Module 6 Cost terms and Activity based costing

Chapter 12 Review Questions

Question 8: The strategic planning process involves four stages: strategic analysis, strategic planning, strategic
choice and strategy implementation. Briefly explain what each stage of the strategic planning process entails.
Providing a relevant example, explain how accounting information contributes to the decisions made by
management at each stage of the strategic planning process.

• Strategic analysis is concerned with understanding the strategic position of the

business. It is used to determine if the current strategies are the best ones for
fulfilling business goals. Where strategic analysis reveals a gap between desired
business outcomes (e.g. to maximise shareholder wealth), new strategies will
need to be created, evaluated, selected and implemented. Depending on the
magnitude of the gap between the firm’s current situation and desired position,
the strategic response could range from a fine-tuning of existing strategies, where
the performance gap is slight, to the development of completely new strategies
where the gap is large. Tools used in strategic analysis include value analysis,
with a focus on how the business creates value, and Strengths, Weaknesses,
Opportunities and Threats (SWOT) analysis, with its focus on organisational
capabilities (i.e. strengths and weaknesses) and the environment within which the
business operates (i.e. for the presence of opportunities and threats).
• Strategic planning follows strategic analysis. After management has obtained a
thorough understanding of the firm’s internal and external environments, it is in a
position to reassess the firm’s existing strategic plan and to revise it as necessary.
Strategic planning is about closing the gaps between current and expected
business performance and intended or desired performance. Among the steps involved
in strategic planning are the development of organisational vision and mission
statements and the identification of goals and objectives at both corporate and business
unit level.
• Strategy choice follows from strategic analysis and the formulation of clearly
articulated mission statements, goals and objectives. In being able to select a
strategy, alternative strategies must be developed and evaluated before a choice of
strategy is made. Thus, strategy choice will involve the generation and evaluation
of strategic options (i.e. how the business will compete such as cost leadership or
a differentiation competitive strategy) and the selection of a preferred strategy
consistent with the mission, goals and objectives and the mutual interests of key
organisational stakeholders.
• Finally, chosen strategies need to be implemented. Most strategies entail a
significant change in business activity or model and require a significant
commitment of financial and other resources. Given the business and
financial risks associated with poorly executed strategies, strategy
implementation is as important as the other management functions identified
above.
The following exhibit details the relationship with the four identified primary
strategic management functions and how accounting information contributes to
the decisions made by management at each stage of the strategic planning
process.
 Contribution of management accounting information to strategic management
Strategic analysis Provides significant information that directs managerial attention
to strategic issues. Prompts include reporting a reduction in
profitability, the loss of a major sales contract, a failure in the
implementation of a project of strategic significance or a major
change to the balance of competitive forces in the firm’s
industry.
External analysis Provides estimates of competitor costs and capital investment
projects. Conduct industry life-cycle growth and profitability
analysis and identifies the bargaining power of suppliers and
customers through the gathering of market intelligence.
Internal analysis Provides a full mapping of the business including product life-
cycle costing, market share, product profitability, process or
activity evaluation and costing, developing and reporting on
performance using balanced scorecard type financial and non-
financial measures (e.g. quality, time, innovation and customer
satisfaction) and customer profitability analysis.
Strategic planning Provides an understanding of the contributions that the business
makes to the benefit of various organisational stakeholders (e.g.
the value created and how it is shared) and the goals and
objectives that are to the mutual benefit of key stakeholders (e.g.
lowering prices for customers results in a greater market share,
improved economies of scale and enhanced returns to
shareholders).
Strategic choice Provides information that enables the sound evaluation and
ranking of the feasibility and profitability of strategies,
considering both capital investment criteria (e.g. discounted
cash- flow measures) for the quantifiable variables (e.g. cash
flows) and strategic costs/benefit analysis of those factors that
are more qualitative in nature (e.g. potential environmental
impacts and level of community concerns).
Strategic Provides accurate and timely product costing as well as financial
implementation and non-financial performance measures that can be used to
manage the implementation process and ensure that the strategy
is being properly executed.
Question 3. In each of the situations below, identify what you believe your information needs would
be.

