I have re-read my last years HNC paperwork and used my current years HND paperwork

to help with the various aspects of the report. I used my HNC costing booklets and
lecture notes, HND Investment Appraisal literature, HND Business Tax literature,
HND Capital Allowances literature and HNC Standard Costing literature.

I went to the library and used college resources such as ebray for information of
more in-depth budgeting control systems. I used Cost and Management Accounting
books which covered cost assignment of direct and indirect costs. They covered
issues about fixed, variable and semi variable costs. I used Accounting Theory and
Practice for in-depth budgetary planning and variance analysis. I used an up to
date Taxation book to allow me the most up to date tax percentages to be used, the
correct Asset Investment Allowances applicable and the written down values for
Capital Allowance calculations.

CASE STUDY ANALYSIS

This formal report has been requested by the Managing Director by Ergo design

He requires a full business report which will appraise the launch of a new quality
ergonomic chair. As well as the appraisal, the managing director would like advice
on how to set up and implement an efficient budgetary control system. Ergo Design
already make a different range of products and are wanting to find out if it would
feasible to undertake the making of another new product. The company currently has
spare capacity and as they don’t want spare capacity are looking into making a new
chair. This however involves the purchase or hire of a new asset namely a new
machine which will be capable of making the new product. This asset is not
inexpensive and cost £125,000. Ergo Design are guaranteed an order for 1 year
amounting to 1800 chairs to be distributed evenly over the month. The factory is
only open 48 weeks of the year to allow for maintenance, repairs etc and therefore
leaves 12 periods of 4 weeks to evenly distribute 160 chairs per 4 weeks. The
company have had a trial period and all seems to be well. The MD awaits reports
before committing final sanctions.

APPENDICES 1-9
Attached as appendices is the Activity Based Costing comparison followed by the
functional budgets then Capital Investment Appraisal and lastly a Break Even
Analysis based on my figures.

Appendix 1. Activity Based Costing comparison. I have used Activity Based Costing
(ABC) to work out the costs of producing the new product. Ergo Design in previous
years have recovered costs using a blanket wide rate based on the number of machine
hours. The last two years however they have changed to ABC. I have made a
comparison using traditional overhead recovery and ABC. ABC was developed in order
to more accurately reflect the factors which cause overhead costs to arise.
Overhead costs are attributed to products on the basis that it is activities that
cause costs to arise. Each activity can be identified with a cost driver and the
cost drivers I have used are machine hours, Labour hours, number of orders,
production runs, set up hours and inspections. After the cost drivers have been
identified then each cost driver’s overheads are collected together. These
collections of costs are called cost pools. Each pool is then divided by its
driver, for example all overheads in the cost pool for the materials ordering
process would be divided by the number of orders placed to give a value for the
cost of placing an order. The costs of all activities relating to a product would
be added together to give the overhead element of the cost of production. Because
activity based costing shares out overheads using cost drivers compared with the
traditional costing systems which use departments, then a greater number of drivers
can be used, reflecting all the different activities taking place in the
manufacturing process. This leads to a fairer and more accurate way of charging
overheads to the products. The traditional methods ignore the detail of many of the
activities that actually take place. In my findings the cost of producing the new
product using ABC is £167.95 per unit whereas the blanket method only £150.18 is
allocated for cost, This would give a higher contribution and a higher profit.

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I have assumed that we are going to be charging £195 per unit and at this price we
are still making a profit of £63,975 for the first year. We can look at raising
prices at the end of the initial 3 year period if the turnover is still constant.

My creditors are to allow me credit purchases payable for :

Aluminium Sheets………. 1 month Memory Foam…………….2 months

Fabric…………………………1 month Hardware……………………3 months

My debtors are to be allowed 1 month’s credit sales.

A new asset is to be purchased at a cost of £125,000, which will gather

depreciation over 10 years straight line method. The new machine will need to be
replaced after this time and will have a residual value of £15,000. Maintenance
will need to be carried out regularly to allow for optimum usage and guarantee
residual value. The maintenance cost will be estimated at 5% of the capital cost
per annum. The asset is purchased with a long term loan for the full £125,000. The
loan will have a 3% fixed rate interest per annum. The interest is added to the
original amount and not compounded yearly. This is to be repaid over 10 years with
repayments and interest payments split. The total cost of the loan is £162,500 with
repayments being £62500 every 6 months and Interest being £1,875.

There is currently spare capacity within Ergo Design’s production facilities and
can therefore produce 2 batches of 20 chairs per week for the full 48 weeks that
the factory is open. This allows for surplus stock of (1920-1800)=120 chairs
surplus at the end of the year. We will supply 150 chairs per month to the customer
and make 160 chairs to allow for full capacity, this will leave us a surplus of 10
chairs which will be opening stock for the month of Feb and the units will 10 more
units every month compounded.

The following budgets are prepared for the first six months of the new multi-level
chair and include:

Appendix 2. Opening Balance at beginning of the month of Jan. This is the beginning
of the month and lists the purchases made to enable the company to begin production
and sell them at the end of the month.

Appendix 3. Key Variables input. As the figures were given for batches I had to
break them down into single units costs so that a uniform approach was taken across
the board. The direct material costs have accounted for the biggest costs followed
by the labour then the variable overheads.

Appendix 4. Sales budgets- This is also the main budget which has to be prepared
first. It shows that we are to sell 150 units per month at a cost of £195 creating
a sales value of £29,250.

Production budget- This budget is prepared after the sales budget and states the
amount of units to be produced within the period. I have carried over excess units
in case of any unforeseen circumstances which will reduce production in later
months e.g. machinery breaking down and staff absences etc. The machinery is also
working at full capacity if I make the amount required as well as the excess.

Direct Material usage budget is prepared next and the figures are for 1 single unit
which is obtained from the key variables sheet shown in Appendix 2.

Direct material purchases budget is next with figures for the required production
for each month and the cost of goods to be purchased. The cost figure is taken from
the key variable appendix 2.

Direct labour budget figures come from the production budget for the amount to be
produced multiplied by the cost of the direct labour unit from key variables
appendix 2.