Introduction
Midwest Office Products (MOP) is a regional distributor of office supplies and to institutions and commercial business organizations. MOP is known for its excellent customer service and responsiveness. MOP Management is concerned because the company just experienced its first loss in history, despite increased sales from the prior year. The company looked at its costs and the activities relevant to its business. The task is to develop a cost accounting system that will accurately reflect the relevant costs of MOP per order with respect to the number and types of activities, processes or transactions that transpire.
Answers to Questions
The first table shows an Activity-based Cost structure while the second table shows the current cost calculation of MOP. According to Investopedia, Activity-based Costing or ABC is a method wherein firms identify the activities or processes involved and assign indirect cost to products. The first table segregates costs appropriately per activity or transaction. This calculation shows us the true cost per order. The current method of calculation of MOPs distorts the cost structure in that it easily divides each cost component based on the number of cartons processed within the year.
C. Explain the difference in profitability of the five orders calculated by the ABC system and the company’s existing cost system.
ABC calculations show us that the most profitable scheme for MOPS is the electronically ordered-commercially shipped route. Having manually entered orders that are desktop delivered by the company makes the least (in fact a loss at low volume orders). Even the electronically ordered but desktop delivered is as not as good as the first although it creates positive earnings for high volume orders.
The current cost calculation distorts this image by negating any specific activity impact on the bottom line costs. For example orders 1 and 2 are both low volume orders yet this cost structure does not differentiate the bottom line significantly, despite the completely different processes they are ordered and delivered.
D. Based on your analysis above, what actions should John Malone take to improve Midwest’s profitability?
Shift to an ABC calculation approach
Remove flexible ordering options or at least minimize manual orders. The bulk of MOPs orders should be made through its website.
Scrap the desktop delivery option. All deliveries should be made through commercial shipping lines.
E. What issues, barriers, or concerns arise in an activity based costing approach?
The common issues and barriers to an ABC approach are the following:
The process is time consuming. Collecting data for ABC is very tedious.
The resources needed to conduct an ABC approach are significant. To some companies, putting up the necessary resources to measure each process/activity in the production line may not be seen as a dutiful way of spending cash.
Managers may resist an ABC approach since it exposes each activity. Some managers would like to keep things hidden so as not to affect their performance evaluation.
Conclusion
MOP has discovered the fallacy of its current method of calculating its costs. Shifting to an ABC approach for calculating costs provides MOP with a tool for critical decision-making. ABC looks at the incremental costs per activity, a more transparent and more accurate approach since it gives a good picture of overhead costs, identifies the relevant and direct costs of production, identifies where the firm creates value, and is an ideal way of setting benchmarks for performance. For MOP, implementing an ABC approach is the only way to go.
References
Activity Based Costing and Management. Retrieved from http://highered.mcgraw-hill.com/sites/dl/free/0073128155/394466/blo28155_ch05.pdf Retrieved on May 15, 2012
Calculating Activity Based Costing. Retrieved from http://www.valuecreationgroup.com/activity_based_costing_calculate.htm Retrieved on May 15, 2012
Cliff Notes: Activity Based Costing Vs. Traditional Costing. Retrieved from http://www.cliffsnotes.com/study_guide/Activity-Based-vs-Traditional-Costing.topicArticleId-21248,articleId-21226.html Retrieved on May 15, 2012
Investopedia: Activity-Based Costing. Retrieved from http://www.investopedia.com/terms/a/abc.asp#axzz1uu2UvWq9 Retrieved on May 15, 2012
Product Cost Calculations. Retrieved from http://herkules.oulu.fi/isbn9514264509/html/x1194.html Retrieved on May 15, 2012
Yahoo! Answers: How to Calculate Activity Based Costing. Retrieved from http://answers.yahoo.com/question/index?qid=20110307110734AASmrOl Retrieved on May 15, 2012
