Managerial Accounting

[pic]
Case Analysis: Elkay Plumbing Vaughn, Reginald

1. Please comment briefly on the benefits of Time Driven Activity Based Costing (TDABC)
Time Driven Activity Based Costing (TDABC) is a popular alternative to Activity Based Costing. First, Activity-based costing (ABC) should be defined. ABC is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. CIMA, the Chartered Institute of Management Accountants defines ABC as an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilizes cost drivers to attach activity costs to outputs. While ABC is considered a valuable tool for management, developing the model, calculating the bottom-lines, and testing the model once it is implemented is costly and arduous. Managers are choosing TDABC because of the following benefits: • it can be easily updated to reflect changes in processes and resources costs • it captures the complexities of operations, it can be easily validated • it can be estimated and installed quickly • it identifies opportunities for process efficiencies • it is inexpensive to use • it can be used in several industries and companies • it creates standard processes and procedures • it is able to calculate huge amounts of data This is just a portion of the benefits that TDABC offers. In addition to this list, additional benefits are impacted by the departments that utilize the tool. Departments with a better fit include sales, distribution, design, engineering, quality assurance, packaging, procurement, underwriting, service, installation, finance, HR, IT and training.

2. How does a company end up in a situation with large cumulative losses with unprofitable customers and unprofitable products? Companies have grown to focus on relationships with customers, but what has been lost in all of the relationship building, is the measurement and the management of profitability. Often times, suppliers are customizing products for customers, not accounting for costs associated with the customizations. Ineffective pricing commonly occurs due to customers driving down the prices while increasing their requests. In situation such as this, suppliers are attempting to retain their customers, but are losing sight on the actual profitability of what they are providing as a product. This is a very common practice amongst very large customers. By providing customized products in large quantities, the costs to produce the products are increasing while the profits are steadily decreasing. One of the major benefits of Activity Based Costing (ABC), is knowing what the operational cost entails. Operational cost allows companies the ability to clearly identify if a customer is profitable or not. They are also able to determine what is profitable, thus leading to effective pricing and increases in profitability. Examples of the differences in profitable customer versus an unprofitable customer are displayed in the following table:
|High Cost-to-Serve Customers |Low Cost-to-Serve Customers |
|Order custom products |Order standard products |
|Small order quantities |High order quantities |
|Unpredictable order arrivals |Predictable order arrivals |
|Customized delivery |Standard delivery |
|Change delivery requirements |No changes in delivery requirements |
|Manual processing |Electronic processing (EDI) (zero defects) |
|Large amounts of pre-sales support (marketing, technical, and sales |Little to no pre-sales support (standard pricing and |
|resources) |ordering) |
|Large amounts of post-sales support (installation, training, warranty, |No post-sales support |
|field service) | |
|Require company to hold inventory |Replenish as produced |
|Pay slowly (high accounts receivable) |Pay on time |

By reviewing the table, it is easy to see the differences in a profitable customer versus an unprofitable customer. Just because you produce a large amount of sales, does not always yield a large return on profits. Overhead costs in comparison to revenue must be identified. If a company is not able to effectively measure costs, they can eventually end up with large cumulative losses with unprofitable customers and unprofitable products.

