Consider a company that produces two hundred different products. Due to mass production, management might lose sight of a product. If that product becomes unprofitable, the company will lose money on every sale of that product. This might lead to repercussions such as increasing the sales price of the product, cut its production cost, or discontinue its production.
This could be the scenario with all the different products.Typically, a company produces variant product lines that generate revenue. Many companies start at a small scale, grow over time with the addition of new products, and develop new markets. At a certain stage of growth, every company needs to analyze whether its existing products or the addition of new products will prove profitable or add any value to its shareholder value. Therefore, to sustain profitability and build a business with profitable products, managers need to do operational planning and make decisions based on predictions of costs and revenues.
This module describes how cost-profit-volume (CVP) analysis can be used to perform break-even analysis—a critical tool essential for determining profit margins.
Complete the following readings early in the module:
Read the online lectures for the Module
From the textbook, Accounting for Managers: Interpreting Accounting Information for Decision Making, 5th, read the following chapters:
Chapter 9: Accounting and Information Systems
Chapter 9 textbook Microsoft PowerPoint slides
Chapter 13: Overhead Allocation Decisions
Chapter 13 textbook Microsoft PowerPoint slides
Chapter 14: Strategic Investment Decisions
Chapter 14 textbook Microsoft PowerPoint slides
In your readings this module, you were introduced to Activity-Based Costing or ABC. It is a method used to determine a reliable predetermined benchmark for the allocation of overhead costs to the products produced based on their activity levels. In this discussion, we will work a case study on ABC together. For your initial response, attempt to answer the questions yourself and post all the required items into the Discussion Area. You may want to post some elements during different days so the class can work this problem together. Then in your response postings, help each other with misunderstandings or miscalculations.
Examine the case below and then…
Calculate the amount of overhead allocated to small and large advertising campaigns under existing methods.
Apply activity-based costing to calculate the cost per cost driver for each of the cost pools.
Use the costs per cost driver to calculate the activity-based overhead applicable to small and large campaigns.
Calculate the percentage to be added to direct advertising costs to recover overhead costs under activity-based costing.
Merit-o-cracy PLC is a specialist advertising agency. It has been long-established but is experiencing difficulties in winning new business. The Chief Executive believes that its pricing methods are leading to the loss of large customer advertising campaigns while it is consistently winning smaller business.
Merit-o-cracy costs work for pricing purposes on the basis of direct advertising costs (i.e. space or time purchased from newspapers, radio and TV) plus 100%. The 100% is intended to cover all the overheads of the business, which run at $2 million per year. It does not include any profit margin. This budget cost comprises:
Creative staff $500,000
Production staff $750,000
Administrative & support staff $300,000
Rental and associated costs $450,000
Merit-o-cracy classifies its advertising campaigns as either small or large. Of the 350 campaigns the agency wins, about 325 are classified as small. A typical small advertising campaign incurs direct advertising costs of $4,000 each (and therefore is allocated $4,000 of overheads under current methods). The other 25 advertising campaigns are large and incur direct advertising costs of $28,000 each.
Merit-o-cracy’s accountant has heard of activity-based costing. After speaking to the management team, she has gathered information on the most common causes of costs. She believes that creative staff costs are linked to the number of advertising campaigns the agency competes for. Production staff costs are related to the number of advertising campaigns the agency wins. Administrative and support staff costs are related to the number of customers the agency has. Rental and associated costs are people-based and as a similar number of staff is employed in each of the three departments, the costs should be equally shared.
The accountant has also collected data on the activity levels in each of the three departments over the budget period. These are:
800 advertising campaigns the agency bids for
400 of these are bids for large campaigns and 400 for small campaigns
350 advertising campaigns the agency wins
325 of these are small campaigns and 25 large campaigns
Admin & support
400 customers the agency services
300 of these are customers with small campaigns and 100 have large campaigns
By the due date assigned, post your initial response to the Discussion Area. Your response should be thorough and address all components of the posted question in detail, include citations of all sources, where needed, according to APA style, and demonstrate accurate spelling, grammar, and punctuation.
Do the following when responding:
Read your answers. Provide substantive comments contributing new, relevant information from course readings, Web sites, or other sources; building on the remarks or questions; or sharing practical examples of key concepts from your professional or personal experiences.
Respond to feedback on your posting and provide feedback to ideas. Make sure your writing is clear, concise, and organized; demonstrates ethical scholarship in accurate representation and attribution of sources; and displays accurate spelling, grammar, and punctuation.
nitial response was: Insightful, original, accurate, and timely. Substantive and demonstrated advanced understanding of concepts. Compiled/synthesized theories and concepts drawn from a variety of sources to support statements and conclusions.
Discussion Response: Offered points of view supported by research. Asked challenging questions that promoted discussion. Drew relationships between one or more points in the discussion.
Writing: Wrote in a clear, concise, formal, and organized manner. Responses were error free. Information from sources, where applicable, was paraphrased appropriately and accurately cited.