Accounting Report Harvard Case Solution & Analysis

Accounting Report Case Solution

INTRODUCTION:

This report deals with the issues faced by a client company Sierra Ltd related to the managerial accounting practices and product pricing strategies that the company and as a consequence company is facing decline in revenue and profits during the previous few years. The company manufactures and sell automotive parts to car manufacturers, company deals in 10 different product lines which are the combination of uniform and distinct variants. The parts are manufactured by using state of the high-quality art processes and technologically updated plants. Other than the concerns that are discussed above, the company faces difficulties in the pricing strategies related to few specific products such as engine components, where the company is facing competition in the industry also the overhead allocation using the traditional basis of costing(Brahmani, ET AL., 2008). In this report, I intend to find out the reason of their costing system failure the impact (positive or negative) after switching to activity based costing commenting on their concerns related to the system changeover i.e. effects of new software development and training requirements and the possible consequences. While implementing new costing system as proposed by their finance director and the achievement of the anticipated percentage of margins in which the company is facing difficulty.

ASSESSMENT OF CURRENT COSTING AND PRICING PRACTICES OF THE COMPANY:

The company is using the traditional basis of costing for the pricing purposes and allocation of overheads to different products based on machine hours.  The tracing of material and labor cost using the traditional basis of product cost determination is easy(Br Godzilla & Abraham, 2012). However, proper allocation of overheads to drive at a proper product cost needs to be handled carefully, the method used to allocate overheads costs plays a vital role in determining the pricing decision and overall formulating the pricing strategy of any firm especially when the firm under consideration is any manufacturing firm.

Currently, the company is not able to reach the anticipated product margin i.e. they wanted to attain 30% margin on their products but current accounting system excessive setup costs related to some of the specialized products of the company. The variance in product ranges that requires additional customized product costs and dealing with the competitors who specializes in one product having agile product designs and fast development processes(Fri & Ida, 2010).

Analysis of the system:

The company is following traditional costing system for all the product ranges, from engine and clutch products up to the highly specialized transmission components allocation of overheads is done on machine hour basis. It is an arbitrary basis of allocation of overheads, the usage of pools in this costing system is very few, and the resulting allocation of cost is highly average. The decision taken on that basis related to pricing might turn erroneous and not for generating high margins for the company. (Brahmani,Foster, and Dakar, 1999).

In traditional basis only basic indirect overheads are accounted for product pricing that is prominent, and the net effect of all the components are ignored. Mammalia and Maria (2008; 7) has pointed out that the true reflection of the relationship between the indirect cost and individual products can rarely be determined by using traditional costing(Johnson, 2015).

Since the company is currently facing decline and cost structure of the company needs revision to avoid the risk of calculating inappropriate product prices, because of the allocation of production overheads on very uniform basis i.e. labor hours, labor dollars or machine hours. The company is using the same methods for the products cost of simple and complex nature having significant range of variance, i.e. the product ranges that requires overhead allocation on more complex basis rather than considering machine hours at the whole.

The company needs to revise its costing as well as pricing strategy because it would ultimately lead manufacturer to calculate wrong and inappropriate selling price and thus overall performance of the company gets affected in short and long run(Lew & Pan, 2007).

SUITABILITY OF ACTIVITY

BASED COSTING:

As the company is considering for accounting system changeover and wants to move to activity-based costing it is first to understand that what activity based costing plan is.

Activity-based costing:

It is method of assigning overhead manufacturing cost to the products in more standardized and more logical manner. In activity-based costing the process is different than traditional costing, it is the process in which overhead costs are not directly assigned to the products by direct labor hours machine hours or any other basis(Major & Hopper, 2005). In this method the overhead cost first assigned to those activities which serve as the real cause of generating overheads after that the cost is then allocated to products for which those activities were performed or which has demanded such activities.

The activity based costing is suitable for the company when the company is involved in the manufacturing of those products which have specialized production processes by customer’s demand and diverse product variants. Sierra Ltd is using the same pricing policy for all ranges i.e. they have standardized range of engine and clutch components that does not require different activities during each production run whereas the transmission components have many variants that require huge labor time for construction............

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