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Key Topics
Requirements
Establishing accounting standards & Behavioral context based on Sea Dot Case Study
Solution
Accounting standards & Behavioral
A. Introduction
In this case the Jennifer smith is a project manager of Sea Dot's Membrane and Related Equipment Group who is facing a problem of cost allocation. The company was facing a problem of significant loss from the project due to poor cost information system so the company made expenditure on technical improvement which cost £5 million. The cost overruns due to different nature of project which occurs at the time of project completion and top level have very less information due to which the cost overruns. The company has already charged £3 million from the A1 project and the project manager is facing the project in allocating remaining £2 million cost of technical innovation which is done by the engineers innovations. The reason of surprising cost is occurred due to different amount of information between the project manager and top level management.
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B. Problem faced by Jennifer
The problem faced by Jennifer is cost allocation of remaining technological expenses which is £2 million. If the cost is charged from the current project namely, A1 then the total cost of the project will be £8.2 million which is approximately thirty percent of the overall budget of a project. It can become a major problem for the company and it impacts on the compensation, bonus and profit margin of the project. The Jennifer is also responsible for two other projects which will be starts in the coming fiscal year so she is facing a problem of remaining £2 million cost allocation and £3 million cost is charged from the project A1. Another two projects will experience the cost saving from the implementation of cost information system which is done by the initiative of engineers and efforts of technological department. If the remaining £2 million will be charged from another two projects then it will increase the profitability of current year which helps to get the bonus and it fulfills the needs of Jennifer’s family.
According to the agency theory the outcome of the profit is depend on the efforts of Jennifer and environmental factors (Ballwieser et al., 2012). Under the sharing rule Jennifer is eligible for the reward as a share of outcome. The effort of Jennifer is measured through management accounting information which provides the outcome of a project. The top level management and Jennifer has different amount of information which may cause moral hazard and adverse selection. The company must provide bonus to the Jennifer to motivate her for the two next coming projects.
C. Total cost for unfinished products
I. Breakeven point
It is defined as the point at which the total revenue of the company covers the total expenses in the particular accounting period (Alhabeeb et al., 2012). It is the point where the company neither makes profits nor loss and it only covers the total expenses of the company with the revenue generated in the specific period of time.
Desired profit = 10 % on sales
Total costs = £ 8.2 Million
Breakeven point = £ 9.02 Million
II. Normal profit
The normal profit is defined as the profit in which the total revenue and total cost difference is zero. It is the level of profit which is required by the company for competing in the market. It is also known as zero economic profit. It is calculated by deducting the total cost which includes explicit cost and implicit cost less from total revenue in the particular period of time.
Normal profit = £ 8.2 Million - £ 8.2 Million = 0
D. Impact on compensation
The total compensation of Jennifer smith includes a salary of £36,500 and if the company earns a standard profit target of ten percent then the bonus will be £20,000. If the project manager deducts the cost from the existing project, namely, A1 then the total cost of the project overrun and the budget exceeds by approximately thirty percent which is a major loss and it will directly impact on the profit margin of the company due to which the project manager will not get the bonus and if the project manager deducts the cost from another two projects of next year then the total profit of current year will increase which enables the project manager to get the profit. The loss in the current project will impact on the performance of Jennifer Smith because it is the responsibility of the project manager to derive the overall profit margin of the project.
2. Review of impact on other shareholders
a. Stakeholders
The stakeholders in the business are project manager, top-level management, organization, consumers, plant operator, site joiner, commercial manager, managing director, and employees. The stakeholders are individuals who are interested in the process of a project and its outcome. The stakeholders are classified as indirect, direct, positive, negative, legitimacy. The direct stakeholders in this project are those who are directly associated with the project such as project team, project manager, project sponsor, and consultants. The indirect stakeholders of this project include internal managers, staff, labor unions, and government. The positive stakeholders include investors, project managers, and employees who are likely to gain from the project. The negative stakeholders of this project are the ones who are indirectly associated with the project such as local residents. The legitimacy includes the one whose perceived validity claims the importance of the project.
b. Rights & expectations of stakeholders
The shareholders have the right to get complete information about the project and to know the reason for failure in a project. The expectations of shareholders include completion of the project on time, no cost overrun, and delivery on time, high-profit margin of a project, standard quality of project, no higher difference between estimated and allocated budget. The business stakeholders include customers, suppliers, investors and the government whose expect to gain profit from the project by cost allocation which helps to increase the profit margin of the project. The expectations and rights of stakeholders depend upon the degree of interest and influence on the business (Du et al., 2014). For example, the investors have high degree of interest then the project manager needs to provide regular updates and information about the project. The expectations of stakeholders are required to be fulfilled by the project manager. For example, federal government agencies want to complete the project with obeying the laws. The impact of expectations is ubiquitous and inescapable. The meeting of stakeholder’s expectations is one of the major responsibilities of a project manager which force them to produce profit from the project.
