Using Relevant Costs to Calculate Overhead Essay

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Accounting

This accounting report is intended to emphasize the importance of the role of a management accountant in business operational and financial decisions. The focus on two companies engaging in different lines of business with disparate concerns, questions, and issues provides a basis for the reader to understand specific instances in which a management accountant can play a pivotal role in the success of an enterprise. W. White Chemicals was perplexed about their loss of market share and a small drop in revenue. When the executives came together to discuss the problems, they each had a different opinion about the source of the problem and the possible solutions. The management accountant was able to demonstrate how a change from the traditional accounting system the company was using to an activity-based system would help the team interpret the market situation and get a handle on the actual, rather than the obfuscated, costs the company was encountering.

Mosby Design & Manufacturing faced a decision common to many companies. The enterprise needed to determine if they should continue to manufacture a particular part or if they should purchase the part directly from another vendor. The question was sufficiently complex that the company needed to rely on information that their management accountant could provide. An in-depth examination of fixed and variable costs associated with the production of part RB911 was needed, and the stakes were high as the production line supervisor's job hung in the balance.

Introduction and Purpose of Analysis

By demonstrating the impact that accounting methods can have on the bottom line, the report enables the reader to gain a perspective about accounting as more than just ensuring that the financial statements align. Many key business decisions depend on the deep knowledge that management accountants bring to the table.

The purpose of the analysis was to provide a comparison between two different types of accounting practices by illustrating the influence that the methods can have on the capability of businesses to address their margins. Gaining competitive advantage is a focus for management accountants, but in order to know what and how to change resource allocation and operations, it is essential to know how the changes will effect the fiscal situation of the firm. Fundamental accounting principles are the touchstones for successful business operations, as this report illustrates through the two brief cases.

Part A: W. White Chemicals

1. The dollars per unit gross margin per product are as shown in the table below:

2. The unit cost for each product and the dollars per unit gross margin for each product are shown in the table below:

Comparison ABC to Traditional Costing (Overhead per Unit)

Traditional

ABC

V-312

$0.13

$3.36

T-415

$0.06

$18.14

3. The company should switch its emphasis from the high volume product to the low volume product since it sells at a premium price. The company can engage in lower levels of production and make a larger margin. The traditional method of accounting uses only the direct labor dollars to calculate the cost allocation. This means that a product with high direct labor dollars will be allocated a larger share of the overhead dollars than a product with low direct labor dollars. When direct labor dollars are used to allocate overhead, the number of orders, setups, or tests the product actually uses do not impact that allocation.

4. The customers are willing to accept a 25% increase in the price of T-415 since the cost of production is actually higher than the company has determined, which most likely means that the customers have shopped around and observed that T-415 is selling at much higher prices by competitors. Although the customers might seem price insensitive, they are actually not: rather, the company is not truly aware of the pricing that competitors use for T-415. Competitors have priced themselves out of the market, thereby lowering the competition for supply of T-415.

5. The company should strive to be more efficient in the production of V-312 as their estimations of production costs were distorted by the accounting method they use; they have considerable room for improvement. The company should be the go-to source for T-415, making pricing changes to accommodate the difficulties of manufacturing the product and the fact that customers expect the price to be higher for T-415 than the company is currently charging.

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Part B: Mosby Design & Manufacturing

1. The decision Mosby needs to make is whether to continue to manufacture the part RB911 or if it would be more advantageous to simply buy the part from an outside vendor. The direct fixed manufacturing costs represent the salary of the production line supervisor and the lease of the production machinery. The decision to make or buy the part RB911 will have no effect on the common fixed costs of the company and any facilities space used for the manufacturing would just be empty and idle, or converted at some other time -- not related to this immediate decision as it has been presented. The company would save $100,000 annually by buying the part from a supplier. If Mosby reports the fixed overhead costs as a part (portion, fraction) of each unit manufactured, it looks more profitable as the production levels increase. And if the extra parts inventory is actually sold, then the profits are actual -- not just on paper. If, on the other hand, the extra parts are stockpiled in the inventory, then that reduction of overhead costs per unit will not really contribute to the company's profit.

2. The most that Mosby would be willing to pay an outside supplier for the part is based on his margin and his break-even point. The most Mosby would be willing to pay an outside suppler for the part would need to be less than his breakeven point, which is .26 per unit and $4. 65 in total sales.

3. If Mosby bought the part instead of manufacturing the part internally, the company's revenue would increase by $100,000 annually.

4. If all fixed overhead is common fixed overhead, Mosby should buy the part because his cost per part is $20.70 as $72, 000 is common fixed overhead manufacturing costs. The figure is 55% of the total fixed overhead costs of $160,000.

5. If all of the fixed overhead is common fixed overhead, the most Mosby would be willing to pay an outside suppler for the part would need to be less than his breakeven point, which is .40 per unit and $7.20 in total sales.

6. If the entire fixed overhead is common fixed overhead, and Mosby bought the part from an outside vendor, the company's income would decrease by $188,000.

Part C: Role of Management Accountant and Conclusion

Management accountants are key members of a company's team, and they are charged with helping to the owners, managers, and board of directors make significant financial decisions. Indeed, " management accountants are risk managers, budgeters, planners, strategists and decision makers" (Investopedia," 2014). It can be seen from the case problems that the role of the management accountant in refining operational costs and helping to set strategic priorities can be critical to successful marketing and production. Clearly, some of the elements of accounting that occupy the efforts of management accountants include accurate accounting, cost determination, choosing the best method of assigning overhead costs, and identifying and reporting on relevant costs.

Activity-based costing (ABC) provides a method to allocate costs with greater accuracy when many of the overhead costs are not incurred all at the same time when the direct labor dollars are being accrued. As activities are identified in production, the costing system can become very complex, so much so, that computer software programs are needed to manage the data. When companies try to manage the complexity of an ABC system by reducing the number of activities included in the costing system, the allocations can become arbitrary, thereby reducing the accuracy of the overall system. A management accountant can help the company understand how these decisions can undermine their best efforts to understand and control costs. With a simple demonstration of the difference that one cost accounting over another can make to the bottom line, a management accountant can go a long way toward encouraging a company to adopt the most effective and accurate accounting system for the needs inherent to the type of business in which they are engaged......

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