Case study:
Stereo Sounds Pty Ltd manufactures radios for cars and trucks. The company produces in high volumes, four basic model radio sets used by manufacturers of large cars and trucks. Stereo Sounds Pty Ltd also has two deluxe radio hi-fi systems designed for use on expensive sports cars. The company costs all its products using a traditional volume-based costing system.
Lately, Stereo Sounds Pty Ltd’s profits have been declining. Foreign competitors have been undercutting the company’s prices in three of its four major product lines, and its sales and market share have fallen significantly. In contrast, the company’s deluxe radio hi-fi systems have been selling steadily, although in relatively small numbers, in spite of three recent price increases.
At a recent staff meeting, Stereo Sounds Pty Ltd’s managing director spoke about the issues faced by the company:
Our profits are going down the tube. It costs us $30 to manufacture our R1 radio set. That’s our best seller, with a volume last year of 20 000 units. But our main overseas competitor is selling essentially the same radio set for $28. They can’t be making a profit. This is just another example of a foreign company dumping product on our shores. It’s outrageous! I’m going to write to my local MP. The government needs to do something about this!
On a bright note, thank goodness for our deluxe hi-fi systems. Our salespeople have to push these radios more and more. Take the DF model, for example. It’s complicated to make and we don’t sell many, but look at the profit margin. Those radio sets cost us $50 to make, and we’re selling them for $110 each!
Required:
1. Suggest any two (2) possible allocation basis for manufacturing overhead for Stereo Sounds Pty Ltd’s current costing system.
2. Comment on Stereo Sounds Pty Ltd’s current costing system. Are there any potential flaws or limitations in this costing approach? Include examples in your answer.
3. What are the factors contributing to the decline in profits for Stereo Sounds Pty Ltd’s four major product lines?
4. Recommend a more suitable costing system with justification for Stereo Sounds Pty Ltd. Include in your answer specific ways the recommended costing system can address the flaws you discussed in Q2 above.
Introduction
Stereo Sounds Pty Ltd, a manufacturer of car and truck radios, has been facing challenges in maintaining its profitability due to fierce competition and declining sales. The company employs a traditional volume-based costing system to allocate manufacturing overhead, but this approach may have inherent flaws. This essay examines the potential allocation bases of manufacturing overhead, critiques the current costing system, analyzes factors contributing to the profit decline, and recommends a more suitable costing system to address the identified flaws.
Allocation Bases for Manufacturing Overhead
Two possible allocation bases for manufacturing overhead are: a) Direct Labor Hours: Allocating overhead based on direct labor hours can be suitable for Stereo Sounds Pty Ltd as it reflects the time spent on manufacturing each unit. For instance, the more labor-intensive the production process, the more overhead cost is allocated. b) Machine Hours: This basis allocates overhead based on the usage of machinery. Given the production of radios involves the use of machinery, this approach can provide a more accurate representation of overhead allocation.
Current Costing System Evaluation
The current volume-based costing system has some potential flaws and limitations. It relies solely on volume as a cost driver and fails to consider other factors that affect overhead costs. For example, using the same overhead rate for all products regardless of their complexity can lead to inaccuracies. The case of the R1 radio set, where the foreign competitor sells at a lower price, suggests that the current system may not accurately capture the costs involved. Moreover, it overlooks the different cost structures between the basic model radio sets and the deluxe hi-fi systems.
Factors Contributing to Profit Decline
The decline in profits for Stereo Sounds Pty Ltd’s major product lines can be attributed to several factors: a) Foreign Competition: The foreign competitors’ ability to offer lower prices indicates that they might be using more sophisticated costing systems or benefiting from economies of scale, allowing them to operate with narrower profit margins. b) Dumping Practices: The term “dumping” implies that foreign competitors are selling products at prices below their cost of production, which can significantly affect domestic players like Stereo Sounds Pty Ltd. c) Lack of Product Differentiation: If Stereo Sounds Pty Ltd’s products lack unique features or value propositions compared to competitors, customers might prefer cheaper alternatives.
Recommended Activity-Based Costing (ABC) System
To address the limitations of the current costing system, Stereo Sounds Pty Ltd should consider implementing an Activity-Based Costing (ABC) system. ABC allocates overhead based on the activities that drive costs, providing a more accurate reflection of the actual cost structure. For instance, in the case of the hi-fi systems, the complex manufacturing process and the need for premium components contribute to higher overhead costs. With ABC: a) Cost Accuracy: ABC recognizes the differences in cost drivers for various products, avoiding over-costing or under-costing issues. b) Product Profitability Insights
The company can gain insights into the profitability of individual product lines, aiding in pricing decisions. c) Better Resource Allocation: ABC helps identify resource-intensive activities, allowing the company to optimize its production processes.
Conclusion
Stereo Sounds Pty Ltd’s declining profits can be attributed to foreign competition, product differentiation challenges, and flaws in the current volume-based costing system. To rectify these issues, implementing an Activity-Based Costing (ABC) system is recommended. This system offers a more accurate allocation of overhead costs, enhances understanding of product profitability, and aids in resource allocation. By adopting a more sophisticated costing approach, Stereo Sounds Pty Ltd can better navigate market challenges and improve its overall profitability in the competitive landscape.
As a renowned provider of the best writing services, we have selected unique features which we offer to our customers as their guarantees that will make your user experience stress-free.
Unlike other companies, our money-back guarantee ensures the safety of our customers' money. For whatever reason, the customer may request a refund; our support team assesses the ground on which the refund is requested and processes it instantly. However, our customers are lucky as they have the least chances to experience this as we are always prepared to serve you with the best.
Plagiarism is the worst academic offense that is highly punishable by all educational institutions. It's for this reason that Peachy Tutors does not condone any plagiarism. We use advanced plagiarism detection software that ensures there are no chances of similarity on your papers.
Sometimes your professor may be a little bit stubborn and needs some changes made on your paper, or you might need some customization done. All at your service, we will work on your revision till you are satisfied with the quality of work. All for Free!
We take our client's confidentiality as our highest priority; thus, we never share our client's information with third parties. Our company uses the standard encryption technology to store data and only uses trusted payment gateways.
Anytime you order your paper with us, be assured of the paper quality. Our tutors are highly skilled in researching and writing quality content that is relevant to the paper instructions and presented professionally. This makes us the best in the industry as our tutors can handle any type of paper despite its complexity.
Recent Comments