Question: Sky Tech Pty Ltd - Assuming you are the Financial Controller of Sky Tech Pty Ltd. You have been designated by the management of your company to propose some resolutions ....

23 Nov 2023,5:51 PM

 

Case Study

Read the case: Sky Tech Pty Ltd..

Required:

Assuming you are the Financial Controller of Sky Tech Pty Ltd. You have been designated by the management of your company to propose some resolutions for the strategic challenges that your company is facing. You are required to write a report to Mr. Kuong Lee, the President of the company addressing the issues shown below. 

 

Your report should contain:

1. 1. 1. 1. 1. Group assessment cover sheet.

 

1. 1. 1. 1. 1. 1.  To be signed by all members of the group.

 

1. 1. 1. 1. 2. A separate title page (not included in page limit): The title page must include your team members’ full names and student ID numbers.

 

1. 1. 1. 1. 3. A maximum of 7 pages of text covering all of the requirements set out in the assignment parts (1 to 4 below), excluding the title page, reference list, and appendices:

 

1. 1. 1. 1. 1. 1. Please use Times New Roman, 12 font in double spaced, and a minimum of 2cm on each margin for the body of the report.
               2. The Excel file that shows all the calculations including the formula used for these calculations.

 

1. 1. 1. 1. 4. Appendices that report all your calculations and reference list. Please use external references instead of the book.

 

 

 

Sky Tech Pty Ltd, a Chinese company, commenced its operations in the production of civilian drones catering to various applications, such as video surveillance, event filming, and children's entertainment. Situated in Guangzhou, the company operates from its primary headquarters and functions through two divisions: the Tech-Parts division and the Drone Assembly division. Within the Assembly division, the company constructs four drone models—D100, D200, D300, and D400. All components for their drone products are internally manufactured within the Tech-Parts division.

Employing a hybrid costing system, the company combines a traditional absorption costing system with a process costing system. The process costing method is utilized to allocate costs to identical units of drone parts produced in batches. Meanwhile, the traditional absorption costing system is implemented to account for the manufacturing expenses associated with the company's four drone models.

To allocate manufacturing overhead costs to individual drone models, Sky Tech assigns a total manufacturing overhead of $840,000. This allocation is carried out using a manufacturing overhead rate derived from dividing the total overhead cost by the total direct labor cost. Specifically, the manufacturing overhead cost for each drone model is determined by multiplying the direct labor cost of each drone model by the established manufacturing overhead rate.

 

 

Part 1: The manufacturing cost of drones

 

Mr. Kuong Lee, the company's president, has expressed growing concerns regarding the profitability of the D400 model. He has been contemplating the removal of the D400 from the company's product line on the ground that the model elevated manufacturing overhead costs that exceed $25 per drone. Mr. Lee does not support the idea of pricing the D400 above $51 on the ground that this may result in a decline in market share, as other competing drones with similar specifications are priced within the range of $40-$43.

To investigate deeper into this matter, Mr. Lee has employed a new financial controller, Ms. Yee Phua, who possesses a Certified Management Accountant (C.M.A.) qualification. Her primary task is to evaluate the profitability of each drone model before any decision is made regarding the elimination of the D400 model.

Upon commencing her role in the first week, Ms. Phua was provided with a table summarizing the various manufacturing overhead categories and their respective costs.

Purchasing	$          36,000
Machine Setups for production runs	$          46,250
Material Movements	$          18,000
Machinery	$        420,000
Design	$        240,000
Inspection	$          79,750
Total	$        840,000

 

Ms. Phua also made a formal request to the Management and Cost Accounting Department for supplementary data concerning the four models. This additional information encompasses the direct costs, the cost drivers of the overhead categories, and the production quantities of each model:

	D100	D200	D300	D400
Units Produced	10,000	10,000	20,000	20,000
Direct Material Cost	$45,000	$45,000	$90,000	$270,000
Price per unit	$40	$40	$40	$40
Direct Labor Cost	$42,000	$42,000	$84,000	$252,000
Overhead Categories
Purchase orders written	90	9	63	18
No. of production run setups	74	18	37	55
Material movements	300	60	180	60
Machine hours	5,250	1,750	14,000	14,000
Design hours	63,200	1,600	8,000	3,200
Inspection hours	5,250	1,750	14,000	14,000

 

Upon scrutinizing the data presented in the above tables, Ms. Phua was surprised to know that the company had been employing a traditional costing system despite the manufacturing overhead being influenced by various activities. Understanding the limitations of the current costing system, Ms. Phua endeavored to persuade Mr. Lee to reconsider his proposal of discontinuing the D400 model. She emphasized that the existing costing method might underestimate the potential profitability of the D400 model.

