ACCY 503-Managerial Accounting-Sections IMB, ONL

Team Assignment: Gibson Agency

Current Costing System

Refer to the table titled “Calculations for Question 1” for the solution.

Recommendation Regarding Eliminating Unprofitable Clients

Based on the profit calculation using the current system, there were losses for ATP in 2018 and

2019, while there were profits for all the years for other clients as well as for ATP in 2016 and

2017. This is, however, in contrast to the results using break-even analysis. Per the break-even

analysis, P. R. Industries budgeted hours for 2018 are the same as the break-even point hours for

Diff Engine Partners. This means that the budgeted hours for Diff Engine Partners and P.R.

Industries do not have adequate safety nets and any changes to the budgeted costs could result in

losses for P.R. Industries and Diff Engine Partners. This also implies that under the current

system, ATP has overallocated its fair share of fixed overheads and may be subsidizing some of

the other clients that are under allocated. However, when the costs are split between fixed and

variable under the break-even analysis, ATP’s budgeted hours seem better than all four years.

When compared to the other clients, ATP’s budgeted hours to break-even point in hours is

higher for all the years than those of the other clients. This also means that ATP would be able to

handle unfavorable changes to costs than other clients. If Bill was to base his decision on which

client to eliminate, then Bill would have to eliminate ATP. However, as shown in the Break-even
analysis in Annex 1, ATP’s budgeted hours are more than the break-even point in hours for all

four years, therefore showing an adequate safety net before losses can be made. Our

recommendation to Bill would be not to rely on the current costing system to decide on the

profitability of each client and whether to eliminate it or not. He should use a system that splits

the overheads into fixed and variable costs as most of the fixed costs within the relevant range

may not be relevant in the decision-making process.

Key Assumptions

One of the key assumptions of our analysis is that of the reliability of the split between the fixed

and variable overheads. For instance, in our break-even analysis, we had assumed that overheads

such as Operator Benefits, Operator Overtime, Unused Operator Time, Communications, and

Miscellaneous are variable. We also assumed that the fixed overheads would remain fixed within

the relevant range. The implication of this assumption is that the fixed overheads that would be

used to calculate the break-even point would not change within the period we have assigned.

Another assumption is that the budgeted hours would not change significantly compared to the

actual hours to be worked for each client. The implication of this assumption is that if there are

significant variations between the budgeted hours and the actuals, then the actual profitability

would also be significantly different from the budgeted profit, which would affect the decision-

making of the management at GA.

Other Considerations/Recommendations

The first of these considerations is the obvious one: what are the rates the competitors offer?

Certainly, some clients may be ‘unprofitable’; but losing them altogether may spell a bigger blow

for the firm. In the short term they can hold on to the “unprofitable” client especially if the

revenue from the client covers most of the variable costs. The other consideration and
recommendation to Billy is that of the budgetary process, cost system, and fee structure. As he is

CEO, he exercises the power to enact major financial and managerial changes in GA. Every year,

ATP Company remains the most interacted with company (in operator hours), so perhaps the

profitability issue lies with resource allocation and overall financial structure of GA if operator

time was wasted. It may be up to Billy and the CFO to reevaluate how GA is run as a whole and

how their resources and operators are distributed. As mentioned earlier, the costing system is due

for an overhaul; it is key that an effective, sound solution is enacted so that this problem does not

happen again. With this change, perhaps the root cause of unprofitability may be found to lie

more with GA’s financial management and structure itself than the company risking elimination.
Calculations for Question 1:

Customers estimated operator hours

Customer 2016 2017 2018 2019

Peripheral 23.5 25 26.1 27.1
P.R. Industries 24.6 27.2 27 29.2
ATP Company 60.2 67.3 70.4 75.5
Diff Engine
Partners 37.5 44.5 50.6 55.5
Virtual Lights,
Inc. 45.4 39.5 0 0
Overhead Rate = Budgeted Indirect cost/Total Estimated operator hours
Budgeted Indirect Cost
2016.0 2017.0 2018.0 2019.0
Total $ 10,352 $ 11,105 $ 11,038 $ 11,283