• If you are the manager of a local branch of a national retailer. All buying is done centrally
and prices are fixed. You are in charge of the day-to-day management and hiring and firing
of staff. Your annual remuneration is fixed.

• The situation is the same as in (a) except that, in addition to your annual salary, you receive
a bonus of $200 for each $20 000 profit made above a target set by your employer.

• The situation is the same as (b) except that you are allowed to set the selling prices.

• You have been so successful as a branch manager that the company has promoted you to
the position of regional manager in charge of 20 shops. Each subordinate store-level
manager works under the same conditions as those outlined in (c).

Problem 3 In terms of the information needs of a manager of a local branch of a

national retailer where you have different responsibilities, the nature of those
responsibilities will define the extent of your decision-making powers and the
information that you will need to have access to in the making of those decisions.
a Where you are a manager where all buying is done centrally and prices
are fixed, your responsibilities are restricted to day-to-day management,
hiring and firing of staff and your annual remuneration is fixed, you may
not need much financial information. For example, as selling prices and
buying prices are fixed, you have little control over the branch’s
profitability, and you would not be judged on profits. As you do have
some control over the costs in the form of labour costs, you may require
information about spending in that area (e.g. actual versus planned
payroll costs) and your daily cash takings and inventory turnover so as to
control for pilferage of cash or inventories.
b In this case, you are a manager where all buying is still done centrally and
prices are fixed, your responsibilities are restricted to day-to-day
management, and hiring and firing of staff but your annual remuneration
now comprises an annual salary plus a bonus of $200 for each bracket of
$20 000 profit made above that expected by the company’s senior
management. In this situation, you would need to have more financial
information such as that contained in budgets where your profit target is
detailed. With the additional information about the profit target for your
branch, you will be more inclined on taking actions that will improve on
the branch’s profitability (e.g. either by increasing sales or by adjusting the
staffing of your outlet to reduce labour costs). Assuming that the branch offers
multiple products with varying levels of profitability, financial information about
product-line profitability and changes in sales mix could be useful to have access
to.
c In this case, while buying is still done centrally, you are now allowed to
set selling prices. In this situation, some of the additional information you
need to have access would include costs by product line, potential sales
volume by product line, the price elasticity of demand for different
products and competitor prices.
 d Given that you were so successful as a branch manager, you have now
been promoted to the position of regional manager with responsibility for
20 shops. With the greater responsibility that attaches to being the regional
manager, you will need to have access to an enhanced level of financial
information. In such a senior management position, you would need
information for planning and control purposes, such as profitability by
branch, turnover by branch, branch cash flows and so on.

Problem 4. Discuss the meaning and difference between strategic and operating decisions.

