Question

Lim & Joyce Consulting, a Perth (Australia) based firm, provides consulting services related to project management and analytical support. It operates in a very tight local labour market and is having difficulty finding quality staff. The firm bills $350 per hour for services performed. The labour cost per hour paid by Lim & Joyce Consulting for professional staff time is $135. Additional information is provided as follows: • Billable hours to clients for the year ended totalled 10 000, consisting of: analytical support services, 3 800 hours; project management consulting services, 6 200 hours. • Administrative costs of $1 026 000 is allocated to both consulting services based on billable hours. These costs consist of staff support, $540 000; in-house computing, $409 200; and miscellaneous office charges, $76 800. A recent analysis of staff support costs found a correlation with the number of clients served. Inhouse computing and miscellaneous office charges varied directly with the number of computer hours logged and number of client transactions, respectively. The following table shows the number of clients, computer hours and client transactions for the analytical support and project management consulting services: Analytical Support Project Management Total Number of clients 100 400 500 Number of computer hours 3 600 5 200 8 800 Page 2 of 3 Number of client transactions 1 200 800 2 000 Required: Respond to the following questions: i. Assume that the firm uses traditional costing procedures, allocating total costs on the basis of billable hours. Determine the profitability of the firm’s analytical support and project management consulting services, expressing your answer both in dollars and as a percentage of revenues for each consulting service. (2 marks for correct calculations; zero marks for incorrect calculations). ii. Repeat requirement i, using activity-based costing. (5 marks; full marks if all calculations are correct; zero marks if calculations are wrong; half marks for minor errors). iii. Activity-based costing (ABC) is said to result in improved costing accuracy when compared with traditional costing procedures. Briefly explain how this improved accuracy is attained.

Answer 1

Part 1 Calculation of total unit cost using Traditional method of cost allocation Allocation of administrative cost per billable hour 1026000 / 10000 $ 102.60 Analytical Support Services Cost per unit Total billable hours Revenue Labor cost Administrative cost Profit Profit Margin (Profit/Revenue*100) $ $ $ $ 350.00 (135.00) (102.60) 112.40 $ $ $ $ Total cost 3,800 1,330,000 (513,000) (389,880) 427,120 Project Management Consulting Services Cost per unit Total cost 6,200 $ 350.00 $ 2,170,000 $ (135.00) S (837,000) $ (102.60) $ (636,120) $ 112.40 $ 696,880 32.11% 32.11% Part 2 Calculation of total unit cost using Activity based method of cost allocation Calculation of activity based overhead rates per cost driver Activity Cost Pool Cost driver Total cost ($) Cost per unit ($) Annual activity per cost driver 500 8,800 2,000 Staff Support costs In house computing Miscellaneous Office charges Number of clients Number of computer hours Number of client transactions $ $ 540,000 409,200 76,800 1,026,000 $ $ S 1,080.00 46.50 38.40 Ş $ Assignment of each activity's overhad costs to products using ABC Analytical Support Services Project Management Consulting Services Activity Cost Pool Expected use of cost drivers per product X Activity based overhead rates Cost assigned Expected use of cost drivers per product X Activity based overhead rates Cost assigned $ 100 3,600 1,200 $ $ $ 1,080.00 46.50 $ $ 400 5,200 800 $ $ 1,080.00 46.50 38.40 $ $ $ 38.40 $ Staff Support costs In house computing Miscellaneous Office charges Total Administrative Costs assigned Total billable hours Cost per billable hour 108,000 167,400 46,080 321,480 3,800 84.60 432,000 241,800 30,720 704,520 6,200 113.63 $ $ $ $ Analytical Support Services Cost per unit Total billable hours Revenue Labor cost Administrative cost Profit Profit Margin (Profit/Revenue*100) $ $ $ $ 350.00 (135.00) (84.60) 130.40 $ $ $ $ Total cost 3,800 1,330,000 (513,000) (321,480) 495,520 37.26% Project Management Consulting Services Cost per unit Total cost 6,200 $ 350.00 $ 2,170,000 $ (135.00) $ (837,000) $ (113.63) $ (704,520) $ 101.37 $ 628,480 28.96% Part 3 Activity-based costing (ABC) is said to result in improved costing accuracy when compared with traditional costing procedures. This improved accuracy is attained because Traditional costing assigns cost to products based on an average overhead rate while ABC determines all activities and costs related to production and allocated them on the basis of cost drivers. In the given sum, a standard allocation rate of 1026000 / 10000 = $102.60 was used to allocate administrative costs to the services provided by Lim and Joyce Consulting As a result, profit % for both these services was 32.11% under Traditional costing. However when ABC method was used, allocation of admimistrative costs to both services changed. As a result, profit % for Analytical Support services increased to 37.26%, while for Project Management Consulting Services, it fell to 28.96%.

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