Managerial Accounting Question: Job Order Costing

Industry Background: The following industry facts should be kept in mind in thinking about the Kauffman & Associates case, described below.

• In all "knowledge industries", such as Consulting, Law Services, Accounting services, Universities, etc. professional development is an extremely important activity. Knowledge and expertise is constantly expanding. Any firm that is in the business of selling knowledge or professional expertise must keep up with all the latest developments, and even contribute new innovations to the industry, in order to build its reputation and/or survive. Professional development is very costly and very time consuming, but it is essential.
• Every professional employee in a knowledge firm has a "billing rate" designated by the firm. At the time of a professional engagement, the client agrees to pay the billing rates of each of the team members that have been assigned to that engagement. Most billing rates are cost based, and include the employee's salary, overhead costs and a markup.
• Knowledge firm's would want their accounting system to at least provide information about the profitability of each client engagement and the kind of information that is needed to determine billing rates of their professional employees. Kauffman & Associates

The Case

• Kauffman & Associates is a management consulting firm supplying information systems services nationally to medium sized clients. Kauffman has two kinds of professional staff: (i) Systems analysts, and (ii) Programmers and web page designers. The systems analysts, constituting the senior professional staff, are highly trained with considerable consulting experience and are highly paid. They are responsible for selling Kaufmann's services, understanding clients' information needs, designing the overall networked information system and directing the work of the junior professional staff. The junior professional staff, consisting of programmers and web page designers, are responsible for the detailed grunt work of writing computer programs and setting up web pages.

Weekly Cost Structure

• Kauffman's weekly cost structure is as follows:
  • Compensation paid to professional staff:
    • 10 System Analysts: $60,000
    • 30 programmers and web page designers: $54,000
  • Occupancy Costs:
    • Office rent, utilities, office equipment: $20,000
    • Travel Costs: Unknown
    • Secretarial and Office Staff: $12,000
    • Computer Associated Costs: $8,000
    • Stationary: $2,000
  • Total Weekly Expenses Exclusive of Travel Costs: $156,000

Additional Information

• Most of the above costs (excluding travel costs) are governed by long term contracts, so there isn't much variability in these costs from week to week.
• However, travel costs do vary considerably from week to week. Professional staff travel for the following purposes: (i) To work on specific client engagements at clients' sites, (ii) To solicit new business (marketing activities), (iii) To attend seminars, trade association meetings and professional conferences (professional development activities).
• Each year, Kauffman specifies an annual travel budget for professional development activities which is enforced quite strictly. The budget for the forthcoming year is $500,000. There is no travel budget for marketing activities, but the annual expenditure is fairly stable, currently running at $600,000. These amounts do not include the salaries of the professional staff who are engaged in marketing and professional development. (Note: There are 52 weeks in a year)
• Each professional staff member is employed 40 hours per week. Each professional staff member submits a weekly time report that shows the number of hours worked during the week on each of his/her client engagements. The time worked on specific client engagements is called "billable time." Time not spent on specific client engagements is called "unassigned time." It is quite common for professional staff members to have some unassigned time on their time reports.
• Kauffman's billable time fluctuates erratically from week to week, ranging from 1,000 hours to 1,500 hours. Kauffman has a simple costing scheme. Billable time is traced to individual clients and costed at that professional staff member's hourly salary ($150 per hour for systems analysts and $45 per hour for junior professional staff). Travel costs incurred for working on specific client engagements are charged to those specific clients. All other costs (travel and non-travel) are treated as overhead. A single overhead rate is calculated each week by dividing the observed overhead cost for the week by the total billable time recorded for the week to obtain an overhead cost per billable hour. This is the rate at which overhead cost is assigned to each client engagement. For example, if this overhead rate turns out to be $80 per billable hour in some week, and if client A is served 100 billable hours in that week, then the accounting system assigns an overhead cost of $8,000 to client A.
• Costing of jobs is different from billing of jobs to clients. Kauffman currently bills its clients at a uniform rate of $300 per hour of billable time, regardless of which professional staff worked on that job. Additionally Kauffman bills for client specific travel at actually incurred costs supported by vouchers/receipts. Some clients have been complaining that Kauffman's billing rate is too high, and the managing partner of Kauffman feels that their billing rates ought to be more closely tied to their costs.

Interview Information:

• The mix of senior staff and junior staff billable time varies considerably across client engagements.
• Most of the "unassigned time" of the professional staff is actually spent on professional development activities, marketing activities and travel. On average, systems analysts report 35% of their time as "unassigned" while junior professional staff report only 5% of their time as "unassigned." The managing partner feels that approximately 40% of the unassigned time of a systems analyst is spent on marketing activities while the remaining 60% is spent on professional development and travel. The junior professional staff are hardly ever used for marketing activities.
• Systems analysts have much larger offices than others and occupy about 40% of Kauffman's office space. About 20% of the space is occupied by the secretarial staff and the remaining 40% is occupied by the junior professional staff.
• About 80% of the time of Kauffman's secretarial and office staff is spent on servicing the systems analysts and only 20% on servicing the junior professional staff.
• About 90% of the computer equipment is used by junior professional staff and only 10% by systems analysts.
• Stationary seems to be consumed equally by each professional staff member.
• The managing partner feels that marketing expenses are an essential cost of doing business and an essential cost of building a professional image. Kauffman would generally put in a greater marketing effort on bigger potential jobs and jobs that provide higher billing rates.

Questions/Problem to Solve:

1. Redesign Kauffman's cost accounting system, keeping in mind the background facts described at the beginning of this case. For this purpose you need to discuss:
   • Which costs should be directly traced to individual client engagements, keeping in mind the feasibility of doing so.
   • Which costs should be treated as support costs? Group these support costs into appropriate overhead cost pools and, using the data supplied in the case, calculate the cost driver rates that would be used to assign support costs to specific client engagements)
   • Wherever necessary, present brief arguments to justify your design. (You are not expected to design vouchers and documents or ledger accounts and journal entries).