Problem 4 Using the metaphor of a ship, strategic decisions are those which have a
significant bearing on the direction the ship is cruising, while the operating decisions
affect the speed at which the voyage is being undertaken and how well the ship is
cruising on a day-to-day basis.
An example of a strategic decision, after accumulating significant losses on its share
of the master’s home improvement business, in January 2016 Woolworths’ made the
decision to shut the business down incurring approximately $1.8 billion in asset
write- downs and total losses of some $3.25 billion. In announcing the appointment
of Brad Banducci as incoming chief executive officer of Woolworths Limited,
Chairman Gordon Cairns2 noted that the decision to the exit home improvement
business would allow Woolworths to ‘… focus its energy and resources on
strengthening and execute its plan in its core business the company’s intention was
to rebuild.’ Cairns also noted ‘At the AGM I outlined clear business priorities to
rebuild Woolworths, with a particular focus on our supermarkets business to ensure
we are competing vigorously …’, winning the trust of customers, increasing its
share of customers’ food spend through lower prices and ‘improving all aspects of
their shopping experience’. These two strategic decisions reflect how the course of
Woolworths was altered in light of a reassessment of the future direction that the
company intended to take.
Operational decisions flow from the strategic decisions made. With the master’s
home improvement business, throughout the life of this business unit,
Woolworths made numerous operational decisions in an attempt to achieve at
least break-even on its venture. These operational decisions ranged from
appointing Matt Tyson, an experienced home improvement executive, as the
managing director for Masters in January 2014; the slowing of the roll-out of
new stores; modifying the in-store offer to include more and higher stock
densities of hardware products and less of low-margin whitegoods and
homewares; reduced staffing levels and so on. In terms of how well the master’s
home improvement business was performing, clearly these operational decisions
failed senior management’s desire to breakeven within an acceptable time frame
and prompted the change in business strategy.
In terms of the strategy to rebuild Woolworths, with a focus on its supermarket
business3, operational decisions taken by the retailer included: investing
approximately $1 billion in cumulative price reductions since January 2015;
ensuring parity between online and store prices; additional employee hours worked
in stores to lift customer service levels; extra stock levels added across the retailing
network to boost availability; a major focus on improving the range and freshness of
fruit and vegetables; store refurbishments and improved use of data analytics.
 2
Cole, Catie, “Woolworths swings to $973m loss, appoints new CEO”, The Sydney Morning
Herald, 26 February 2016 at 10.15 AM AEDT. Source:
https://www.smh.com.au/business/companies/woolworths- announces-supermarkets-
boss-brad-banducci-as-chief-executive-20160226-gn42mz.html).
3
Mitchelson, Alana, “How Woolworths is winning over consumers”, The New Daily, 23 February 2018
at 9.14 PM AEDT. Source: https://thenewdaily.com.au/money/finance-news/2018/02/23/woolworths-
half-year- profit-coles/).

Problem 6. Give illustrations of ways in which the behaviour of individuals can affect the planning
and control process.

Problem 6 This is an ideal situation to focus on how people will react to setting their
own targets, having targets set for them, and then relating this to a business
situation. For example, in terms of students who are using this textbook for a unit
that will be assessed, what pass mark would they set for an examination they are
about to sit? How would students react if the instructor specifies that a pass mark is
80 per cent or more? Where a student sets a low pass mark as it can be easily
achieved and may offer some motivation to the student to succeed, it is unlikely to
elicit the drive to obtain a higher level of learning. On the other hand, while the
instructor in setting a pass mark of 80 per cent or more might be intended to
encourage students to achieve a higher level of learning, students may feel
demotivated as the pass mark is beyond their ability or capacity to achieve. In a
business situation, who (i.e. a superior or subordinate managers) sets input and
output budget targets would raise similar issues as those discussed above.

Problem 8. Describe why it is important to set strategic goals for a business and comment on the
problems of setting those goals.

Problem 8 If precise objectives are not set, a business may drift along not knowing
where they are going. Planning will be hazardous as planners are not aware of
what specifically is required from them and there is no basis for establishing
whether or not the business is actually succeeding. The major problems associated with
setting objectives relate to the fact that different people involved in a business will have
varying goals (e.g. shareholders, lenders and employees), and these objectives may be in
conflict.

Chapter 14 review questions

Question 1. Explain why it is important to determine product or service cost.

 1 The main reasons why it is important for a firm to determine product or service costs
include:
• To aid planning. As the planning process involves in forming
estimates of future (e.g. budgeted) costs of products or services, the
determination of the current costs of products or services provides a
base upon which those estimates can be prepared.
• To control costs. If costs are to be controlled, an estimate of future
costs of products or services must be determined to enable the
comparison of actual with budgeted costs.
• For valuing inventories remaining on hand at the end of the accounting
period. It follows that these values will be influential in determining
income. Note that as services cannot be stored for subsequent sale, this
reason only applies to products.
• To aid in the setting of selling prices. In a number of situations, the
selling price of a product or service will be based on setting the cost of
that product or service (e.g. where a market price does not constrain a
firm’s pricing decisions, as in the case of a monopoly or an oligopoly
where the firm is a price maker than a price taker).
• To ascertain the relative profitability of individual products or
services in a multi- product/service firm. As the profitability of each
product or service may vary, knowledge of product or service cost is
essential if managers are to make a decision about the optimal mix
of products or services to supply to the firm’s market.

