Report on Sierra Ltd.
Report on Sierra Ltd.
Introduction
This report will assess the dip in profit of the Sierra Ltd. and will closely monitor the current costing and pricing strategies. It will also assess whether the activity based costing is suitable for the company or not. On further, if activity based costing is implemented, the steps that should be taken by the management to ensure the implementation will also be analyzed. Mr. Kaur’s suggestions will be deeply assessed to ensure if going along his way is safe and profitable.
The important concerns of the Sierra Ltd. are due to the refinancing to upgrade the factory in 2002. The company has been challenged with a long term and heavy loan. Although interest charging has remained the same in last five years due to the dip in sales revenue, the profit of the company is on a constant dip for the same years.
The report will analyze and tackle the issues by finding the suitable way to increase the profit, and all the suggestions given by Mr. Kaur will be taken in account to ensure that activity based costing will be suitable for increasing the profits. Activity based costing is the means by which the costs will be determined by the activities and the costing of a product will be liable to all the total and rightful consumption of it.
This section will be dealing with the assessment of the dip in profit of the Sierra Ltd. Although the Taxes have remained the same, only criteria pointing towards the dip in profit is the decrease in sales revenue. The sales revenue are on a dip since last five years due to the result of several startups which take up less number of variants which effects the major companies like Sierra but has no impact on startups since they can choose different variants which will lead to more startups entering the market and a tough competition to the big companies like Sierra Ltd. It is not possible to stop the outbreak of startups or reduce the competition, thus by means it might not be possible to increase the revenue, but increase in profit may be possible by means of costing.
Since we have analyzed the dip in profit at Sierra Ltd. we will go on to the ongoing costing system at the company as there is a huge connection between the profits and the costing methods adopted .There are more than 200 variants produced at Sierra, and for the costing traditional costing methods are used at Sierra. And, according to Naidoo (2002, p. 32), abiding by the traditional costing method, it can be useful in easy management and only less effort is required in this regard. Although it is easy to manage and less hazardous to the management, the traditional costing methods are outdated at Sierra since the company is fully automated and traditional costing method mostly depend on the labor hours for the costing. The labor hours for costing were an earlier method. It cannot be used for an automated company like Sierra and it is required to take immediate action to increase the profit rates. The limitations of the traditional costing system have mae a huge impact on the company since the labor hour is considered and labor hour consideration of costing is termed as one of the major defects of the system according to Drury (2015, p. 273). The traditional costing method depends on single volume of costing method and the non-production costs are included in production cost and the resultant leads to the pricing; and since the overhead costs have risen, the method of traditional costing is outdated as stated in CIMA Activity Based Costing (2008). Mr. Silvia states that the traditional costing system has served them well for the past years and want to continue that way; but what is to be noted is that the company is not the same as it was previously. The company has been automated and the labor hours can no more be used for the calculations. Since the overhead would certainly be on a rise and with just the 30% of excess calculated for the overhead, it might be a very old approach that the overhead might be less than 30% for certain products or it might be higher than 30% . In both conditions, the Company is taking a loss in terms of production or sales. So the costing needs to be more precise, which means the traditional system is outdated at least for an automated company like Sierra Ltd. and the recent declination in profit and revenue of the company is an example of the outdating of the Traditional costing method.
Activity based Costing and its Relevance to Sierra Ltd.
The activity based costing is a concept which started to take shape since the late 1980's with the advent of technologies into the industrial field and the overhead costs were rising rather than the labor hours (CIMA Activity Based Costing-2008). The same practice is going on in Sierra Ltd., The overhead cost allocation has not been so perfect and the costs seem to be in a rise and a completely automated factory should consider the overhead cost as a major criterion, and the 30% of the allocation to the overhead costs must be enough for the clutch components and transmission components but it is not faring very well for the engine components. And since the Engine components have contributed to the most for the Sierra Ltd. in the past, it is a must to overlook the pricing of the engine components. The activity based costing will also help to figure out the non-profitable components and it can be scrutinized in terms of production or pricing. If it is to continue with a traditional costing method, we cannot identify the variants which cause the losses and it will not be possible to stop producing or rectify the production mistakes happening. With more than 200 variants it is very much important to assess the profit or loss of every variant for an overall profit turnover. Activity based cost may not be the most friendly way to get a result in the increase in revenue and there is a possibility that the revenue may take a dip, but it is sure to bring about an increase in profit since the overall profit or loss of every component is analyzed and by doing that it is easier to concentrate on making profit rather than increasing the total revenue turnover. The activity assessment is the challenging job of the activity based costing system. It is an initial process and shall not be repeated if no more changes or variants are to be brought up, If changes are to be made, the total reassessment is not required, only the assessment of the new or modified product is required. A direct benefit for the activity based costing system is to confidently price or make alterations in the production as per Porteus, (2001) stated in “As easy as ABC”. Mr. Kaur's proposal is to be moved forward since the arguments raised by him are relevant in the new technological aspects. Developed countries are proven to have adopted these techniques and found to be very successful, especially in England far before as specified by Liu and Pan (2007) in “The implementation of Activity-‐Based Costing in China: An innovation action research approach". The Sierra Ltd. being a company in England should have been implemented way back. There are drawbacks, but they do not seem to be relevant to the issue. Drawbacks include the time consumption of implementation, expensive in implementation, and it is a bit tough to assert all overhead costs for certain products (CIMA Activity Based Costing-2008).
