective action should be taken. This will ensure that the firm is able to stick to the ABC system even when convenience demands that the traditional costing method may be used. Conclusion As has been seen, the proposed activity based costing method is far much better than the current traditional cost accounting method as far as giving realistic costs is concerned. As such, the managing director needs to support the accountant in her bid to change the company’s cost accounting system. This will go a long way into helping the company regain its profitable past if implemented together with the measures suggested by the managing director. However, care needs to be taken and all the suggested measures taken in order to ensure successful implementation of the system. References: Charles, T2010, Cost accounting, Oxford, Oxford University Press. Read More