Estimated operator hours

2016 2017 2018 2019
Total Hours 191.2 203.5 174.1 187.3

Overhead Rate
2016 2017 2018 2019
Overhead Rate $ 54.14 $ 54.57 $ 63.40 $ 60.24
Customers estimated overheads
 2016 2017 2018 2019
Peripheral $ 1,272.34 $ 1,364.25 $ 1,654.75 $ 1,632.51
P.R. Industries $ 1,331.90 $ 1,484.30 $ 1,711.81 $ 1,759.02
ATP Company $ 3,259.36 $ 3,672.56 $ 4,463.38 $ 4,548.14
Diff Engine
Partners $ 2,030.33 $ 2,428.37 $ 3,208.06 $ 3,343.33
Virtual Lights,
Inc. $ 2,458.06 $ 2,155.52 $ - $ -

Total $ 10,352.00 $ 11,105.00 $ 11,038.00 $ 11,283.00

Operator Wages = Customers estimated Wages/ Wages Cost

Customers 2016 2017 2018 2019
Peripheral 635 675 705 732
P.R. Industries 665 734 729 788
ATP Company 1625 1820 1902 2040
Diff Engine
Partners 1014 1204 1367 1500
Virtual Lights,
Inc. 1225 1067 0 0
Total $ 5,164 $ 5,500 $ 4,703 $ 5,060

Customers Estimated Total Cost

Customers 2016 2017 2018 2019
Peripheral $ 1,907.34 $ 2,039.25 $ 2,359.75 $ 2,364.51
P.R. Industries $ 1,996.90 $ 2,218.30 $ 2,440.81 $ 2,547.02
ATP Company $ 4,884.36 $ 5,492.56 $ 6,365.38 $ 6,588.14
Diff Engine
Partners $ 3,044.33 $ 3,632.37 $ 4,575.06 $ 4,843.33
Virtual Lights,
Inc. $ 3,683.06 $ 3,222.52 $ - $ -
Total $ 15,516.00 $ 16,605.00 $ 15,741.00 $ 16,343.00

Customers Specific Revenue

Customers 2016 2017 2018 2019
Peripheral $ 2,140.00 $ 2,273.00 $ 2,452.00 $ 2,547.00
P.R. Industries $ 2,536.00 $ 2,797.00 $ 2,778.00 $ 3,063.00
ATP Company $ 5,084.00 $ 5,690.00 $ 5,946.00 $ 6,381.00
Diff Engine
Partners $ 3,867.00 $ 4,588.00 $ 5,209.00 $ 5,719.00
Virtual Lights,
Inc. $ 4,626.00 $ 4,027.00 $ - $ -
Total Cost $ 18,253.00 $ 19,375.00 $ 16,385.00 $ 17,710.00

Budgeted profit for each of Gibson's clients

Customers 2016 2017 2018 2019
Peripheral $ 232.66 $ 233.75 $ 92.25 $ 182.49
P.R. Industries $ 539.10 $ 578.70 $ 337.19 $ 515.98
ATP Company $ 199.64 $ 197.44 $ - (419.38) $ - (207.14)
Diff Engine
Partners $ 822.67 $ 955.63 $ 633.94 $ 875.67
Virtual Lights,
Inc. $ 942.94 $ 804.48 $ - $ -
Total Profit $ 2,737.00 $ 2,770.00 $ 644.00 $ 1,367.00

Annex 1

Break-even Analysis

Calculation of Contribution per client for each of the four years

2016 2017 2018 2019
Peripheral
Revenue 2140 2273 2452 2547
Wages 635 675 705 732
Variable cost 387 400 490 448
Contribution 1,118 1,198 1,257 1,367

PR Industries
Revenue 2536 2797 2778 3063
Wages 665 734 729 788
Variable cost 405 435 507 483
Contribution 1,466 1,628 1,542 1,792

