ACC203 – Activity-based costing- East Coast Marine Ltd (ECM) manufactures parts for small marine craft. Over the past

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ACC203 – Management Accounting

East Coast Marine Ltd (ECM) manufactures parts for small marine craft. Over the past decade, ECM’s management has met its goal of reducing its reliance on government contract work to 50 per cent of total sales. ECM is now equally reliant on commercial sales and government contracts. Traditionally, the costs of the Material Handling Department have been allocated to direct material as a percentage of direct material dollar value.

 This was adequate when the majority of the manufacturing was homogeneous and related to government contracts. Recently, however, government auditors have rejected some proposals, stating that ‘the amount of Material Handling Department costs allocated to these proposals is disproportionate to the total effort involved’. Eloise Smith, the newly hired cost accounting manager, was asked by the manager of ECM’s Government Contracts Unit, Paul Jones, to find a more equitable method of allocating the Material Handling Department costs to the user departments. 

Her review has revealed the following information: ? The majority of the direct material purchases for government contracts are high-dollar, low-volume purchases, while commercial materials represent low- dollar, high-volume purchases. ? Administrative departments such as Marketing, Finance and Administration, Human Resources and Maintenance also use the services of the Material Handling Department on a limited basis but have never been charged in the past for material handling costs. ? One purchasing manager with a direct phone line is assigned exclusively to purchasing high-dollar, lowvolume material for government contracts on an annual salary of $36 000. Employee on-costs are estimated to be 20 per cent of the annual salary. The annual costs of the dedicated phone line are $2800. ? The components of the Material Handling Department’s budget for the coming year, as proposed by Lindley’s predecessor, follow. Payroll $180000 Employee on-costs 36000 Telephone 38000 Other utilities 22000 Materials and supplies 6000 Depreciation 6000 Direct material budget: Government contracts 2006000 Commercial products 874000 Smith has estimated the number of purchase orders to be processed in the coming year as follows: Government contracts* 80000 Commercial products 156000 Marketing 1800 Finance and Administration 2700 Human Resources 500 Maintenance 1000 Total 242000 3 * Exclusive of high-dollar, low-volume materials. Smith has recommended to Jones that material handling costs should be allocated on a per purchase order basis. Jones realises that the company has been allocating to government contracts more material handling costs than can be justified. However, the implication of Smith’s analysis could be a decrease in his unit’s earnings and, consequently, a cut in his annual bonus. Jones told Smith to ‘adjust’ her numbers and modify her recommendation so that the results will be more favourable to the Government Contracts Unit. Being new in her position, Smith is not sure how to proceed. She feels ambivalent about Jones’ instructions and suspects his motivation may not be in the best interest of ECM. To complicate matters for Smith, the company’s new managing director has asked her to prepare a three-year forecast of the Government Contracts Unit’s results, and she believes that the newly recommended allocation method would provide the most accurate data. However, this would put her in direct opposition to Jones’ directives. Smith has assembled the following data to project the material handling costs over the next three years: ? The number of purchase orders increases 5 per cent per year. ? The ratio of government purchase orders to total purchase orders remains at 33 per cent. ? Total direct material costs increase 2.5 per cent per year. ? Material handling costs remain the same percentage of direct material costs. ? Direct government costs (payroll, employee on-costs, and direct phone line) remain constant. ? In addition, she has assumed that the cost of government material in the future will be 70 per cent of total material. Required: 1 Calculate the material handling rate that would have been used by Eloise Smith’s predecessor at East Coast Marine. 2 Calculate the revised material handling costs to be allocated on a per purchase order basis. 3 Discuss why purchase orders might be a more reliable cost driver than the dollar amount of direct material. 4 Calculate the difference due to the change to the new method of allocating material handling costs to government contracts. 5 Prepare a forecast of the cumulative dollar impact over a three-year period (based on the coming year plus 2 more years) of Eloise Smith’s recommended change for allocating Material Handling Department costs to the Government Contracts Unit. Round all calculations to the nearest whole number. 6 Referring to the standards of ethical conduct for accountants described in Chapter 1: (a) Discuss why Eloise Smith has an ethical conflict. (b) Identify several steps that Smith could take to resolve the ethical conflict. 4

 Question 2: Pricing & possible plant closure Handy Household Products Ltd is a multiproduct company with several manufacturing plants. The Fremantle plant manufactures and distributes two household cleaning and polishing compounds, standard and commercial, under the Clean & Bright label. The forecast operating results for the first six months of the current year, when 100000 boxes of each compound are expected to be manufactured and sold, are presented in the following statement: Clean& Bright Compounds, Fremantle plant Forecast results of operations for the six-month period ending June 30 (in $'000s) Sales Standard $2000 Commercial $3000 Total $5000 Cost of goods sold 1600 1900 3500 Gross profit $ 400 $1100 $1500 Selling and administrative expenses: Variable $ 400 $ 700 $1100 Fixed* 240 §QQ Total selling and administrative expenses $ 640 $1060 $1700 Profit (loss) before taxes $ (240) $ 40 = $ (200) *The fixed selling and administrative expenses are allocated between the two products on the basis of dollar sales volume. The standard compound sold for $20 a box and the commercial compound sold for $30 a box during the first six months of the year. The manufacturing costs are presented in the schedule below. Each product ismanufactured on a separate production line.Annual normal manufacturing capacity is 200 000 boxes of each product. However. the plant is capable of producing 250 000 boxes of standard compound and 350000 boxes of commercial compound annually. Cost per box Standard Commercial Direct material $7.00 $8.00 Direct labour 4.00 4.00 Variable manufacturing overhead 1.00 2.00 Fixed manufacturing overhead 4.00 5.00 Total manufacturing cost $16.00 $19.00 Variable selling and administrative costs $4.00 $7.00 The following schedule reflects the consensus of top management regarding the price-volume alternatives for the Clean & Bright products for the last six months of the current year. These are essentially the same alternatives management had during the first six months of the year. Standard compound Commercial compound Alternative prices (per box) Sales volume (in boxes) Alternative prices (per box) Sales volume (in boxes) $18 120000 $25 175000 20 100000 27 140000 21 90000 30 100000 22 80000 32 55000 23 50000 35 35000 5 Handy Household Products' top management believe that the loss for the first six months reflects a tight profit margin caused by intense competition. Management also believe that many companies will leave this market by next year and profit should improve. 

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