THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC.Jefferson Multi Media, Inc. I’m sorry, but I’m having a very difficult time using the information on this cost report. I mean, salary totals and the average developmental cost per product may be useful to you and the people in the central office, but I need to know more detail. We have so many different types of activities in the Audio Division that I need to know the unit cost for each if I’m going to do anything about cost control. The speaker was Adam King, General Manager of the Audio Division of Jefferson Multi Media, Inc. (JMMI). Mr. King was discussing JMMI’s cost accounting system with Michael Abbot, the company’s assistant controller. Mr. King had requested the meeting because he felt he needed more information than that contained on his division’s cost report, contained in Exhibit 1. Interested in improving cost control methods in the division, Mr. King was arguing that the average perproduct cost calculation was not an accurate measure of the division’s costs because the type and content of products varied depending on recording studio hours, special effects used, concept and design activities, and the amount of time and effort spent with the recording artist. According to Mr. King, JMMI’s cost accounting system needed to be revised to identify the specific unit costs of these various activities. During the discussion, Mr. Abbott became interested in Mr. King’s approach, and agreed to help him design a cost accounting system that made these distinctions. BACKGROUND About two years ago, in conjunction with JMMI’s move toward decentralizing its media activities, a divisional cost accounting system had been developed. As one of the company’s largest divisions, the Audio Division was among the first to implement the new system, which required division general managers (DGMs) to monitor their division’s expenditures. By involving DGMs in the budgeting and expenditure review process, Nell Chamberlain, JMMI’s president, hoped to gain more control over divisional costs and to improve the company’s overall financial performance. The Division-Based Cost Accounting System (DBCAS) [pronounced Debcas] was based on a standard costing unit that each division could use to measure its overall costs. For the Audio Division, the DBCAS used a completed product as the basic cost calculation unit. At that point, the product was transferred to the manufacturing stage where it was produced in large quantity and shipped to distributors. To calculate an average cost per product for the division, the DBCAS first collected the direct costs on the Divisional Cost Report (DCR), as shown in Exhibit 1. The Controller’s Office then allocated the company’s central office costs, such as depreciation, health and life insurance and administration to each division according to a predetermined method. These allocation methods had been determined by Mr. Abbott, and included space, number of employees, and salary dollars. The basis of allocation for any given cost was designed to provide the fairest means possible for distributing it to the various divisions in the company. After all costs had been allocated to divisions, the controller’s staff would calculate the average cost per unit in each division by dividing the division’s total costs by the appropriate unit of activity. These calculations also are shown on Exhibit 1. The unit of activity for the Audio Division was a completed product, which included audio cassettes, computerized disks (CDs), and digital sound tracks (DSTs) prepared for the company’s Video Division. According to Mr. Abbott, the main advantage of this system was that it allowed him to quickly compare the cost of producing a unit of activity in different divisions. For the Audio Division, he also thought the system could be used to calculate the cost of developing a product of a particular type. For example, to determine the cost of producing a CD, Mr. Abbott could multiply the number of CDs produced by the division’s average cost per product. HBSP Product Number TCG 015 TFor Ms. Chamberlain, the DBCAS was to be the basis for greater fiscal accountability, and she had notified the DGMs that she expected them to work with the DBCAS data in attempting to control costs. This was the main source of concern for Mr. King, since he thought the average cost per product was not an accurate measure for most of the division’s products. According to him, the actual cost of a product varied because different types of products required different types and levels of resources. Mr. King argued that the average cost per product misrepresented the resource needs of most products, and, because of this, the DBCAS did not provide him with the data he needed for accurate budgeting and planning. Product Type-Based System In an effort to address this problem, Mr. Abbott suggested that the DBCAS for the Audio Division be based on product distinctions. He divided the division’s products into three categories: audio cassettes, CDs, and DSTs. With Mr. King’s