ARTHUR: Are there any issues with cost? OPERATIONS MANAGER (Truc Nguyen): Costs keep rising. The basic costs at ADS are sorting, delivery, administration and promotion. Here's a copy of the budget for 20X5 (Exhibit 1). All of the costs have been classified as fixed except for sorting labour, which is strictly variable. You'll notice that we split the sorting costs into labour and overhead and separately keep track of both classes of parcels, express delivery and regular delivery. Both the standard and actual sorting labour rates were raised to $20.00 per hour in 20X5. We don't plan on increases for 20X6 as our rates are on par with both private and government-funded delivery services. I sense that we may not be accurately allocating sorting costs to each of our delivery services. When we implemented the automated sorting equipment for processing letters two years ago, our margins changed very little. I assumed that variable sorting labour costs would decrease for letters. Administration costs are categorized as 20% maintenance costs and 40% janitorial costs, with the Yemainder classified as office administration, which includes office supplies, phone charges and consulting fees. The maintenance and janitorial costs have remained stable over the past couple of years; however, the office administration costs seem to fluctuate somewhat, depending on volume. We split the administration costs as roughly 50% of the total to letters and prorate the remainder to the parcel services based on total weight for each department. It's a fairly large portion of our costs that we arbitrarily allocate to each service. The allocation of delivery costs to each of our services has been affirmed by our controller, who has worked with me and an outside consultant to set effective rates and cost measures. We've already confirmed that the 20X5 variance in delivery costs is due to the increase in fuel prices across the country. We intend to maintain advertising costs for 20X6 and are confident that it will boost sales volume. We predict that letter sales will increase to 42 million pieces, while express-delivery parcel sales will increase to 2.5 million kilograms and regular-delivery parcel sales will increase to 28 million kilograms. ADS's overall mandate is for operations to at least break even. ARTHUR: Has anyone performed an analysis of the Aardvark Delivery Service (ADS)' was formed 30 years ago with a mandate to establish a private delivery system in the country of Aardvark. By 20X5, ADS was handling close to 30 million pieces of mail and 29 million kilograms of parcels per year. Arthur Chapman has spent several years working with small-scale private delivery companies in many countries. Recently, Arthur was hired by ADS to assist in improving its operating and financial performance. The owners of ADS were dissatisfied with the recent trend in financial results (Exhibits 1 to 3). Farid Banai, president of ADS, has called a meeting with Arthur and Truc Nguyen, operations manager, to review the 20x5 results. PRESIDENT (Farid Banai): From where I sit, the situation doesn't look very Our volume is fairly constant; however, the deficit keeps getting larger. We planned to break even in 20X5 but failed to accomplish our goal. The basic mission of ADS is to provide effective and efficient delivery services to the entire population and to network with other delivery services around the world. The vast distances, rugged terrain, natural obstacles and severe winter weather all contribute to making our job a great challenge. We calculate, for example, that in the month of March it costs us $2.75 to send a letter from a small town in our most easterly region to one of the northern outposts, but our revenue on that letter is still just $0.48. 3.RTHUR: Tell me about the profitability of each type of 12delivery service ADS offers. PRESIDENT: Letter delivery has not been profitable even after the installation of more highly automated equipment. We had planned on express parcels generating the most profit for us; however, the 20X5 results were disappointing. Some of the issues are that other private carriers are encroaching on the parcel end of our business and the number of kilograms in sales for 12 before we were able to implement the plan. I've included an illustration of the sorting process (Exhibit 4) and a copy of the suggested sorting activities and cost pools (Exhibit 5). She also did an analysis of the administration costs, first, to determine a better way to allocate service department costs (Exhibit 6) and, second, to understand the behaviour of the office administration costs (Exhibit 7). ARTHUR: And what about revenues? OPERATIONS MANAGER: Well, the rates throughout 20X5 