Description
Document that describes how to Study current cost structure of a company and suggest changes if required and to identify different cost pools and cost drivers, to propose a activity based cost model.
2009
[MAC PROJECT - COST RESTRUCTURING]
Study current cost structure of a company and suggest changes if required
Table of Contents
Table of Contents....................................................................................................... 2
Cost Structure: Leaps n Bound Shoe Company
Page 2
1. Acknowledgement
This project has been an opportunity for all of us to gain a hands?on experience on a live project. First of all we would like to thank Mr. Yoginder Singh, MD, Leaps n Bound Shoe Company to show trust in the students of IMT Ghaziabad and entrusting us with the responsibility to restructuring their costing framework. We would like to convey our heartfelt thanks to Prof Ashish Verma to give us the opportunity to take up this project. His suggestions have been the only source of guidance for us throughout.
Cost Structure: Leaps n Bound Shoe Company
Page 3
2. Introduction
In business, retail, and accounting, a cost is the value of money that has been used to produce something and hence not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically. Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the Supply Chain (the series of events in the production process that, in concert, result in a product) into financial values. There are various managerial accounting approaches ? ? ? ? ? ? Standardized or Standard Cost Accounting Lean accounting Activity-based Costing Resource Consumption Accounting Throughput Accounting Marginal Costing / Cost-Volume-Profit Analysis
Classical Cost Elements are:
Cost Structure: Leaps n Bound Shoe Company
Page 4
1. Raw Materials 2. Labor 3. Indirect Expenses / Overhead In Traditional costing system the entire overhead cost is subdivided either on the basis of predetermined overhead rates or on the basis of total number of units produced. The overhead rates are obtained by either historical data analysis or by dividing the overhead cost by the units of the overhead driver. Activity-based costing (ABC) is a costing model that identifies activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each: it assigns more indirect costs (overhead) as direct costs. The entire overhead cost is divided into various cost pools and cost drivers are determined. The cost pools are associated with corresponding cost drivers. The cost is then divided as per the amount of the activity used by a product. Thus, amount of overhead to be assigned to each product is determined. In this way an organization can precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and reducing the prices of those which are overpriced.
Cost Structure: Leaps n Bound Shoe Company
Page 5
3. Objective
a) To study to the cost structure of a manufacturing company b) To identify different cost pools and cost drivers c) To propose a activity based cost model
Cost Structure: Leaps n Bound Shoe Company
Page 6
4.
Company Background
The company under study is a shoe manufacturing firm based out of Ghaziabad. The name of the company is Leaps n Bound Shoe Company. The company operates in a monopolistically competitive environment and thus it is a price taker. As the selling price of the product is sacrosanct, cost is a major factor impacting the bottom line of the company. Company is in its nascent stage of growth with a capital investment of Rs. 6 million. It currently manufactures two types of shoes viz. P.T Shoe and Jungle Shoe. It plans to develop more types of footwear in the coming years.
a) Current Cost Structure
The company currently follows a traditional costing system. The current overhead driver is labor hour. The overhead cost consists of electricity bill, generator operating cost, indirect labor cost, delivery cost, communication cost, machine depreciation and maintenance cost. The shoe of each type is produced in lots of 100 pieces each. Separate machines are used to manufacture each product. The cost break up for each product has been listed in the attached excel sheet. The total cost of P.T shoe is Rs. 39 per pair and the cost of Jungle shoe is Rs.53.50 per pair. The corresponding overhead cost per pair is Rs. 14 and Rs.17.50 respectively. It can be easily analyzed that the overhead cost is a significant percentage of the overall cost. Thus, it makes sense to look for other costing options.
b)
Manufacturing Process
The manufacturing process consists of the following steps.
i)
Purchase of Raw Material All the raw material viz. cloth, threads, laces, PUC, adhesives etc are purchased before the start of the production process. The raw material cost per unit for P.T Shoe and Jungle shoe is Rs. 20 and Rs. 30 respectively.
ii)
Hiring Contract Labors
Page 7
Cost Structure: Leaps n Bound Shoe Company
Labors are hired for two main processes viz. stitching and sole creation. The hired labor charges a per piece rate for each of the two products. As more effort goes into stitching of Jungle shoe, the rate per piece is high. Also, amount of time spend in stitching per piece is also more as compared to P.T Shoe.
The labor for the two above mentioned processes is different. The amount of work performed for sole creation of both the products is same and thus same charges are applied. The working hours per day are 10.
iii)
Production Process The production process consists of cutting cloth into upper section of the shoe, supplying the same to the sole creation department, affixing the upper into the die and attaching the die in the machine for sole manufacturing, detaching the piece from die.
iv)
Inspection Each piece is inspected and packaged before delivery.
v)
Delivery A lot of each good is transported from the factory to the distributor every alternate day. P.T Shoe is delivered every alternate day and Jungle shoe once in 4-5 days.
