Your role in this case, is to serve as a consultant experienced in implementing activity-based costing systems as a means to providing management with the requisite information to make more informed and effective business decisions. Specifically, you will compute the cost of providing a service to a client using traditional cost allocation methods. Then you will apply the concepts of activity-based costing to determine the cost of providing a service to a client that reflects the resources consumed for the client. You will write a report to the partners of the firm highlighting the benefits of activity-based costing and discuss the impediments to implement the system in the law firm. You will also use incremental analysis to analyze information and make a recommendation regarding the outsourcing of the library research services.
The case begins at the offices of Clark, Long, winters, and Smith. The partners at Clark, Long, winters, and Smith, a medium size law firm in the Northeast, have hired you because the firm is experiencing a severe decline in income. The firm has four partners and currently does litigation work for clients. Partners are evaluated based on the revenues they bring into the firm. Presently, the accounting system tracks partner hours and paralegal hours to every client. It also charges a basic overhead rate that is determined at the beginning of each year. Quarterly, the firm's accountant prepares a report comparing actual costs to budgeted costs.
Attorneys Clark and Smith have long believed the current accounting system is not providing them with the information they need to make informed decisions, including how to improve profits. Both Clark and Smith recently read an article that discussed how activity-based costing could help them in determining the profitability of each of client. All of the partners are considering outsourcing the library research department; it is a costly resource that may be cheaper on a per usage basis using an external research organization. Long and Winters have consistently generated the largest revenues in the firm and do not see the benefit of hiring you. They definitely do not want to change the way the firm is managed, but are eager to find ways to increase profits.
Clark recently attended a professional development seminar where she listened to your presentation on activity-based costing. She thought it would be good for her firm to see if the concept would help the firm identify profitable and unprofitable clients. The firm is currently considering outsourcing the library and research department. She feels you may be able to provide the analysis that would help the firm make the right decision.
You begin your consulting job by discussing your information needs with the office manager and asking for the latest financial statements. After a thorough review of the financial statements, you discover the firm prepares an annual budget, but has not computed the overhead application rate for the current year. In past years, the overhead application rate has been calculated by allocating the projected overhead expenses divided by the billable hours of the four partners. Typically, partners work 2,000 hours a year and charge 80% of their time to clients. The rest of their time is associated with professional development seminars, community presentations, and charity work.
Your first task is to develop the overhead application rate currently used to bill a client. You may feel the need to review information and the calculation of an overhead application rate. The firm currently has five very large clients and several smaller clients. Some of the clients require extensive travel while others require extensive research. You will use traditional job-order costing to determine the costs associated with five of the law firm's biggest clients.
You then interview the partners, paralegals, and support staff. As a result of your discussions, you find that the firm currently tracks the following direct costs:
1. Professional partner compensation - You were informed that partners are paid $500 an hour and are billed to the client at $800 per hour
2. Paralegal compensation- You were informed that paralegals are paid $40 per hour and are billed to the client at $200 per hour.
The firm treats all of the following as indirect costs:
1. General office support, the office
2. Library and research support
3. Travel expenses
4. Telephone for making appointments and responding to clients
5. Photocopying
6. Rent, heat, property taxes, insurance, and accounting services
Currently, the firm's accounting system only treats professional hours as direct. All other costs, such as the paralegal costs are treated as overhead. Determine the overhead rate per professional direct labor hour. Consider the impact of only 80% of the partners' time is charged to clients. All of the paralegal labor is considered overhead.You prepare a report using an EXCEL file that demonstrates how the overhead rate is determined. Your report includes the operating budget for the year, the calculation of the overhead rate, and the costs assigned to the five clients for the month of January.
Satisfied that your traditional job-order costing analysis and allocation are correct, you apply activity-based costing to determine the cost associated with the same five clients for the month of January. The law firm's accounting department provides you with cost data. The department also provided you with additional information that you requested related to several cost drivers associated with each cost pool. You continue with the same EXCEL file to include the cost pools and cost data. You demonstrate how you determined the cost driver rate per cost pool item. You then determine the cost of each client for January using the ABC approach to cost allocations.
Next, you compare the costs assigned to each client under both methods. After comparing the cost associated with each client using traditional costing methods and activity-based costing procedures, you will write a recommendation to the partners.
The report must include sufficient explanation as to why there are differences. Identify which clients are consuming more or less of which resources. Your report should discuss the complexity of using seven cost pools and how to reduce the number of cost poolsYour report will include advantages as well as disadvantages of activity-based costing. You will also discuss how to overcome resistance to change. In addition, you will conduct an incremental analysis to determine whether to retain or discontinue the library and research support department or outsource these services and make recommendations to the partners.
Attachment:- Assignment.rar