were $0.48 for the average letter, $2.10 per kilogram on express-delivery parcels and $1.05 per kilogram for regular-delivery parcels. So far, we've only been able to justify increasing the letter rate to $0.49 in 20X6. PRESIDENT: Things didn't go too well for ADS in 20X5 (see Exhibit 2) and unless some changes are made, don't see much future improvement. The profits for the standard letter service appear to be pretty bleak, but our owners refused our request to drop the letter delivery business. ARTHUR: So the future is in parcels? PRESIDENT: When I saw the 20X5 results, that seemed to be the way we were heading. However, I'm skeptical of this approach until we have a better handle on costing. That's what I'm hoping you'll do for us. As I see it, there are two tasks I would like you to accomplish: 1. Provide a better allocation of sorting and administrative costs between departments. 2 Take a closer look at the express-delivery parcel 6/ opportunities. Many of our customers who use our letter 12 and regular-delivery service also use the express- delivery parcel service. I believe there's a future in this line of business, but for now we need to increase our bottom line. In support of that, I would like you to investigate the following two options relating to express- delivery parcels: - Increase the rate to $2.75 per kilogram. According to marketing, we might lose 2% of our business if we do this. However, due to increases in fuel costs and demand, many of our competitors are increasing prices as well, so we don't expect this decrease in demand to continue. . Increase our advertising campaign for express-delivery Required: For the first requirement, assume the role of a junior management accountant internal to ADS. For the balance, assume the role of Arthur Chapman and prepare a report to Farid Banai, President of ADS. The report should Tanalyze ADS's current cost allocations and provide advice for the future. It should include the following: 1. Overview: Provide a high-level analysis of the 20X5 operating variances (Exhibit 3). The variances in Exhibit 3 are based on the budgeted and actual figures in Exhibits 1 and 2. (8 marks) 2. Analysis: Using the documents provided by the consultant, prepare an analysis of each of the following 20X5 costs: a) Sorting labour and overhead: Reallocate the total sorting labour and sorting overhead costs to each of the departments using the activity-based costing analysis in Exhibit 5. (10 marks) b) Administration costs: i. Service department portion of administration costs: Prepare a comparison of cost allocations of the janitorial and maintenance departments to the production departments using the direct and step methods. Use the allocation bases provided in Exhibit 6 and begin with the janitorial costs using the step method. Your analysis should discuss which method provides the most reasonable estimate of service department costs to production departments and explain why it is the best method. (8 marks) ii. Office administration costs: Review the summary printout of two Excel regression analyses (Exhibit 7): one that tests the correlation between administration employee hours and office administration costs and one that tests the correlation between documents used and office administration costs. Explain which activity driver is the best representation of cost behaviour and reallocate the office administration costs to the production departments using the 20X5 activities provided in the exhibit. As a result, the office administration costs should be split into variable and fixed portions. Fixed costs should be allocated among the services using the original allocation base. (10 marks) 3. Prepare a revised operating statement for 20x5 using the costing analyses from requirement 2. Provide a short analysis of the results including d) For expedited parcels, the hours used varies by the number of parcels. e) Service department allocations and fixed costs will be unchanged. (10 marks) 5. Analyze the president's two options concerning the express-delivery parcel business. Your analysis should use the 20x6 budgeted figures and the additional information provided in Exhibit 8. Based on the quantitative analysis, make a recommendation and provide your reasons. Your recommendation should include at least two changes 9/ that the organization could make regarding the express- 12 delivery parcel business. (9 marks) 6. Provide management with at least two observations you have made during your research that can be considered for future analysis. (2 marks) Note: In addition to the above, award 3 marks for format and professionalism. Exhibit 1 Aard vark Delivery Services Express Regular 20x5 budget posts post (in '000s) parcels