There are two supervisors one each for P.T Shoe and Jungle shoe. One guard, two helpers and two housekeeping persons help to maintain the facility. One driver has also been hired to transport goods from factory to the distributor’s location and vice versa.
Generators takes over when the electricity supply from electricity board is discontinued.
Cost Structure: Leaps n Bound Shoe Company
Page 8
5. Activity Based Cost Structure
The manufacturing process mentioned above consists of a lot of steps. Also, overhead cost is a significant portion of the product cost. Thus, it makes sense to look into activity based cost structure. The entire overhead cost can be broken down into 9 activities viz. Indirect labor, electricity bills, generator operating cost, delivery cost, communication cost, inspection cost, machine depreciation, maintenance and miscellaneous cost. The amount corresponding to each activity has been listed in the attached excel sheet. The cost pool and the corresponding cost driver have also been listed in the attached excel sheet. After applying ABC, the costs of the two products have changed a bit. P.T shoe now costs Rs. 41 and Jungle shoe Rs. 52, a change of Rs. 2 and Rs 1.50 respectively. Although the changes may not look significant at the first look but introduction of new products (and new processes) in the later stages of expansion of the company may lead to a significant difference.
Cost Structure: Leaps n Bound Shoe Company
Page 9
6. Analysis
The price of P.T Shoe and Jungle shoe as per the current cost structure is Rs.39 and Rs.53.50 respectively and the prices for the same post ABC application comes out to be Rs.41 and Rs.52. The selling price of the P.T Shoe is Rs.45 and Jungle shoe is Rs.60. With the initial cost structure, selling P.T shoe fetched a profit of 15.38% and Jungle shoe fetched a profit of 12.1%. Post ABC structuring, the profits of P.T shoe and Jungle shoe have changed to 9.7% and 15.38% respectively. It can be seen that the profit margins have changed. Jungle shoe has become more profitable. It makes more sense to manufacture more Jungle Shoe if demand is there.
Cost Structure: Leaps n Bound Shoe Company
Page 10
7. Recommendation
As can be seen, Activity based costing presents a better picture of the cost associated with a product. Thus, we recommend using Activity based costing.
Cost Structure: Leaps n Bound Shoe Company
Page 11
Bibliography
a) Managerial Accounting by James Jiambalvo
b) www.wikipedia.com
Cost Structure: Leaps n Bound Shoe Company
Page 12
doc_612690633.doc
Document that describes how to Study current cost structure of a company and suggest changes if required and to identify different cost pools and cost drivers, to propose a activity based cost model.
2009
[MAC PROJECT - COST RESTRUCTURING]
Study current cost structure of a company and suggest changes if required
Table of Contents
Table of Contents....................................................................................................... 2
Cost Structure: Leaps n Bound Shoe Company
Page 2
1. Acknowledgement
This project has been an opportunity for all of us to gain a hands?on experience on a live project. First of all we would like to thank Mr. Yoginder Singh, MD, Leaps n Bound Shoe Company to show trust in the students of IMT Ghaziabad and entrusting us with the responsibility to restructuring their costing framework. We would like to convey our heartfelt thanks to Prof Ashish Verma to give us the opportunity to take up this project. His suggestions have been the only source of guidance for us throughout.
Cost Structure: Leaps n Bound Shoe Company
Page 3
2. Introduction
In business, retail, and accounting, a cost is the value of money that has been used to produce something and hence not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically. Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the Supply Chain (the series of events in the production process that, in concert, result in a product) into financial values. There are various managerial accounting approaches ? ? ? ? ? ? Standardized or Standard Cost Accounting Lean accounting Activity-based Costing Resource Consumption Accounting Throughput Accounting Marginal Costing / Cost-Volume-Profit Analysis
Classical Cost Elements are:
Cost Structure: Leaps n Bound Shoe Company
Page 4
1. Raw Materials 2. Labor 3. Indirect Expenses / Overhead In Traditional costing system the entire overhead cost is subdivided either on the basis of predetermined overhead rates or on the basis of total number of units produced. The overhead rates are obtained by either historical data analysis or by dividing the overhead cost by the units of the overhead driver. Activity-based costing (ABC) is a costing model that identifies activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each: it assigns more indirect costs (overhead) as direct costs. The entire overhead cost is divided into various cost pools and cost drivers are determined. The cost pools are associated with corresponding cost drivers. The cost is then divided as per the amount of the activity used by a product. Thus, amount of overhead to be assigned to each product is determined. In this way an organization can precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and reducing the prices of those which are overpriced.
Cost Structure: Leaps n Bound Shoe Company
Page 5
3. Objective
a) To study to the cost structure of a manufacturing company b) To identify different cost pools and cost drivers c) To propose a activity based cost model
Cost Structure: Leaps n Bound Shoe Company
Page 6
4.