help, he calculated personnel and supply estimates for each product. For example, he estimated that although there were fewer DSTs produced, most required greater time and effort with artist relations personnel. This was because they were still relatively new as a medium and the recording artists had not yet learned some of the new approaches being used. In most instances, cassettes and CDs did not require this level of effort. From these estimates, Mr. Abbott assigned the division’s direct costs to each product type. Next, Mr. Abbott set about devising a method for allocating overhead costs to product categories. After much discussion with Mr. King and his staff, they decided to allocate all these costs so that they were roughly proportional to direct production costs. The resulting calculations are contained in Exhibit 2. Although the new system maintained a product as the standard costing unit, Mr. Abbott argued that it was a more accurate approach than the system currently in use. Instead of an average cost per product, he now had three average cost figures: one for each product category. In evaluating these revisions to the system, Mr. King and Mr. Abbott explored the differences in cost calculations resulting from the two methods. Some quick computations by the two pointed out the differences in the cost per product under different accounting procedures. From these findings, Mr. Abbott concluded that his “product-type” system could greatly increase Mr. King’s ability to budget and control costs. As Mr. King reflected on the new system, he was bothered by a few continuing problems. While he agreed that product-type costs were more accurate than division-wide calculations, he felt there were further distinctions in resource use that the system did not sufficiently address. He was particularly disturbed by the varying amounts of recording studio hours, special effect hours, concept and design activities, and artist relation activities needed for each product type. Mr. King explained to Mr. Abbott that, according to the new accounting system, it appeared as though all DSTs received the same amount of resources, but from his perspective this clearly was not the case. He pointed out by way of example that a DST recording of a new artist received far more concept and design resources than one for an established artist. Similarly, an artist who needed more time and assistance on the part of Mr. King’s Artist Relations staff used more of the staff’s resources than an artist who needed little assistance. These sorts of distinctions could be made, he argued, for special effects as well. As such, the product-type breakdown was not a sufficiently accurate measure. Service-Based System Unable to convince Mr. Abbott of the importance of this additional refinement, Mr. King himself began experimenting with a third cost accounting method—based on levels of services received—that he thought might be more accurate. As the first step in his calculations, he divided the division’s costs according to the type of service provided: recording studio, special effects, concept/design, and artists relations. He decided that a product’s use of the recording studio could be measured most easily in terms of the number of hours spent in the studio. Examining the division’s records, he decided that it was more complicated to measure special effects. He consulted with some of the special effects personnel and, with them, developed a system based on levels of special effects needed. They decided to define special effects in terms of units on three levels: one unit represented minimal special effects; two units were for moderate special effects; three units represented extensive special effects. Concept/design and artists relations were measured in a similar fashion. Products that required only minor modifications to the concept and design used in a prior recording received one unit. Two units were given for extensive modifications to the prior concept/design, and three units were _____________________________________________________________________________________________ Jefferson Multi=Media , Inc. • June 2012 2 of 6 Purchased by: Chung wen Huang on January 06, 2014 assigned for a new concept/design. Products that required minimal artists relations received one unit; those that required artists relations more regularly received two units; those who used them continually received three units. Having developed these classifications, Mr. King solicited Mr. Abbott’s assistance in allocating indirect costs to these four types of service. Their cost summary is contained in Exhibit 3. In this analysis, Mr. King expected to use more than the number of products as the costing unit. For each product, he would need to calculate the number of hours in the recording studio, and estimate the number of units required for special effects, concept and design, and artists relations. To compare this system with the others, Mr. King chose three products at random in order to determine their costs. According to his