parcels Total Letters Volume (pieces) 40,000 $0.48 $19,200 2.560 $2.10 $5,376 23,094 $1.05 $24,249 $48,825 788 Volume (kilograms) Rates ace Total revenue eta Expenses: Sorting labour Sorting overhead Delivery Administration Promotion Total expenses 1,578 840 8,997 15,775 15,502 2,051 6,310 7,140 3,426 964 19,891 342 6,158 7,888 7,522 3,084 368 25,019 (771 6,851 368 1,699 48,825 3,915 Surplus (deficit) S (691) $1.461 $ (0) 10/ 12 12 Exhibit 2 Aardvark Delivery Services 20X5 actual results (in '000s) Express Regular delivery delivery Letters parcels parcels Total Volume (pieces) 37.800 Volume (kilograms) 2,310 26.880 $0.48 $2.10 $1.05 Total revenue $18,144 $4,851 $28,224 $51,219 Expenses: Sorting labour 2,100 797 7,168 10,065 Sorting overhead 6.773 1,693 8.466 16,931 Delivery 7,508 998 9,240 17,745 Administration 3.276 259 3,017 6,552 EMPLOYEE HOURS $ Surplus (deficit) $ (2,667) $ 527 (66 4) $ (2,805) 1 Administration costs are allocated equally to letters and parcels. The amounts assigned to the two categories of parcels are based on the number kilogra 2 Promo df SS MS 1 712961166.1 712961166.1 campa 10 1998854942 199885494,2 11 2711816108 dj SS MS 1 2393512148 2393512148 Exhibit 4 The Aardvark delivery system consists of three main activities: collection sorting delivery Aardvark Delivery Services Parcel-sorting process Mail collection and delivery Operations management of Aardvark has developed a sophisticated grid that networks the collection and delivery process. The organization contracted a consultant two years ago to research the most economical and efficient ways to collect mail. Mail is collected at various periods throughout the day to ensure that idle time in the sorting process is minimal. Mail is also delivered throughout the day to ensure that delivery vehicles can make more than one delivery in a day, thus capitalizing on existing delivery resources. 8/12 Pre-sort After being collected, all mail enters the pre-sort process, where it is separated into letters and parcels. Sort letters Letters are sorted using automated sorting equipment. The capacity of the equipment is 10,000 letters per hour. Letters are sorted by delivery route. A delivery route can consist of a street, a subdivision or a building. Separate regular-delivery and express-delivery parcels After the pre-sort all parcels are sorted into regular- ARTHUR: Are there any issues with cost? OPERATIONS MANAGER (Truc Nguyen): Costs keep rising. The basic costs at ADS are sorting, delivery, administration and promotion. Here's a copy of the budget for 20X5 (Exhibit 1). All of the costs have been classified as fixed except for sorting labour, which is strictly variable. You'll notice that we split the sorting costs into labour and overhead and separately keep track of both classes of parcels, express delivery and regular delivery. Both the standard and actual sorting labour rates were raised to $20.00 per hour in 20X5. We don't plan on increases for 20X6 as our rates are on par with both private and government-funded delivery services. I sense that we may not be accurately allocating sorting costs to each of our delivery services. When we implemented the automated sorting equipment for processing letters two years ago, our margins changed very little. I assumed that variable sorting labour costs would decrease for letters. Administration costs are categorized as 20% maintenance costs and 40% janitorial costs, with the Yemainder classified as office administration, which includes office supplies, phone charges and consulting fees. The maintenance and janitorial costs have remained stable over the past couple of years; however, the office administration costs seem to fluctuate somewhat, depending on volume. We split the administration costs as roughly 50% of the total to letters and prorate the remainder to the parcel services based on total weight for each department. It's a fairly large portion of our costs that we arbitrarily allocate to each service. The allocation of delivery costs to each of our services has been affirmed by our controller, who has worked with me and an outside consultant to set effective rates and cost measures. We've already confirmed that the 20X5 variance in delivery costs is due to the increase in fuel prices across the country. We intend to maintain advertising costs for 20X6 and are confident that it will boost sales volume. We predict that letter sales will increase to 42 million pieces, while express-delivery parcel sales will increase to 2.5 million kilograms and regular-delivery parcel sales will increase to 28 million kilograms. ADS's overall mandate is for operations to at least break even. ARTHUR: Has anyone performed an analysis of the Aardvark