Successful Implementation of Activity Based Costing system
The activity based costing system is found to be very relevant for the Sierra Ltd. and the steps needed to be taken for implementation shall be discussed in this section. The implementation of the activity based system can be tedious and may be a bit expensive; but it can be very useful since the company will only take gains from the change in the system of costing. The implementation cons are very negligible considering its benefits. Referring to Major and Hopper (2005), for the smooth implementations the management staff shall first;
Identify all the activities that are included in making a product,
In this step, the management staff should assess all the activities that are included in making each of the products. That means all 200 variants shall be assessed in Sierra Ltd. and all the process that goes into making the product should be listed down. This is the most tedious work for the implementation.
Assigning the costs for each activity identified,
In this step, the cost of all the listed activity is supposed to be identified, this is an important step since the accumulation or summation of all the assigned cost will be the most influential part of the pricing, and if the calculations are wrong then the product may fall into a loss.
Identification of the Final Products,
Identification of final products is not such a boring work since all the variants are already known and are assessed previously. This doesn't obviously need to be repeated unless there is an addition of variants to the company.
Costing,
Based on the demand of the product and the total production cost the final costing is done. This will ensure that the product is profitable and consumer friendly. And,
New Software
New software should be made through with the staff. The software should include all the above mentioned qualities; and the software will make the work easier for the management team.
(Source: Major & Hopper, 2005).
Another important aspect of implementing the activity based cost system is that the implementation of the system or the change from the old system shall be well funded. The activity analyzing and costing them are a bit expensive job, but if done right then the profit will rise and it is indeed very certain to pass the loss made by the change in system and with the profit in upcoming years it won't be a big deal to go with the new system that is the activity based accounting system.
And it should be made clear to the production staff that the problem is not with them and the quality of the products they make is high but the system is outdated and the change in system will bring good to the company, and also that their hard work would be appreciated by the new system. This awareness should be given so that the morale of the staff are not let down.
Summary
As discussed in the report, the main points concerning to Sierra Ltd. are the Dip in profit, ongoing system of costing and its efficiency, a change in costing system to ABC. These are the most important criteria since the profit loss of Sierra Ltd. cannot be altered by increase in revenue, but can only be done by increasing the profit by not considering how much revenue the company makes. It is evident that the traditional costing system did affect the company in reducing its profit. And for Large companies, especially if automated, it is very much useful to use a system like ABC.
Recommendations
As per the summary of the report, Sierra Ltd is advised to leave the Traditional costing system behind and change to the activity based costing system as it is an easy way to increase the profit without increasing the revenue. A company that has high turnover can easily yield a high profit if it depends on activity based costing system rather than the traditional system. I also suggest while implementing the system the criterions for the implementation shall be clearly assessed and there shall be no loose links which can result in a loss. The morale of the workers should be taken care by ensuring that they have been given awareness of the problems of the old system and how the new system helps the company.
Bibliography
CIMA (2008) “CIMA Topic Gateway Series Number 1: Activity Based Costing.” Available from http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.p df [accessed 24 October 2016]
Drury, C. (2015) Management and Cost Accounting, 9th edition. Cengage Learning EMEA..
Liu, L. Y. and Pan, F. (2007) "The implementation of Activity-Based Costing in China: An innovation action research approach", The British Accounting Review, Volume 39, Number 3, pages 249-264.
Major M. and Hopper T. (2005) “Managers divided: Implementing ABC in a Portuguese telecommunications company”, Management Accounting Research, Volume 16, pages 205–229.
Naidoo, S. (2002) "Voyage of Discovery", Financial Management, May, pages 32-33
Porteus, J. (2001) “As easy as ABC”, Financial Management, November, pages 40-41.