3. Why did Hrundicka believe that Elkay PPD needed a new cost system? Initially Elkay’s Vice President of Sales did not trust the changes Hrundicka was trying to implement in the cost strategy. His concern was that it lacked a more formal approach, providing a budget and forecasting cost for the future. The VP of sales believes that budgeting allows the company to make sound business decisions for the future. Hrundicka approach was to eliminate a budget and in its place implement a new process with continuous planning. This process allows for responding of business decisions in real-time. The new term became known as “Beyond Budgeting Concepts,” allowing change to easily become accomplished, while laying out his four major components. According to the article the core of Elkay business model was “their strategy with emphasis on monitoring and measurement to ensure execution”. Hrundicka’s activity based costing structure focused on four major components to execute: (1) “transparency, knowledge, and guided analytics”, its designed to ensure that processes needing improvement is communicated in real-time and all groups involved are on board with any changes in the strategy, (2) “business performance management”, which is designed to measure and monitor performance to execute and identify changes, yielding any corrective action to implement. (3) “Discrete Product Cost (DPC)”, which is why Hrudicka believed Elkay needed to change its cost system to align with the four major components to ensure their future profitability. In the article, Hrundicka notes that Elkay’s DPC system “foundation will be a traditional time-driven activity based costing system”. To ensure on going profitable analytics, “driving behavior and creating a culture of awareness and understanding around the profitable profiles of their customers, segment products, and activities”. The fourth and final component was (4) the “Customer Relationship Management (CRM)”, its designed to give an overall view of the customers interaction with the product (any issues, needs, changes, etc.). The need for a time–driven costing system is simple…, it saves time, provides transparency, and gives real-time updates during the changing process. 4. What causes a product or customer to be highly profitable? Unprofitable? What distinguishes low-cost-to-serve customer from a high-cost customer? Some customers are more profitable than others. Most executives understand that, but simply acknowledging the truth of that statement is not enough. If companies are to maintain profitability over the long term, managers must have an understanding of the profitability of each of their customers and their products. With that knowledge, they can segment customers according to their value and maximize the mutual benefits of their relationships. Customers and/or products ultimately are profitable and/or not profitable as a result to how well a company utilizes cost saving concepts such as ABC. One of the major themes of this case was the lack of cost control to customers regarding customized products. Customers whom order customized products often cost’s businesses more upfront to produce package and ship. Take Kemp LLC for instance, they were able to identify their losses of capital with one of their customers due to the customers low volume, high order variety and it’s very unique just-in-time delivery system. Kemp LLC realized that in order to balance out cost to meet this customers needs (High-Cost-To-Serve Customer), they had to increase service charge’s to this customer or simply cut loose the business relationship altogether. In the end, Activity-based costing (ABC) provides a more effective way to understand the economic structure of any organization. Most organizations undertake activities that are unnoticeably required to produce products and services, or serve customers. These other activities are required to sustain the business. Whereas the typical financial accounting practice allocates all costs to products, ABC assigns activity costs to the categories of products, services, serving customers and business sustaining, specifically without cross over or allocation. By eliminating misleading allocations from management cost information, extremely different performance results are recognized. Typical ABC results identify that some proportion of customers consume more activities and resources than the revenue they actually produce. To distinguish a low-cost-to serve customer from a high-cost-to serve customer can be put as simple as saying…. The high-cost-to-serve customer is complex and costly while a low-cost-to-serve customer is simple and standard. The characteristics of the two are total opposites as a high-cost-to serve customer typically orders customized products at small quantities with a more sophisticated delivery expectation, while a low-cost-to serve customer order standard products at higher order quantities and only require a standard delivery. High-cost-to serve customers should essentially pay premiums for additional services incurred. As a for profit organization, your goal is gain a profit not a loss…and when a company has specials needs and unique taste they should be charged accordingly. 5. How did the information on product and customer profitability help PPD’s managers? Product and customer profitability assist PPD’s managers with the able to report their costs on an ongoing basis, giving them the ability to determine when and how to cut cost of unused resources in subsequent periods, cost-drivers are now calculated by real time assign costs. With a more systematic approach the ability to produce fewer delays of product, better quality with less labor allows PPD’s mangers to give more actual numbers. Product and customer profitability is an evaluation process that focuses on assigning costs and revenues to segments of a customer base vs. actual products (WiseGeek, 2013). Information on product and customer profitability assists PPD’s managers with the organization’s accomplishing of actual numbers based on the processing of an order versus employee surveys. Estimating the unit times of activities has become more resourceful given a more sufficient accuracy and frequent updates throughout the year. It is the cost-driver rates that are more accurate in calculations that can be applied to real time assign cost to transactions in product and customer profitability evaluation process. Managers have the ability to estimate the process required for each activity without continuous interviewing of personnel, giving the ability to add new elements to the equations with less strain on accounting system. 6. What limitations do you have with the Elkay’s DPC system? The limitations Elkay’s DPC system will have is the ability to trace back any initiative, technology investment, or other resources that will assist with alignment and execution of the business objective. Discrete product costing (DPC) will limit the ability to have an impact of fixed costs on profits, not allowing conventional income statements to have the data needed for the income statements. Having the ability to estimate profitability of products, customers, and other segments of the income statement will not be as easy to review (Accounting, 2013).

7. What actions should Mark Whittington take with Elkay’s most profitable customers? With profitable customers Elkay should address any opportunities that TDABC clearly identifies. By adjusting the cost drivers associated with their normal operations to align with their customers, the company can make better decisions on how to generate additional profits after analyzing any issue identified through TDABC. Examples may include creating more cost efficient contracts, offering new methods of delivery that create more efficient profit margins. By eliminating any unnecessary actions or process affiliated with the customer the business can establish guidelines to promote greater profits. The key component to making an already profitable customer more rewarding depends on the actions taken after a thorough analysis has been made of the relationship between and the customer.

8. What actions should Mark Whittington take with Elkay’s most unprofitable customers?

References

Accounting Explanation, Advantages Disadvantages and Limitations of Variable Costing Systerm (n.d.) 2013. Retrieved on July 6th 2013 from http://www.accountingexplanation.com/advantages_disadvantages_limitations_of_variable_costing.htm

Customer Profitability Measurement and Management by Robert S. Kaplan and V.G. Narayanan http://www.bankersonline.com/vendor_guru/acorn/acorn_mkt051704.htm

Time-Driven Activity-Based Costing by Robert S. Kaplan and Steven R. Anderson http://hbswk.hbs.edu/item/5436.html

Time-Driven Activity-Based Costing, Harvard Business Review. Nov 2004, Vol. 82 Issues 11, p131-138. Kaplan, Robers s. Elkay plumbing

Player, S., A Total Remodel, Business Finance 15.1 (Spring 2010):6 (Copyright 2010 by Penton Media, INC all right reserve). Take from TSU Blackboard Elkay Case Study reading material, eMBA 631 Summer 2013 reading.

WiseGeek, What is Customer Profitability Analysis (n.d.) 2013. Retrieved on July 5th 2013 from http://www.wisegeek.com/what-is-customer-profitability-analysis.htm