CASE STUDY - Historical Cost Accounting

Company History:

Neptune Shipyard is a shipyard operating on the River Clyde near Glasgow, Scotland in the form of a private company. It has a workforce of around 300, roughly divided into the following areas: Marketing 8, Accounting 22, Human Resources 12, Purchasing 8, and Production 200. Production is divided into two departments: New Construction (ship building) and Ship repair. Neptune Shipyard is a wholly owned subsidiary of regional shipping giant Jupiter Shipping PLC. The shipyard is considered to be in the "medium" category. For example, it owns and operates one "floating dock" (ship repair berth) and it is also constructing one new ship at present.

The Issues:

The company historically (before it was purchased eight years ago by Jupiter Shipping) was primarily known as a medium sized ship repairer. Recently, under the direction of Managing Director, Mr Angus Young, who is also a director of Jupiter Shipping, the parent company has decided to "allocate" more and more financial capital and human capital (labourers) to New Construction, and away from Ship Repair. There is presently one vessel being constructed in the company's yard. It is 12 months into an 18 month estimated construction time. The vessel will be used by the parent company in its shipping business. The parent company has fixed a price so that the ship will generate a 6% profit above budgeted cost. The contract sales price is 1,900,000.

These are the viewpoints of the major departments about the company's proposed new business direction:

Mr Young and Jupiter Shipping progressively plans to shift more and more financial and human capital to the construction of new vessels to be used in the parent company's operations. Their argument has been that this business produces a safe, guaranteed fixed return of 6% over the duration of the vessel's construction life which, although on the low side, it exposes the company to much less risk than if ship repair remained the company's focus. The ship repair business has become much more competitive globally, and bad debts run at 10%.

The New Construction manager, Philip Rudd, is obviously very pleased with the company's new direction. He points out that it is easy to shift workers to shipbuilding and away from ship repair because the skills bases required are very similar.

The Ship repair Manager, Mr Balakrishnan, known as Bala, is very unhappy about the company's new business direction and has been attempting to rally supporters from within supposedly neutral departments such as Accounting, Finance, Information technology and Human Resources. He has been known to debate his views in the staff canteen at lunchtimes. He fears that his department will be down-graded over the longer term to the extent that it might ultimately disappear. He relies upon the company's long standing tradition as a skilled ship repairer, and argues that ship repair should continue to be the focus. Bala regards

it as weak, cowardly and sub-servient to see a great ship yard become just a vehicle for the parent company's agenda. He fears losing skilled staff to other "yards" (ship repair companies). He is also aware of the general perception among ship repair labourers that shipbuilding yields very low job satisfaction compared to ship repair because often there are few visible signs of progress for long periods.

Bala also argues that because the company has only one floating dock, and is presently operating at full capacity, Neptune should buy a second small floating dock at a cost of 1,000,000, so that the yard has the capacity to repair more than one vessel at once. Typically the average ship-repair job takes one month, has a profit margin of 20% and sales prices average around 200,000. However, Ship repair also has a bad debts rate of around 10% because it is very difficult to secure payment from a ship-owner based say in Japan for emergency repairs done in Scotland.

Bala has developed an interesting counter-argument recently. This is his prime trump-card, which is he is ready to release at the next staff meeting. He argues that because ship-building occurs on the land, but ship- repair in the water, one third of the cost of land rental of 30,000 per month should be borne by New Construction and none by Ship repair. He argues that this is a fairer cost allocation than the present system of not allocating any of it to production departments, because (as he says) if shipbuilding takes up land area, it should bear the cost. New Construction has heard of this argument through the canteen grapevine and strongly opposes it.

Lastly, the Sales Department, led by Sales Manager Belford Scott, tends to side with Ship repair. Primarily Scott is concerned that his two young and motivated salesmen might be lost to competing yards if the company shifts focus to New Construction.

Other additional information:

(a) The useful life of the floating dock is 6 years.

(b) Also assume that the 1/3 land rental allocation would apply for 2 ships being built at once that is the expansion of New Construction.

REQUIRED:

(1) Compute the Return on Assets (ROA) for the second floating dock versus the ROA for building a second new ship, assuming that existing operations (one floating dock and one ship in progress in construction continues unchanged).

(2) Does the new cost allocation scheme proposed by Bala make any difference to the outcome computed in (1) above? Re-calculate the ROAs assuming the new cost allocation scheme applies.

(3) State and explain accounting theories applicable to the above case study and also discuss the political, organizational and cultural issues at the shipyard.

Suggest some possible ways forward for the company that will satisfy the interests of labour and capital to a certain minimum extent.

Hint: Please state all your assumptions clearly.