ACT310: Managerial Accounting Assignment By Dr. Abdulhadi Ra ✓ Solved

ACT310: Managerial Accounting Assignment Dr. Abdulhadi Ramadan and Dr. Susith Fernando

Analyze Tiptop Street Deli's profit performance of its ice cream counter and evaluate the appropriateness of the given cost allocations. Identify any incorrectly allocated costs and propose a revised analysis indicating the net financial impact of closing the ice cream counter. Additionally, provide two examples of sunk costs and explain their irrelevance in decision-making.

Paper For Above Instructions

Introduction

In managerial accounting, accurate cost allocation is essential for effective decision-making and a clear understanding of a business unit’s financial performance. Misallocations can lead to distorted profit figures, possibly affecting strategic decisions such as whether to continue or discontinue a product line or service. This paper examines the profit analysis of Tiptop Street Deli’s ice cream counter, identifies any incorrectly allocated costs, and presents a more accurate analysis. It also discusses the concept of sunk costs and their irrelevance in managerial decisions.

Analysis of the Original Profit Calculation

According to the provided data, Tiptop Street Deli's ice cream counter reported the following for the year:

• Sales: $67,500
• Cost of sales: $30,000
• Gross profit: $37,500
• Operating expenses:
  • Wages of counter staff: $18,000
  • Paper material costs (e.g., napkins): $6,000
  • Utilities (allocated): $4,350
  • Depreciation of counter equipment and furniture: $3,750
  • Depreciation of building (allocated): $6,000
  • Deli managerial salaries (allocated): $4,500

Total operating expenses sum to $42,600, resulting in a reported loss of $5,100.

Identification of Incorrectly Allocated Costs

In managerial accounting, some costs are considered traceable directly to the product or service, while others are indirect and should be allocated prudently. Allocated costs that do not directly relate to the ice cream counter's activity or are shared across business units can lead to misrepresentation.

Specifically, the following costs are potentially incorrectly allocated:

• Depreciation of building: Usually a fixed, shared expense that benefits the entire establishment, not just the ice cream counter. Allocating it entirely to the counter inflates costs unnecessarily.
• Managerial salaries: Total managerial salaries allocated across units may not be proportional or directly linked to the counter’s operations. It might be more appropriate to allocate only the managerial effort supporting the counter.
• Utilities: If utilities are allocated evenly or proportionally, the allocation should be based on actual usage or square footage dedicated to the counter rather than a flat amount.

Such misallocations can distort the true profitability of the ice cream counter, thereby affecting managerial decisions.

Revised Analysis with Corrected Cost Allocations

To determine a more accurate picture, we should exclude or reallocate the costs identified as incorrectly assigned. Here is a revised analysis:

• Sales: $67,500 (unchanged)
• Cost of sales: $30,000 (directly traceable)
• Gross profit: $37,500

Operating Expenses (Adjusted)

• Wages of counter staff: $18,000 (directly attributable; include as is)
• Paper material costs: $6,000 (directly attributable; include as is)
• Utilities: $4,350 (assuming proportionate usage; include as is)
• Depreciation of counter equipment and furniture: $3,750 (directly related; include)
• Depreciation of building: Exclude or allocate proportionally if necessary
• Managerial salaries: Exclude or allocate proportionally if necessary

Assuming the depreciation of the building ($6,000) and managerial salaries ($4,500) are shared costs not directly attributable, they should be excluded from the counter's expenses for the purpose of analyzing its true profitability.

Adjusted Operating Expenses Total

• Wages of counter staff: $18,000
• Paper material costs: $6,000
• Utilities: $4,350
• Depreciation of counter equipment and furniture: $3,750

Total adjusted expenses: $32,100.

Calculation of the Net Profit or Loss of the Counter

Subtracting these from gross profit:

Gross profit: $37,500

Adjusted operating expenses: $32,100

The adjusted net operating profit: $5,400

Implication of Dropping the Ice Cream Counter

By removing the counter, the business would eliminate the operating expenses directly attributable to it ($32,100). The loss of sales ($67,500) would be avoided, but fixed costs like building depreciation and managerial salaries, which are not directly attributable, would likely remain unaffected in the short term.

Therefore, the net financial impact of dropping the counter would be a reduction in losses by approximately $5,400, turning the ice cream counter from a loss-making activity to a break-even or potentially profitable activity if fixed costs are further allocated or eliminated.

Sunk Costs and Their Relevance

Sunk costs are costs that have already been incurred and cannot be recovered. Examples include investments made in equipment that cannot be sold or allocated costs already paid irrespective of current decisions.

Two examples of sunk costs are:

1. Purchase prices of obsolete machinery: Once paid, these costs are unrecoverable regardless of the decision to keep or dispose of the machinery.
2. Prepaid rent for a vacated premises: If the business ceases operations or moves, the prepaid rent expenses are already incurred and cannot be recovered.

Sunk costs are irrelevant for future decision-making because they do not change regardless of the outcome of a decision. Managers should ignore sunk costs and focus on relevant costs—those that will be affected by the decision, such as future operating costs, revenues, or incremental costs.

Conclusion

The profit analysis of Tiptop Street Deli's ice cream counter indicates that the initial allocation of costs may have exaggerated losses. By excluding or proportionally allocating shared costs such as building depreciation and managerial salaries, the counter appears more financially viable than initially reported. Therefore, the decision to discontinue or continue the activity should be based on a more accurate analysis of incremental and avoidable costs, ignoring sunk expenses. Recognizing sunk costs further helps managers make rational decisions focused on marginal benefits and costs.

References

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