ATP Company
Revenue 5084 5690 5946 6381
Wages 1625 1820 1902 2040
Variable cost 991 1,076 1,321 1,248
Contribution 2,468 2,794 2,723 3,093

Diff Engine
Partners
Revenue 3867 4588 5209 5719
Wages 1014 1204 1367 1500
Variable cost 617 712 950 918
Contribution 2,236 2,672 2,892 3,301

Virtual Lights
Inc
Revenue 4626 4027
Wages 1225 1067
Variable cost 747 632
Contribution 2,654 2,328

Calculation of Variable cost for each of the clients*

Variable cost 3146 3254 3267 3097
Variable rate -
Peripheral 12% 12% 15% 14%
Variable rate -
P.R. 13% 13% 16% 16%
Variable rate -
ATP 31% 33% 40% 40%
Variable rate -
Diff 20% 22% 29% 30%
Variable rate -
Virtual lights 0.237448 0.194103 0 0

2016 2017 2018 2019

Variable cost -
Peripheral 387 400 490 448
Variable cost -
P.R. 405 435 507 483
Variable cost -
ATP 991 1,076 1,321 1,248
Variable cost -
Diff 617 712 950 918
Variable cost -
Virtual lights 747 632 - -
*This assumes that the following overheads are all variable. Operator Benefits, Operator Overtime, Unused Operator Time,
Communications and Miscellaneous.

Fixed costs per year

2016 2017 2018 2019

Fixed costs per year* 7,206 7,851 7,771 8,186

*This is made up of the following: Support staff wages, Support staff benefits, Managerial salaries, Managerial benefits,
Depreciation and property taxes, and Utilities

Contribution per unit 2016 2017 2018 2019

Peripheral 48 48 48 50

P.R. Industries 60 60 57 61

ATP Company 41 42 39 41

Diff Engine Partners 60 60 57 59

Virtual Lights, Inc. 58 59

Breakeven point in units

for 2016 136.7
Budgete
d hours
over
Proportion Budget break-
2016 of 2016 Break-even hours ed even
Revenue Revenue per client hours hours
Peripheral 2140 12% 16.0 23.5 147%

P.R. Industries 2536 14% 19.0 24.6 130%

ATP Company 5084 28% 38.1 60.2 158%

Diff Engine Partners 3867 21% 29.0 37.5 130%

Virtual Lights, Inc. 4626 25% 34.6 45.4 131%

0 -

Total 18253 1 136.7 191.2 140%

Breakeven point in units

for 2017 148.3
Budgete
d hours
Budg over
Proportion eted break-
2017 of 2017 Break-even hours hour even
Revenue Revenue per client s hours

Peripheral 2273 12% 17.4 25 144%

P.R. Industries 2797 14% 21.4 27.2 127%

ATP Company 5690 29% 43.6 67.3 154%

Diff Engine Partners 4588 24% 35.1 44.5 127%

Virtual Lights, Inc. 4027 21% 30.8 39.5 128%

19375 100% 148.3 203.5 137%

Breakeven point in units
for 2018 158.26
Budgete
d hours
Budg over
Proportion eted break-
2018 of 2017 Break-even hours hour even
Revenue Revenue per client s hours

Peripheral 2452 15% 23.7 26.1 110%

P.R. Industries 2778 17% 26.8 27 101%

ATP Company 5946 36% 57.4 70.4 123%

Diff Engine Partners 5209 32% 50.3 50.6 101%

Virtual Lights, Inc. 0 0% - 0

16385 100% 158.3 174.1 110%

Breakeven point in
units 157.9
Budgeted
hours
over
Proportion Break-even break-
2019 of 2019 hours per Budgeted even
Revenue Revenue client hours hours

Peripheral 2547 14% 22.7 27.1 119%

P.R. Industries 3063 17% 27.3 29.2 107%

ATP Company 6381 36% 56.9 75.5 133%

Diff Engine Partners 5719 32% 51.0 55.5 109%

Virtual Lights, Inc. 0 0% - 0

17710 100% 157.9 187.3 119%