ABC Costing

ABCCosting

To: [Susanand Jack Serma)

From: [ChiefFinancial Officer]

Needto Change the billing Method for GLO

[30November.2015]

Dear Jack and Susan, Ihave completed my evaluation of the current billing method for ourcompany and realized it needs change. Besides, I would like topropose that instead of the square footage approach it is beneficialfor the company top adopt the ABC method of billing on the variousjobs (Horngren,1999).

First, the currentbilling method is unacceptable since it leads to the undervaluationof the costs of different jobs. By using the square footage, thereare chances of overlooking substantial components of costdeterminants. My analysis revealed that various jobs have differentcosts contributions, and consequently, they should be billeddifferently. Specifically, non-routine, extraordinary and routinejobs have a cost contribution of 3,354,909, 3,313,130 and 3,042,060respectively. Consequently, they should be billed differentlyaccording to their cost weights. In contrast, the Current square footmethod allocates the costs as 3,324,000 for each category ofnon-routine, extraordinary and routine jobs. My results indicate thatthe current approach leads to creating an undervaluation of therelated costs for non-routine and extraordinary jobs. It also createsan overvaluation for routine jobs. Consequently, the process leads tothe undervaluation of billing for non-routine, extraordinary andordinary jobs. Specifically, under the ordinary method, the billingis 3,324000 for each job while, for the ABC method, the billing is4,025,891.16 3,975,636.63 and 3,042,060.18 respectively fornon-routine, extraordinary and routine tasks (Excel sheet 1)

The ABC methodrealizes the additional costs associated with non-routine tasks andallocates equal billing based on the 20% markup on costs. Concerningsquare footage, the current method assigns same square footage-133,333 for each job type. The method overlooks the fact that thenon-ordinary jobs only cover 76,649.89 square foot whileextraordinary jobs cover only 40, 262.58 square foot. For these twojob types, the square footage is overvalued by the current method.Besides, the present method undervalues the square footage covered bythe ordinary jobs by assigning 133,333 square foot while the inactual terms, the job covers a total 280,087 square feet.Consequently, the current method leads to an undervaluation duringbilling that result in losses for the GLO Company (Excel sheet 1).

The ordinary methodfails to capture that fact that the non-routine and extraordinaryjobs take a long time to complete yet they cover a small amount ofsquare footage. Such jobs require different billing structures basedon the time and other costs contribution. Such facts are captured bythe ABC method and consequently results in more profits for the firm.Specifically, while the ordinary method only results in a profit of262,000 dollars, the ABC method results in a profit of 1,942,000dollars. Consequently, the current method has contributed to thefirm making losses amounting to 1,680,000 United States Dollars (thedifference between 1,942,000 and 262,000) for every 400,000 squarefoot covered (Excel sheet 1).

Similarly, thedifference in the billing system is indicated in the billing for the1000 square feet. The Current method results in a profit of 655 whilethe ABC method results in a profit of 5,840. The resultant lossamounts to a loss of 5,185 (the difference between 5840 and 655) forevery 100 square foot covered. Given the above facts, I would highlypropose that we change the billing system to improve theprofitability of GLO. Kindly find the results of the analysisattached to the Memo for your review and feedback (Excel sheet 2).

[Chief Financial Officer]

Activity

Cost Driver

Estimated Annual Cost Driver Activity

Estimation

Number of jobs

457 jobs

Size

No. of square foot

400000 square foot

Setup

No. of jobs

457 jobs

Non-routine

No. of non-routine jobs

91 Non Routine jobs

Extra-ordinary

No. of exra ordinary jobsEo

46 Extra Ordinary jobs

Routine

No. of routine Jobs

320 Routine jobs

Forone thousand square feetReferences

Horngren, C.(1999).&nbspManagementand cost accounting.London: Prentice Hall Europe.