MANAGEMENT ACCOUNTING

PROJECT REPORT BY:

----------GROUP B9----------
AMIT KUMAR 20PGPM077

DHAANYA 20PGPM090

GURKIRAT SINGH BASOOR 20PGPM092

ROHAN TEKRIWAL 20PGPM115

SAYAN MITRA 20PGPM120

VISHAL DAYMA 20PGPM133

GUDAPATI JITENDRA PAVAN 20PGPM136

SUBMITTED TO:
DR. PINKU PAUL MA’AM
INSTEEL WIRE PRODUCTS: ABM AT ANDREWS
YEAR OF ACTIVITY-BASED COSTING (ABC)
Analysis Report

CASE ANALYSIS

 BEFORE ABC

 In the Andrews plant, 4 product lines have 477 individual products.

 20% of the products account for 85% of Andrews’s annual revenues of about $60 million.
 20% of Andrews' customers account for 95% of all sales.
 Raw material costs represent 70% of all costs.
 Raw material prices and prices of finished goods remained constant over the last 25 years.
 Wages and salaries had been growing at the inflation rate.

 VOLUME-BASED COSTING

 Its primary sales strategy was volume-oriented.

 Before ABC, the price per ton of steel rod, the basic raw material, was monitored for costing
purpose.
 This price was used to estimate the material costs of all of Insteel's products.

Calculated By-
 Multiplying the weight of the product by the price of the steel rod.
 Freight was tracked as a separate cost.
 Price quotations were based on the weight of the product & estimated freight costs.

 DECISION OF ABC OR WHY ABC?

 Wages and salaries had been growing at the inflation rate. This resulted in pressure to control
overhead & labor costs by boosting productivity.
 With increasing pricing pressure & capacity constraints at various locations, management
recognized the need for a cost system which would guide managerial decisions about various
choices & tradeoffs facing the firm.
 And then they decided to adopt an Activity-based cost system that would provide a much better
understanding of resource consumption byproducts & by customers than a traditional volume-
based cost system.

 IMPLEMENTATION OF ABC 1996

ABC team
 surveyed the employees,
 Calculated overhead costs in 80 cost pools, and
 a cost driver was associated with each cost pool to assign the overhead costs.
 And finally, come up with a cumulative product & customer profitability figures.
 AFTER ABC 1996

 Galv. Wire products & mesh products were losing money contrary to the fact that they were
considered profitable before ABC.
 Small wire customers were more profitable than larger ones.
 About 45% of the plant's customers & products were profitable.
 Nail business was the most profitable among all which was thought to be moderately profitable.
 And, most importantly, within nails, galvanized pallet nails turned out to be the plant's most
profitable product.

 FOLLOW-UP IN 1997

 Total sales increased by $5.9 million.

 Total operating costs increased by $5.4 million.
 Total operating profit increased by more than half a million dollars.
 Reduction in quality costs of $1.8 million.
 Reduction in freight costs by $555,000.
 Raw material prices increased relative to the previous year.

 EFFECTS OF ABC 1997

 After all this realizations, process improvements were initiated in quality, preventive
maintenance, & freight handling.
 Product & customer mix were changed.
 Company decided to expand the production of galv. Pallet nails from two cells to four, third
being added first, and after its success, the addition of fourth one.
 Although ABC improved profitability & efficiency, still galv. Pallet nails were losing money &
became most unprofitable product in 1996-97 fiscal year.

 EFFECTS OF ABC

 Nails are turning out to be most profitable product group for the plant. Major reason for its
profitability is its sales volume. Nails have the highest sales amount all the product groups.
 In contrary, product group-Mesh have incurred highest losses major reason being its lowest sales
among the product group.
 Meanwhile, bright wire and galv are not incurring huge losses/profit because of it’s low sale
value.
 On comparing the cost, we can observe that material cost is the most significant cost in all of the
product group.
 For the third cell

 Major reason for its profitability is its sales volume. Nails have the highest sales amount among
all the product groups.
 Insteel invested $900,000 on heading & threading machine with zero salvage value at the end of
its 10 year life.
 $200,000 was spent on labor.
 But the cell didn't go into production until June 1997 because of delay in equipment installation
and running.
 Management realized that, there had been problems with the execution of the third cell, and if the
speed could be ramped up, then this line could be very profitable.

 But, the central problem still was, that whether the decision to add a third cell was
justifiable or not?

The main reason in such a higher conversion cost of adding the third cell are

 $9,00,000 Investment & Depreciation on additional heading & threading machine (as observed in
Exhibit 4).
 $2,00,000 investment on Labor Cost
 Increased cost on order processing as compared to the invoicing due to delay in the production
because of the introduction and late installation of the Third cell of galvanized pallet nails.
 DATA ANALYSIS
Findings of ABC 1995-96 Analysis
Product Material Production Customer Business Facility/Sustaining Total
Sales Profit
group Cost Cost Cost cost Cost
Bright Wire 10.462 6.763 1.235 1.499 0.416 9.913 0.549
Galv Wire 12.866 8.816 2.057 1.567 0.545 12.985 -0.119
Nails 30.613 19.902 6.585 1.327 1.219 29.033 1.58
Mesh 5.07 4.277 0.708 0.504 0.24 5.729 -0.659
59.01
Total 39.758 10.585 4.897 2.42 57.66 1.351
1

 We can observe that the only nails and bright wires are profitable for the plant where as
they are incurring loss on galv wire and mesh.
 Nails are turning out to be most profitable product group for the plant. Major reason for
its profitability is its sales volume. Nails have the highest sales amount all the product
groups.
 In contrary, product group- Mesh have incurred highest losses major reason being its
lowest sales among the product group.
 Meanwhile, bright wire and galv are not incurring huge losses/profit because of its low
sale value.
 On comparing the cost, we can observe that material cost is the most significant cost in
all of the product group.

