Product and Cost Allocation
“Luggage R Us” is a new luggage company that helps customers design, make and ship their own personalized travel luggage. The company offers four standard luggage sizes that can be used by individuals for business trips, couples on a romantic vacation, and even for a family of four. The four sizes are segregated into the carry-on, medium, large, and the extra-large (Samsonite, 2016). The standard size used for the carry-on is at 22”x14.5”x9.75”, which is within the maximum size limit for baggage for most airline companies (Samsonite, 2016).
Figure 1. Luggage sizes offered
However, most carry-on luggage weigh 6.8 lbs (Zazzle, 2016) but the company uses a modified polycarbonate material mimicking Samsonite’s curv material resulting to only 4.4 lbs weight (Samsonite, 2016). Samsonite (2016) and their competitors only offer a limited color option resulting to difficulties by travellers when looking for their luggage at the baggage carousel. The higher baggage fees and the limited number of luggage colors are the reason why the company is offering custom-designed luggage for discerning travellers.
Figure 2. Determining the selling price for custom products
Sales and Cost Pricing
The product is perceived to be a combination of direct and indirect costs since some materials and labor can be directly traced to the finished product (Blocher, Stout and Cokins, 2010, p.64). The direct cost includes sticker printing, luggage and transportation while indirect costs could include varnish, paint, depreciation, rent and energy. Some of the indirect costs could be classified as either a variable or fixed cost (Edmonds, Tsay & Olds, 2011, p.160). Production, selling and administrative costs must be considered when determining the sales price, which was initially the same as the products sold in Sizzle (2016). However, the problem is that each traveller has their own favored colors with regards to the PVC segments of the luggage and that it cannot be accurately forecasted during bulk orders, which also includes popular luggage sizes.
The effect of which is that additional materials and labor are added to the luggage, which means that the break-even point will change (Edmonds, Tsay and Olds, 2011, p.108). Taking into consideration the customer design preference, the monthly break-even point is computed to be at 35.14 or 36 carry-on units or achieve monthly sales of $15,915.79 under the assumption of a purely carry-on volume sale. However to make the business profitable the fixed costs should include a desired profit value, which will increase the break-even point in units and dollars. The formulas used under the cost-profit-volume analysis are from the equation, contribution margin per unit, and contribution margin ratio methods (Edmonds, Tsay and Olds, 2011, p.110).
Costing Methods
Job order costing is considered to be the most appropriate costing method for the company since costs are accumulated to a specific customer order (Blocher, Stout and Cokins, 2010, p.92). The reason for this is that the company is included in the type of companies that primarily use job order costing (Blocher, Stout and Cokins, 2010, p.92). This can be perceived as variable costing since only the variable costs were considered (Edmonds, Tsay and Olds, 2011, p.501).
Figure 3. Variable cost per product
Activity-based costing is considered to be a mismatch for the product since the additional activities to be performed by the company are not that complex (Edmonds, Tsay and Olds, 2011, p.208). ABC is perceived to be applicable to companies that use multiple activity centers, which is contradictory to a unit-level activity (Edmonds, Tsay and Olds, 2011, p.208) like the production of a custom product.
Process costing is defined as the accumulation of costs before being allocated to identical products and services (Blocher, Stout and Cokins, 2010, p.93). Process costing is primarily used in companies with a mass production process, which means that costs are not easily traced to individual products (Blocher, Stout and Cokins, 2010, p.93). This is not considered to be applicable to the company since each luggage is individually designed by the customer and therefore the objective is to develop a customized product.
Absorption costing or full-costing is defined by Edmonds, Tsay and Olds (2011, p.500) as the inclusion of all variable and fixed manufacturing costs to the product until it is sold. This is considered to be impractical for the company since the product will also accumulate a portion of the fixed costs especially when the production cycle occurs within two accounting periods (Blocher, Stout, and Cokins, 2010, p.663). This is despite the fact that absorption costing is the preferred method of external parties due to income-tax effects (Blocker, Stout and Cokins, 2010, p.649).
Ethical Considerations
Choosing a single costing method is not only difficult but also requires some ethical considerations. This includes the amount of working capital available to the company since small companies cannot afford ABC despite its numerous advantages. Another consideration is that despite the recommended use of absorption costing (Blocker, Stout and Cokins, 2010, p.649) it cannot be used in all industries especially with a company that focuses on making custom products.
Capital Budgeting
The company’s future sustainability is dependent on the popularity of the product to its potential market. If the monthly volume sales exceed 100 units then the company can purchase a sticker printing equipment. The capital budgeting decision is therefore to purchase a sticker printing machine in order to improve cost controls while increasing custom designing flexibility. The reason for this is that the company cannot afford to produce different luggage sizes as well as the different PVC colors.
Two of the most practical capital budgeting methods are the IRR and the payback period (Edmonds, Tsay and Olds, 2011, p.450). The IRR determines the investment’s profitability, which only needs to be higher than the cost of capital while considering the time value of money (Edmonds, Tsay and Olds, 2011, p.450). The payback period only considers the number of years that the investment can be recovered and is the easiest method to use (Edmonds, Tsay and Olds, 2011, p.458). The value of using the two methods is whether it considers or ignores the time value of money the resulting decision will still be the same (Edmonds, Tsay and Olds, 2011, p.458).
References
Alibaba. (2016). Polycarbonate Luggage. Alibaba. Retrieved from https://www.alibaba.com/product-detail/Factory-price-wholesale-suitcase-luggage-cheap_60512559250.html?spm=a2700.7724838.0.0.Rct52q&s=p
Blocher, E. J., Stout, D. E., & Cokins, G. (2010). Cost management: A strategic emphasis (5th ed.). New York, NY: McGraw Hill Irwin.
Edmonds, T. P., Tsay, B., & Olds, P. R. (2011). Fundamental managerial accounting concepts (6th ed.). New York, NY: McGraw-Hill Irwin.
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Samsonite. (2016). Luggage. Samsonite. Retrieved from http://shop.samsonite.com/luggage/luggage-sets/
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