Question 5. Give examples of expenditure in a manufacturing firm that would be classified as direct
costs and indirect costs.

1 Where the cost object is a product, the following are typically categorised as
direct costs in a multi-product firm:
• direct materials
• components specifically purchased for the production of products
• direct labour
• any other costs that are directly traceable to products and services (e.g.
utility costs that are metred to a dedicated manufacturing production
line).
The following are examples of indirect costs in a multi-product firm:
• supervision
• inspection
• maintenance
• personnel services.
Question 12 ‘ABC is only really useful for costing manufactured products. Thus ABC is of no use to
service-providing organisations’. Critically evaluate this statement using an example of a service-
providing industry (e.g., health care, higher education, banking or retailing) to support your view.

1 The use of the term ‘activity’ in activity-based costing (ABC) is important

as it infers that wherever activities are undertaken and costs incurred, ABC
could feasibly be employed. While ABC is commonly associated with
manufacturing activity, partly because of the tangibility and measurability
of the output produced (i.e. products), wherever activities are performed
and there is some complexity in the output arising from those activities,
ABC could be meaningfully employed.
For example, the needs of a retailer’s customers are served by a wide range of
activities such as marketing, customer order receipt, processing and despatch
and after-sale support. As not all customers place the same demands on those
services, some customers will be more costly to support than others.
Similarly, as customers vary in the volumes (i.e. low or high) and the mix of
products (i.e. low versus high margin) purchased and the prices offered (e.g.
volume- based or preferred customer discounts), the revenue generated from
each customer will be different.
Notwithstanding any differences that might occur in the costs of the products
actually sold and the sales revenue generated, the retailer’s recognition of the
differences in support costs between different customers may alter the firm’s
perception as to who are the most and least profitable customers. Hence ABC
will allow a better allocation of customer support costs to the customers that
consume the activities that cause those costs to be incurred.
As an extension, the usefulness of ABC to other types of service providing
industries could be explored. For example:
• A university. A university’s academic programs encompass different
disciplines (e.g. business, arts and the sciences); different levels of study
(e.g. undergraduate commerce versus MBA), length of study (e.g. two,
three or four years), modes of study (e.g. on- campus, online or blended
learning) and are supported by a wide range of services (e.g. library and
information services, academic and student services, and
administration). If a cost object is a ‘student’, given the variability in the
consumption of the academic and support activities that are supplied to
and consumed by each student, ABC might provide a better estimate of
the ‘true’ cost of each student. With deregulated higher education fees in
some settings, a university and other stakeholders (e.g. potential
students), knowledge of such ‘true’ costs might be invaluable
information to the university in setting the fees for different degrees and
for potential students in them being able to enrol is an institution and
program providing a superior value for money (i.e. fee) offer.
• A financial institution (e.g. a bank). A bank offers a wide range of
financial products (e.g. deposit accounts, credit and debit cards, personal
and business loans, insurance and wealth management) to a diverse
clientele (e.g. small, medium and large customers and personal and
business banking) and supports these customers in different ways (e.g.
the mode of banking such as face-to-face branch-based services,
 telephone and internet banking and access to dedicated personal banking
managers). As with the multi-product manufacturer, a bank might find
that not only will ABC provide a better appreciation of the true cost of
each financial product offered it also gives a more accurate
understanding of the costs it incurs in servicing the banking needs of
individual customers (or customer groups).
• A large tertiary-level hospital. Large tertiary level hospitals provide
a wide range of highly specialised health care services, often for in-
patients and on referral from a
primary (i.e. general practice) or secondary (i.e., specialist) health care
professional. This often includes particularly complex medical or
surgical procedures in various areas of health care (e.g. audiology, burns,
cancer, cardiology, clinical psychology and clinical neuro-psychology,
clinical immunology, dietetics, emergency and intensive care,
endocrinology and diabetes, gastroenterology, gynaecology, medical
imaging, orthopaedics, podiatry, respiratory medicine, urology and so
on) to a diverse patient cohort (e.g. age, ethnicity and gender) and
differing levels of severity (e.g. chronic and acute health conditions). As
with the multi-product manufacturer, a hospital might find that not only
does ABC provide a better appreciation of the true cost of each form of
health care it provides but it also gives a more accurate understanding of
the costs it incurs in servicing the health needs of different patients. This
is particularly important when the hospital receives its funds based on
the number and mix of patients it treats and the complexity of care
provided (See activity-based funding (ABF). Source:
https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/
Parliamentary_ Library/pubs/rp/rp1819/Quick_Guides/FundingPH).
While ABC was initially introduced as an improved approach for product
costing purposes, its value in accurately measuring the cost of other cost
objects became apparent. Thus, ABC is not just about product costing as it
represents a systematic approach to analysing the costs associated with all
management decisions impacting on the activities undertaken and resources
consumed. Although accurate costing of products is a critical aspect of
strategic analysis, as this information is important in pricing and product-mix
decisions so too are
ABC-based analyses of customer profitability and supplier costs.