calculations, each required the following: Recording Special Concept/ Artist Studio Effects Design Relations Product Type (Hours) (Units) (Units) (Units) C101 Cassette 170 2 0 1 D3420 CD 111 0 2 1 S466 DST 321 3 3 3 Mr. King was satisfied with the results of this cost accounting system. He thought that it accurately distinguished among the various types of resources provided, and that the differences in costs reflected actual differences in resources used. Moreover, because he could now isolate costs by both the nature and intensity of the resources used, he would be able to locate and manage cost problems in the division more easily, thereby complying more effectively with Ms. Chamberlain’s expectations. Mr. Abbott, however, remained skeptical. Although he thought Mr. King might be able to make effective use of the system in the Audio Division, he doubted that it could be transferred to other divisions since, in his view, other divisions would not be able to develop utilization units for their various resources. Furthermore, he was afraid that the system was too complicated to be implemented in all divisions. Finally, he seriously questioned the ability of DGMs to use this more complex system effectively. Assignment: 1. What is the cost for each of the three products Mr. King chose at random? What explains the differences? 2. Which of the three systems is the best? Why? 3. How might you improve upon the system you identified in Question 2? 4. What should Mr. King do? _____________________________________________________________________________________________ Jefferson Multi=Media , Inc. • June 2012 3 of 6 Purchased by: Chung wen Huang on January 06, 2014 JEFFERSON MULTI-MEDIA Exhibit 1. Division-Based Cost Report (for most recent year) Number of products produced 22 Direct costs—Production Professional salaries $1,755,000 Clerical salaries 158,000 Contract services 68,000 Supplies and materials 85,200 Other services 97,700 Total $2,163,900 Direct costs—Administration Administrative salaries $215,000 Administrative supplies 58,000 Operations and maintenance 120,000 Other 25,000 Total $418,000 Total direct costs $2,581,900 Indirect costs allocated from central office Administration $43,300 Health/life insurance 135,200 Operation and maintenance 7,400 Rent and depreciation 3,500 Contract services 2,200 Travel 4,350 Total $195,950 Total direct and indirect costs $2,777,850 Average cost per product (rounded) $126,266 Purchased by: Chung wen Huang on January 06, 2014 JEFFERSON MULTI-MEDIA Exhibit 2. Product-Type Cost Report Cassettes CDs DSTs Total Direct costs—Production Professional salaries $710,000 $555,250 $489,750 $1,755,000 Clerical salaries 51,000 55,600 51,400 158,000 Contract services 20,300 19,800 27,900 68,000 Supplies and materials 34,080 29,820 21,300 85,200 Other services 37,000 28,550 32,150 97,700 Total $852,380 $689,020 $622,500 $2,163,900 Direct costs—Administration Administrative salaries $75,300 $68,900 $70,800 $215,000 Administrative supplies 22,650 15,800 19,550 58,000 Operations and maintenance 45,000 32,300 42,700 120,000 Other 8,640 7,320 9,040 25,000 Total $151,590 $124,320 $142,090 $418,000 Indirect costs allocated from central office Administration $17,320 $15,126 $10,854 $43,300 Health/life insurance 53,700 43,500 38,000 135,200 Operation and maintenance 2,960 2,585 1,855 7,400 Rent and depreciation 1,400 1,223 877 3,500 Contract services 880 769 551 2,200 Travel 1,740 1,520 1,090 4,350 Total $78,000 $64,723 $53,227 $195,950 Total direct and indirect costs $1,081,970 $878,063 $817,817 $2,777,850 Number of products 5 15 2 Average cost per product (rounded) $216,394 $58,538 $408,909 Purchased by: Chung wen Huang on January 06, 2014 JEFFERSON MULTI-MEDIA Exhibit 3. Resource-Based Cost Report Recording Special Concept/ Artist Studio Effects Design Relations Total Direct costs—Production Professional salaries $895,000 $380,000 $235,000 $245,000 $1,755,000 Clerical salaries 35,200 35,000 42,000 45,800 158,000 Contract services 6,500 25,600 22,600 13,300 68,000 Supplies and materials 25,200 25,000 20,000 15,000 85,200 Other services 28,200 17,500 26,000 26,000 97,700 Total $990,100 $483,100 $345,600 $345,100 $2,163,900 Direct costs—Administration Administrative salaries $55,300 $52,000 $55,000 $52,700 $215,000 Administrative supplies 9,500 19,500 25,150 3,850 58,000 Operations and maintenance 33,200 28,500 33,277 25,023 120,000 Other 8,562 7,755 3,680 5,003 25,000 Total $106,562 $107,755 $117,107 $86,576 $418,000 Indirect costs allocated from central office Administration $24,648 $12,216 $5,336 $1,100 $43,300 Health/life insurance 76,956 38,144 16,663 3,437 135,200 Operation and maintenance 4,212 2,088 912 188 7,400 Rent and depreciation 1,992 987 431 90 3,500 Contract services 1,252 621 271 56 2,200 Travel 2,476 1,227 536 111 4,350 Total $111,536 $55,283 $24,149 $4,982 $195,950 Total direct and indirect costs $1,208,198 $646,138 $486,856 $436,658 $2,777,850 Total number of hours or units 3,500 280 180 220 Cost per hour or unit (rounded) $345 $2,308 $2,705 $1,985