AYB321 Strategic Management Accounting Discussion Leadership Questions Tutorial 8 Activity Based Costing/ Activity Based Management 1. Wheelco Pty Ltd manufactures car and truck wheels. The company produces four basic, high-volume wheels used by manufacturers of large cars and trucks. Wheelco also has two specialty wheel lines. These are fancy, complicated wheels used in expensive sports cars. Lately, Wheelco’s profits have been declining. Foreign competitors have been undercutting Wheelco’s prices in three of its four major product lines, and Wheelco’s sale volume and market share have declined. In contrast, Wheelco’s specialty wheels have been selling steadily, although in relatively small numbers, in spite of three recent price increases. At a recent staff meeting, Wheelco’s managing director made the following remarks. ‘Our profits are going down the tube. It costs us $29 to manufacture our A22 wheel. That’s our best seller, with a volume last year of 17,000 units, but out chief competitor is selling basically the same wheel for $27. I don’t see how they can do it. I think it’s just one more example of foreign dumping. I’m going to push those wheels more and more. Take the D52 model, for example. It’s a complicated thing to make and we don’t sell many, but look at the profit margin. Those wheels cost us $49 to make, and we’re selling them for $105 each. (a) What do you think is behind the problems faced by Wheelco? (b) Comment on the managing director’s remarks. Do you think his strategy is a good one? What do you recommend and why? 2. Safe Removal Ltd is a company specializing in the removal and recycling of hazardous wastes, and has always been primarily concerned with environmental compliance. At present, Safe Removal Ltd uses small trucks to collect oil from service stations in a 300 km radius. These small trucks then unload the oil into tanks at Safe Removal’s centres, therefore avoiding storage costs. Once the tanks are full, bigger trucks unload the oil and transport it to a rail yard, where it is then transported to their oil recycling plant. Every time the oil is unloaded from the trucks and the oil tanks, the oil is tested and paperwork is completed to ensure that environmental regulations are complied with. This means that the oil is tested at three different times. Recently, Safe Removal Ltd has begun to struggle in a competitive, slow growing market. To survive, they must improve their efficiency of operations and reduce costs. Answer the following in relation to Safe Removal: (a) Identify the activities that drive actual costs at Safe Removal Ltd, and propose a cost driver for each, noting whether it is a transaction, duration r intensity driver. (b) Applying the principles of ABM, how can they improve their removal processes, and what cost savings would result? 3. Springfield Motor Mechanics Ltd performs mechanical services and repairs to a wide variety of motor vehicles for retail customers, and is thinking about implementing an ABC system for allocating costs to activities. The firm operates out of only one outlet, and Harry Simpson, the owner/managing director, and an experienced mechanic himself, prides himself on being very ‘hands on’ in the business. Springfield operates in a highly competitive environment and, as such, is mainly a ‘price taker’. By far the biggest cost for the firm is direct labour, with the costs of maintaining the workshop (insurance, rent, depreciation on equipment, etc) running a close second. Harry pays quarterly bonuses to his staff based on firm profits; the bonus pool is calculated as 10% of quarterly profit, and each staff member receives an equal share. Required: Advise Simpson on the pros and cons of introducing ABC in his particular situation. In doing so, you are asked to refer to the general costs and benefits of ABC, the use of ABC in service organisations, and the ABC research findings discussed in the lecture.