c. Jennifer’s obligations
The Jennifer Smith is the project manager of the company and she is responsible for cost allocation, on-time delivery, high-profit generation from the project, designing of project management standards, control and coordination with the project team, planning, and monitoring, develop and maintain the stage of the project, managing of risk, quality management, effective communication, meet the project milestones, relationship management with the senior responsible owner and motive the project team. The main role of a project manager is to complete the project successfully by allocating the cost and implement the plan in an effective manner. The profit is derived by the project manager through the utilization of resources in a mast efficient and effective manner. Another responsibility is to meet the expectation of stakeholders by completing the project on time.
3. Decision making
a. Cost allocation
The project manager has two options for cost allocation. One is to deduct the expense from the current project, namely, A1 and second option is to deduct the cost from the coming two projects in the next fiscal year. The cost allocation is the major responsibility of the project manager which directly impact on the profitability of the project (Kru? et al., 2000). If the cost deduction of remaining £ 2 Million is done from the current project then the cost overruns from the budget by approximately thirty percent which directly impacts on the profitability of the current year which also eliminates the bonus of project manager. Another option is to deduct the remaining £ 2 Million from the coming two projects in the next fiscal year on which the technology will be implemented. From the above two options, the second option is suitable because the cost deduction of £2 Million must be done from the project on which the technology will be implemented because it also helps to save the cost of the project and if the cost is deducted from a current project it will impact on the current profits of the company. The cost deduction from the second option helps to provide the sustainable profit for the company.
b. Role of cost accounting system
The decision making is defined as the process which helps to solve the business problems by selecting the alternatives. The prudent project manager uses various techniques of cost accounting which helps to take the best decision in the business. The cost accounting provides statement of labor utilization and material, cost sheet, budget, and other various reports which helps to compare the standard costs. The following information of cost accounting can be utilized for taking the business decisions:
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Labor costs reports: It is defined as the report which helps to minimize the labor turnover and idle time cost. The statement of time utilization of individual labour in production purpose helps to minimize the idle time of labor by transfer the workers to another department which helps to utilize the human resource effectively.
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Cost sheet: It is defined as the sheet which reflects the cost of each unit. The sheet helps to compare the cost from the previous year which can be used by the project manager in taking the decision regarding cost minimization. It also helps to predict the reason of an increase in cost which can be minimized through reducing the wastage by implementing other techniques and it helps to produce standardized products (Anily et al., 2007).
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Overhead utilization report : It is defined as the report which helps to pay the genuine overheads and distribute them on the basis of validity. The reports help to determine the correct cost of overheads and controlling the indirect expenses of the project.
Following are the techniques of cost accounting which helps in decision making:
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Analysis of variance: It helps to analyze the deviations in the project which enables us to minimize the risk.
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Marginal costing: It helps to maximize the profitability of a project by analyzing the relationship between level of production and variable costs.
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Break-even analysis: It helps to determine the level of sales to cover the total cost of the project which helps to take best decision for completing the project successfully.
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Activity-based accounting: It helps to cost each unit on the basis of various activities. It also helps to reduce the indirect cost which directly impacts the profitability of a project (Vanovermeire et al, 2014).
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Kru?, L., &Bronisz, P. (2000).Cooperative game solution concepts to a cost allocation problem. European Journal of Operational Research, 122(2), 258-271.
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Anily, S., &Haviv, M. (2007).The cost allocation problem for the first-order interaction joint replenishment model. Operations Research, 55(2), 292-302.
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Du, J., Cook, W. D., Liang, L., & Zhu, J. (2014). Fixed cost and resource allocation based on DEA cross-efficiency. European Journal of Operational Research, 235(1), 206-214.
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Vanovermeire, C., Sörensen, K., Van Breedam, A., Vannieuwenhuyse, B., &Verstrepen, S. (2014). Horizontal logistics collaboration: decreasing costs through flexibility and an adequate cost allocation strategy. International Journal of Logistics Research and Applications, 17(4), 339-355.
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Ballwieser, W., Bamberg, G., Beckmann, M. J., Bester, H., Blickle, M., Ewert, R., ... & Gaynor, M. (2012). Agency theory, information, and incentives. Springer Science & Business Media.
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Alhabeeb, M. J. (2012). Break? Even Analysis. Mathematical Finance, 247-273.
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