ABC Analysis for Galvanized pallet nails

By working on Exhibits 4, 5 and 6 we did detailed ABC calculations for Galvanized pallet nails in both
the years separately. From total spending and volumes drivers we calculated the conversion cost for
Galvanized pallet nails activity and we arrived at that there is total of conversion cost for the year.
NOTE: We have attached its working in excel for detailed calculations

Analysis of ABC calculation for Galvanized pallet nails 1995-96

We calculated the conversion cost for Galvanized pallet nails activity and we arrived at that there is total
of approx. 858K conversion cost for the activity. We can observe that the Material cost and conversion
stand at 900K and 858K respectively which resulted in total cost of 1.75M. By reducing the total cost
from the sales we found that there is PROFIT of 191K in the year.

Analysis of ABC calculation for Galvanized pallet nails 1996-97

Similarly like we did in year 1995-96, by working on Exhibits 4,5 and 6 we did detailed ABC
calculations for Galvanized pallet nails in year 1996-97, we can observe that the Material cost and
 conversion stand at 1.1M and 1.2M respectively which resulted in total cost of 2.3M. By reducing the
total cost from the sales we found that there is LOSS of 270K in the year.

Broader/Macro Level Analysis of ABC Calculations For Both Years

Macro Level Comparison of ABC Calculations
Particulars 1995-96 1996-97 Absolute change Percentage change
  Material Cost 900000 1100000 200000 22%
less Conversion Cost 858638 1270623 411985 48%
Total Cost 1758638 2370623 611985 35%
           
  Sales 1950000 2100000 150000 8%
less Total Cost 1758638 2370623 611985 35%
Profit/Loss 191362 -270623 -461985 -241%

Now let’s do analysis of the ABC calculations of Galvanized nail for the year 1995-96 and 1996-97 at
macro level.

On comparing, we can see that increase in sales i.e. 8% is less than increased in total cost i.e. 35%. In
costing we can see that conversion cost is causing significant change in the total cost. On analysing the
calculations we found out that the in conversion cost of 1996-97, adding the 03rd pallet unit is causing the
major costing in the year. However, it is mentioned in the case that it took approx. the whole year to setup
the machinery and make it in working condition. Hence, it couldn't generate the production in accordance
to the expectations, hence it resulted in the loss of 241% on Year on Year basis.

Deeper/Micro Level Analysis of ABC Calculations For Both Years

While doing micro level comparison, we can see that the orange highlighted items are causing the
significant changes on Year on year basis.

NOTE: We have attached its working in excel for detailed calculations

 Depreciation- Heading and Threading

Depreciation has increased by 180% or say 90000 dollars in absolute terms. Reason being
the addition of new unit which is costing 900K and has life for 10 years and with 0
salvage value. There increasing the depreciation costing by 90K per year.
 LABOUR.
The Labour has increased by 50% i.e. from 4,00,000 to 6,00,000. This is solely caused by
adding the new machine.
 EVA on Heading/Threading Machine
We can see that The EVA on heading/threading machine is caused by the new cell
addition.
After observing, all of above signification costs, we can see that the three mentioned
items are causing the significant changes in the conversion cost. After analysing all the
 factors we can conclude that addition of cell unit 3 is the primary and sole reason for such
high increase of 48% in the conversion cost in the year 1996-97.
Budgeting and forecasting for 1997-98
Particulars 1995-96 1996-97 Forecasting 1997-98
Sales ($M) 1.95 2.1 3.2
Sales (tons) 2600 2817 4226
Material Cost ($M) 0.9 1.1 1.7
Conversion Cost ($M) 0.859 1.271 1.3
Net Profits ($M) 0.191 -0.271 0.2

XXXXXXX

Recommendations

 Insteel shouldn't have started the 3rd cell for galvanized nails after immediate ABC analysis.
Or else, the delay in installing would have avoided.
 Manufacturing overhead costs of galvanized nails, mainly the heading & threading machine cost 0f
$900000 & labour cost of $200000 could've been reduced.
 The company should realize that not all products or services share equally in activities.
 In the manufacturing process flow chart given in the case, we can observe that galvanized nails is
having the most complicated & long production process & in ABC method the more complex a
product’s manufacturing operation, the more activities and cost drivers it is likely to have. Therefore,
when Insteel increased its production & added third cell allocated only to this product, it incurred too
many cost pools & cost drivers which consumed a lot of overhead costs & thus causing such a sudden
loss in galv. Nails production, in just one year.
 Ultimately, adding third cell and then planning for fourth cell was not at all recommended.
Conclusion
 Although, switching to ABC method was successful for Insteel in determining loopholes & actual
profitability, still it failed to make use of this in the welfare & growth of the company.
 Also, the conversion cost, including heading & threading machine overhead, & labour cost caused a
huge loss.
 Difference in order processing & invoicing of galvanized nails was also contributing to the Loss
factor.
 A hasty & premature decision of starting the 3rd cell for nails.
 Imbalance between company's goals & ABC management team's objectives.
 Focus only on Andrew's plant & not on other 7 plants.
 Lack of detailed analysis of overheads & decision without forecasting.