Delivery Service (ADS)' was formed 30 years ago with a mandate to establish a private delivery system in the country of Aardvark. By 20X5, ADS was handling close to 30 million pieces of mail and 29 million kilograms of parcels per year. Arthur Chapman has spent several years working with small-scale private delivery companies in many countries. Recently, Arthur was hired by ADS to assist in improving its operating and financial performance. The owners of ADS were dissatisfied with the recent trend in financial results (Exhibits 1 to 3). Farid Banai, president of ADS, has called a meeting with Arthur and Truc Nguyen, operations manager, to review the 20x5 results. PRESIDENT (Farid Banai): From where I sit, the situation doesn't look very Our volume is fairly constant; however, the deficit keeps getting larger. We planned to break even in 20X5 but failed to accomplish our goal. The basic mission of ADS is to provide effective and efficient delivery services to the entire population and to network with other delivery services around the world. The vast distances, rugged terrain, natural obstacles and severe winter weather all contribute to making our job a great challenge. We calculate, for example, that in the month of March it costs us $2.75 to send a letter from a small town in our most easterly region to one of the northern outposts, but our revenue on that letter is still just $0.48. 3.RTHUR: Tell me about the profitability of each type of 12delivery service ADS offers. PRESIDENT: Letter delivery has not been profitable even after the installation of more highly automated equipment. We had planned on express parcels generating the most profit for us; however, the 20X5 results were disappointing. Some of the issues are that other private carriers are encroaching on the parcel end of our business and the number of kilograms in sales for 12 before we were able to implement the plan. I've included an illustration of the sorting process (Exhibit 4) and a copy of the suggested sorting activities and cost pools (Exhibit 5). She also did an analysis of the administration costs, first, to determine a better way to allocate service department costs (Exhibit 6) and, second, to understand the behaviour of the office administration costs (Exhibit 7). ARTHUR: And what about revenues? OPERATIONS MANAGER: Well, the rates throughout 20X5 were $0.48 for the average letter, $2.10 per kilogram on express-delivery parcels and $1.05 per kilogram for regular-delivery parcels. So far, we've only been able to justify increasing the letter rate to $0.49 in 20X6. PRESIDENT: Things didn't go too well for ADS in 20X5 (see Exhibit 2) and unless some changes are made, don't see much future improvement. The profits for the standard letter service appear to be pretty bleak, but our owners refused our request to drop the letter delivery business. ARTHUR: So the future is in parcels? PRESIDENT: When I saw the 20X5 results, that seemed to be the way we were heading. However, I'm skeptical of this approach until we have a better handle on costing. That's what I'm hoping you'll do for us. As I see it, there are two tasks I would like you to accomplish: 1. Provide a better allocation of sorting and administrative costs between departments. 2 Take a closer look at the express-delivery parcel 6/ opportunities. Many of our customers who use our letter 12 and regular-delivery service also use the express- delivery parcel service. I believe there's a future in this line of business, but for now we need to increase our bottom line. In support of that, I would like you to investigate the following two options relating to express- delivery parcels: - Increase the rate to $2.75 per kilogram. According to marketing, we might lose 2% of our business if we do this. However, due to increases in fuel costs and demand, many of our competitors are increasing prices as well, so we don't expect this decrease in demand to continue. . Increase our advertising campaign for express-delivery Required: For the first requirement, assume the role of a junior management accountant internal to ADS. For the balance, assume the role of Arthur Chapman and prepare a report to Farid Banai, President of ADS. The report should Tanalyze ADS's current cost allocations and provide advice for the future. It should include the following: 1. Overview: Provide a high-level analysis of the 20X5 operating variances (Exhibit 3). The variances in Exhibit 3 are based on the budgeted and actual figures in Exhibits 1 and 2. (8 marks) 2. Analysis: Using the documents provided by the consultant, prepare an analysis of each of the following 20X5 costs: a) Sorting labour and overhead: Reallocate the total sorting labour and sorting