Company Background
The company under study is a shoe manufacturing firm based out of Ghaziabad. The name of the company is Leaps n Bound Shoe Company. The company operates in a monopolistically competitive environment and thus it is a price taker. As the selling price of the product is sacrosanct, cost is a major factor impacting the bottom line of the company. Company is in its nascent stage of growth with a capital investment of Rs. 6 million. It currently manufactures two types of shoes viz. P.T Shoe and Jungle Shoe. It plans to develop more types of footwear in the coming years.
a) Current Cost Structure
The company currently follows a traditional costing system. The current overhead driver is labor hour. The overhead cost consists of electricity bill, generator operating cost, indirect labor cost, delivery cost, communication cost, machine depreciation and maintenance cost. The shoe of each type is produced in lots of 100 pieces each. Separate machines are used to manufacture each product. The cost break up for each product has been listed in the attached excel sheet. The total cost of P.T shoe is Rs. 39 per pair and the cost of Jungle shoe is Rs.53.50 per pair. The corresponding overhead cost per pair is Rs. 14 and Rs.17.50 respectively. It can be easily analyzed that the overhead cost is a significant percentage of the overall cost. Thus, it makes sense to look for other costing options.
b)
Manufacturing Process
The manufacturing process consists of the following steps.
i)
Purchase of Raw Material All the raw material viz. cloth, threads, laces, PUC, adhesives etc are purchased before the start of the production process. The raw material cost per unit for P.T Shoe and Jungle shoe is Rs. 20 and Rs. 30 respectively.
ii)
Hiring Contract Labors
Page 7
Cost Structure: Leaps n Bound Shoe Company
Labors are hired for two main processes viz. stitching and sole creation. The hired labor charges a per piece rate for each of the two products. As more effort goes into stitching of Jungle shoe, the rate per piece is high. Also, amount of time spend in stitching per piece is also more as compared to P.T Shoe.
The labor for the two above mentioned processes is different. The amount of work performed for sole creation of both the products is same and thus same charges are applied. The working hours per day are 10.
iii)
Production Process The production process consists of cutting cloth into upper section of the shoe, supplying the same to the sole creation department, affixing the upper into the die and attaching the die in the machine for sole manufacturing, detaching the piece from die.
iv)
Inspection Each piece is inspected and packaged before delivery.
v)
Delivery A lot of each good is transported from the factory to the distributor every alternate day. P.T Shoe is delivered every alternate day and Jungle shoe once in 4-5 days.
There are two supervisors one each for P.T Shoe and Jungle shoe. One guard, two helpers and two housekeeping persons help to maintain the facility. One driver has also been hired to transport goods from factory to the distributor’s location and vice versa.
Generators takes over when the electricity supply from electricity board is discontinued.
Cost Structure: Leaps n Bound Shoe Company
Page 8
5. Activity Based Cost Structure
The manufacturing process mentioned above consists of a lot of steps. Also, overhead cost is a significant portion of the product cost. Thus, it makes sense to look into activity based cost structure. The entire overhead cost can be broken down into 9 activities viz. Indirect labor, electricity bills, generator operating cost, delivery cost, communication cost, inspection cost, machine depreciation, maintenance and miscellaneous cost. The amount corresponding to each activity has been listed in the attached excel sheet. The cost pool and the corresponding cost driver have also been listed in the attached excel sheet. After applying ABC, the costs of the two products have changed a bit. P.T shoe now costs Rs. 41 and Jungle shoe Rs. 52, a change of Rs. 2 and Rs 1.50 respectively. Although the changes may not look significant at the first look but introduction of new products (and new processes) in the later stages of expansion of the company may lead to a significant difference.
Cost Structure: Leaps n Bound Shoe Company
Page 9
6. Analysis
The price of P.T Shoe and Jungle shoe as per the current cost structure is Rs.39 and Rs.53.50 respectively and the prices for the same post ABC application comes out to be Rs.41 and Rs.52. The selling price of the P.T Shoe is Rs.45 and Jungle shoe is Rs.60. With the initial cost structure, selling P.T shoe fetched a profit of 15.38% and Jungle shoe fetched a profit of 12.1%. Post ABC structuring, the profits of P.T shoe and Jungle shoe have changed to 9.7% and 15.38% respectively. It can be seen that the profit margins have changed. Jungle shoe has become more profitable. It makes more sense to manufacture more Jungle Shoe if demand is there.
Cost Structure: Leaps n Bound Shoe Company
Page 10
7. Recommendation
As can be seen, Activity based costing presents a better picture of the cost associated with a product. Thus, we recommend using Activity based costing.
Cost Structure: Leaps n Bound Shoe Company
Page 11
Bibliography
a) Managerial Accounting by James Jiambalvo
b) www.wikipedia.com
Cost Structure: Leaps n Bound Shoe Company
Page 12
doc_612690633.doc