Problem 2

GPS Ltd produces digital mapping devices for luxury cars and uses a normal costing
system. The following data is available for the current year:
Budgeted
Units to produce and sell 120000
Manufacturing overhead 1275000
Machine hours 40000
Direct labour hours 60000
Actual
 Units produced 125000
Overhead 1275000
Prime (direct) costs 1875000
Machine hours 40835
Direct Labour Hours 64375

Calculate the predetermined overhead rate where overhead is applied on the basis
Required of:
Budgeted Overhead 1275000
a (i) budgeted units 120000 10.625
a(ii) budgeted machine hours 40000 31.875
a(iii) budgeted direct labour hours 60000 21.25
Calculate the applied overhead for the current year where overhead is applied on
the basis of:
Budgeted rate times
actual level of allocation
b(i) budgeted units 1328125 basis
b(ii) budgeted machine hours 1301616
b(iii) budgeted direct labour hours 1367969
Determine if and by how much overhead was over-applied or (underapplied) during
the current year, where overhead was applied on the basis of:
c(i) budgeted units 53125
c(ii) budgeted machine hours 26616
c(iii) budgeted direct labour hours 92969
Calculate the manufacturing cost per unit for the current year where overhead is
applied on the basis of:
Prime Cost per
Costs Overhead Total unit
d(i) budgeted units 1875000 1328125 3203125 25.625
d(ii) budgeted machine hours 1875000 1301616 3176616 25.413
d(iii) budgeted direct labour hours 1875000 1367969 3242969 25.944
solution
Problem 10 (page 462)
Jay Dees Boats Ltd builds custom-designed company boats. The company uses an activity-based
costing system for determining the costs of each boat it produces. The following activities and cost
drivers apply to the construction of boats
Activity Cost driver
Construction Direct labour hours (DLH)
Inspection Time to inspect (TTI)
Testing Time to test (TTT)

At the beginning of the current year, the following estimates were made for each activity and cost
driver.

Estimated cost
Estimated costs for year driver hour Rate

Construction 3,000,000 100000 DLH 30.00

Inspection 1,000,000 20000 TTI 50.00

Testing 500,000 8000 TTT 62.50

4,500,000
During March this year, the actual direct materials and amounts for each cost driver for two boats
were
Mustang Jaguar
Direct materials 160000 120000
Construction DLH 4000 6000
Inspection time 800 1200
Testing time 200 300
Required
a. Determine the total cost for Mustang and Jaguar

Costs Mustang Jaguar total

Direct Materials 160000 120000
Direct Labour -
Construction 120000 180000 300000
Inspection 40000 60000 100000
Testing 12500 18750 31250
Total 332500 378750 431250

b. if the actual overhead for March was $440 000, was the overhead under or over-applied in
March?
440000
431250
8750 Underapplied