overhead costs to each of the departments using the activity-based costing analysis in Exhibit 5. (10 marks) b) Administration costs: i. Service department portion of administration costs: Prepare a comparison of cost allocations of the janitorial and maintenance departments to the production departments using the direct and step methods. Use the allocation bases provided in Exhibit 6 and begin with the janitorial costs using the step method. Your analysis should discuss which method provides the most reasonable estimate of service department costs to production departments and explain why it is the best method. (8 marks) ii. Office administration costs: Review the summary printout of two Excel regression analyses (Exhibit 7): one that tests the correlation between administration employee hours and office administration costs and one that tests the correlation between documents used and office administration costs. Explain which activity driver is the best representation of cost behaviour and reallocate the office administration costs to the production departments using the 20X5 activities provided in the exhibit. As a result, the office administration costs should be split into variable and fixed portions. Fixed costs should be allocated among the services using the original allocation base. (10 marks) 3. Prepare a revised operating statement for 20x5 using the costing analyses from requirement 2. Provide a short analysis of the results including d) For expedited parcels, the hours used varies by the number of parcels. e) Service department allocations and fixed costs will be unchanged. (10 marks) 5. Analyze the president's two options concerning the express-delivery parcel business. Your analysis should use the 20x6 budgeted figures and the additional information provided in Exhibit 8. Based on the quantitative analysis, make a recommendation and provide your reasons. Your recommendation should include at least two changes 9/ that the organization could make regarding the express- 12 delivery parcel business. (9 marks) 6. Provide management with at least two observations you have made during your research that can be considered for future analysis. (2 marks) Note: In addition to the above, award 3 marks for format and professionalism. Exhibit 1 Aard vark Delivery Services Express Regular 20x5 budget posts post (in '000s) parcels parcels Total Letters Volume (pieces) 40,000 $0.48 $19,200 2.560 $2.10 $5,376 23,094 $1.05 $24,249 $48,825 788 Volume (kilograms) Rates ace Total revenue eta Expenses: Sorting labour Sorting overhead Delivery Administration Promotion Total expenses 1,578 840 8,997 15,775 15,502 2,051 6,310 7,140 3,426 964 19,891 342 6,158 7,888 7,522 3,084 368 25,019 (771 6,851 368 1,699 48,825 3,915 Surplus (deficit) S (691) $1.461 $ (0) 10/ 12 12 Exhibit 2 Aardvark Delivery Services 20X5 actual results (in '000s) Express Regular delivery delivery Letters parcels parcels Total Volume (pieces) 37.800 Volume (kilograms) 2,310 26.880 $0.48 $2.10 $1.05 Total revenue $18,144 $4,851 $28,224 $51,219 Expenses: Sorting labour 2,100 797 7,168 10,065 Sorting overhead 6.773 1,693 8.466 16,931 Delivery 7,508 998 9,240 17,745 Administration 3.276 259 3,017 6,552 EMPLOYEE HOURS $ Surplus (deficit) $ (2,667) $ 527 (66 4) $ (2,805) 1 Administration costs are allocated equally to letters and parcels. The amounts assigned to the two categories of parcels are based on the number kilogra 2 Promo df SS MS 1 712961166.1 712961166.1 campa 10 1998854942 199885494,2 11 2711816108 dj SS MS 1 2393512148 2393512148 Exhibit 4 The Aardvark delivery system consists of three main activities: collection sorting delivery Aardvark Delivery Services Parcel-sorting process Mail collection and delivery Operations management of Aardvark has developed a sophisticated grid that networks the collection and delivery process. The organization contracted a consultant two years ago to research the most economical and efficient ways to collect mail. Mail is collected at various periods throughout the day to ensure that idle time in the sorting process is minimal. Mail is also delivered throughout the day to ensure that delivery vehicles can make more than one delivery in a day, thus capitalizing on existing delivery resources. 8/12 Pre-sort After being collected, all mail enters the pre-sort process, where it is separated into letters and parcels. Sort letters Letters are sorted using automated sorting equipment. The capacity of the equipment is 10,000 letters per hour. Letters are sorted by delivery route. A delivery route can consist of a street, a subdivision or a building. Separate regular-delivery and express-delivery parcels After the pre-sort all parcels are sorted into regular