ACCT20001 Cost Management - Tutorial Week 2: solution guide

1. Bhimani et al 6e, 1.13

1.13 Value chain and classification of costs, computer company (15 min)

Cost item Value-chain business function

a Production

b Distribution
c Design
d Research and development
e Customer service
f Design (or research and development)
g Marketing
h Production

2. Find ONE short article from the financial/business press relevant to management/cost accounting. Write a short
paragraph outlining the management/cost accounting issue addressed in the article. Be prepared to discuss in
class.
Exercise 3

Required:
Part a.

An organization might choose to be highly vertically integrated for several reasons. The below are by no
means the only solutions as every organization will be different.

o Highly valued work commands a higher margin. Thus, assuming all activities add “value”, the
more of the value-chain an organization “owns” the greater its margins. For instance, MD
 operates Sheep Farming, Knitting mills, Distribution and Retailing and is deriving a profit from all
of these activities

o A fully integrated company can be more market-orientated. Since MD sources and knits its own
wool it can have greater control over its Supply Chain and the quality of the garment. Customers
may increase their trust in the brand and subsequently are willing-to-pay a premium since the
organization is viewed as more premium / ethical / customer-orientated

o Enhanced operational efficiency/effectiveness. By owning more of the ‘value-chain an

organization MD can remove bottlenecks in the supply chain and get a product to market
quicker.

o Opportunities for growth, new markets and business model innovation. New business
opportunities can arise across various activities within the value-chain. For example, MD may
be able to sell its wool to other customers in other industries such as carpet manufactures. If it
did not operate a Sheep Farm it would be unlikely to realise this new business opportunity.

Part b.

Structural cost management relates to management decisions and choices about the way the firm
participates in the industry value-chain.

It employs tools of organisational design, product design and process design to create a supply chain
cost structure that is coherent with firm strategy.

Examples of structural cost management decisions

o Where to participate in the value chain – how vertically integrated should we be.

o How large are its operations (scale) – how many sheep should it have, how large should the
capacity of its factory be?

o How should its processes be designed – e.g., level of factory automation

o How should its product be designed

o Inter-firm relationships – not that important for Merino (since they operate end-to-end)

Executional cost management employs measurement and analysis tools to evaluate supply chain
performance.

Examples of executional cost management tools

o Product costing

o Activity-based costing

o Budgets and variance analysis

o Customer profitability analysis

Exercise 4.

Rent and Electricity allocation – this exercise has parallels with the problem of allocating indirect costs to cost
objects (e.g., units of output or customers)

A possible approach to allocating costs is as follows.

Step 1: Determine what factors cause/influence the amount of cost incurred1.

Step 2: Allocate each cost item to each tenant based on the amount of cost each tenant has ‘caused’ as a
proportion of total cost based on the chosen factor2.

(i) Weekly rent

Step 1: The main factors that determine (cause) the amount of rent paid for the flat are
 Location of property
 Size of property
 Condition of property

The location and condition of property are not suitable drivers to use as a basis of allocation. Therefore, size of
property is chosen as the basis to allocate the rental cost amongst the tenants.

Step 2: Using size of the property, the rental cost could be allocated as follows in at least two different ways

2a: Based on the relative size of the rooms

 Alice is allocated 12/ (12 + 10 + 8) of the rent = 40%

 Brendon is allocated 10/30 of the rent = 33.33%
 Carl is allocated 8/30 of the rent = 26.67% of the rent

2b. Based on equal share of the common area and relative size of the rooms

 Common area = 100 – 30 = 70 square metres.

 Therefore 70% of the rent is equally shared = 23.33% each
 30% of the remaining rent is shared based on the relative size of the rooms
o Alice = 12/30 x 30% = 12%
o Brendon = 10/30 x 30% = 10%
o Carl = 8/30 x 30% = 8%

 Therefore overall allocation is

o Alice = 12 % + 23.33% = 35.33%
o Brendon = 10% + 23.33% = 33.33%
o Carl = 8% + 23.33% = 31.33%

Which is the fairer allocation?

1
These factors are also known as the cost driver – more about this in Lecture 2
2
The chosen factor is also known as the allocation base – more about this in Lecture 2
  Arguably depends on how the common area is used by the different tenants.
 If extent of use is in proportion to size of rooms (i.e., Alice uses the common areas most, followed by
Brendon and Carl), then 2a would be fairer.
 If all tenants use the common area equally, then 2b would be fairer

(ii) Electricity fixed supply charge

Step 1: The factor that causes the supply charge to be incurred is the fact that all three tenants want electricity
supplied to their flat.

Step 2: Since all three tenants want electricity to be supplied, one way of allocating the supply charge is
equally amongst the tenants i.e., Alice, Brendon and Carl each is allocated 1/3 x $30 = $10

(iii) Electricity usage charge of $0.20 per kWh

Step 1: The factor that causes the usage charge to be incurred is the amount of electricity consumed by the
flat.

Step 2: There are a couple of options of allocating the usage charge to the tenants.

a) Determine the energy consumption of all the electrical appliances in the flat (i.e., how many kWh does
a hairdryer consume). Keep records of the usage of electrical appliances by each tenant and how long
they used it for. Then multiply the electricity consumed by each tenant by the energy price of $0.20 per
kWh. This method would be the most accurate but unlikely to be economically feasible to do this (i.e.,
the cost would outweigh the benefits)

b) Use the relative size of the rooms to allocate this cost. The argument here is that the larger the room,
the more electricity it would consume. As a result, Alice pays 40%, Brendon pays 33.33% and Carl
pays 26.67% of the electricity usage charge.

c) Allocate the cost equally amongst the three tenants

As you would have noticed, there is not a single right way to allocate these costs. Appropriate allocation
requires knowledge of the behaviour of the respective tenants (to determine how much cost they actually
‘caused’) and some judgment (e.g., whether the cost of keeping records of electricity usage of each tenant
exceeds its benefits).