Ms. Phua proposed the adoption of a more precise costing system that allocates overhead costs to specific activities and then assigns the costs of the activities to the four drone models based on each model's utilization of these activities. Highlighting the potential for increased accuracy, she suggested that this approach could unveil the D400 model's actual profitability.

Fascinated by Ms. Phua's proposed approach, Mr. Lee expressed interest and subsequently requested her to compile a report detailing the cost per unit for each drone model utilizing the suggested new costing systems.

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Required:

Assuming you are the financial controller of Sky Teck Pty Ltd:

1. Prepare a report for Mr. Lee detailing the computations of the cost per unit for each drone model (both total and per unit) under two distinct costing systems: the conventional/traditional costing system and an alternative costing system that you have proposed for enhancing the accuracy of cost calculation.
2. Comment on the differences in the unit cost for each model under the two costing systems AND the profitability of the four models under the two costing systems.
3. Write your recommendations to Mr. Lee on whether to discontinue the D400 model based on the cost per unit determined by the suggested costing system.
4. Explain how the new costing system suggested by Ms. Phua improves the accuracy of the reported cost of individual models compared to the traditional costing system.

 

Part 2: The manufacturing cost of drone parts

The Tech-Parts manufactures the parts for the four brands of its drones. The process-costing system at Sky Tech has direct materials and conversion costs. Direct materials are added at the beginning of the process. Conversion costs are added evenly during the process. The company is currently using the weighted-average method of process costing. However, Mr. Lee has also expressed concerns with the new financial controller Ms. Phua about the possibility of incurring high-income taxes in the current period due to using the weighted-average method which results in a lower cost of goods sold. Ms. Phua asked Mr. Lee to consider the use of another method which leads to a higher cost of goods sold and subsequently lower income taxes. Ms. Phua further explained that, unlike the weighted-average method, the new method separates the work done on beginning inventory from the work done in the current period. That is, only costs incurred and units produced in the current period are used to calculate the cost per equivalent unit of work done in the current period. This method, as a result, yields a higher cost of units completed, a higher cost of goods sold, and therefore lower income taxes than the weighted-average method.

Mr. Lee looked a bit confused and so requested Ms. Phua to prepare a comparative report showing the calculations of the costs assigned to units completed of drone parts under the weighted-average method and the suggested method, given the following data for the Tech-Parts department for November 2020:

	Physical Units (Drone parts)	Direct Materials	Conversion Costs
Work in process, November 1a	15,000	$80,000	$20,000
Started during November	60,000
Completed during November	67,500
Work in process, November 31b	????
Total costs added during November		$150,000	$50,500
aDegree of completion: direct materials,?%; conversion costs, 60%.  bDegree of completion: direct materials,?%; conversion costs, 70%.

 

Required:

Assuming you are the financial controller of Sky Tech Pty Ltd:

1. Prepare a comparative report to Mr. Lee that shows the calculations of the costs assigned to units completed of drone parts under the weighted-average method and the suggested method.
2. Explain the differences in both methods and why the suggested method leads to lower income taxes than the weighted-average method.
3. Based on your analysis, should Mr. Lee choose the weighted average method or the suggested method? Explain briefly.

 

Part 3: Transfer pricing of Drones 

Sky Tech Pty Ltd operates its Tech-Parts and Drone Assembly divisions in a decentralized management design. The Tech-Parts division manufactures components used in producing the company's four drone brands. This division has the freedom to sell these components internally to the company's drone brands or externally to customers, with the objective of maximizing profitability for both the division and the company as a whole.

Presently, the Tech-Parts division sells 65,000 parts packages to the four drone brands of the company at a reduced price of $4.50 per parts-package. Alternatively, it can choose to sell the same parts packages on the open market at $6.50 per parts-package. The Tech-Parts division is considering a proposal to elevate the transfer price of internal sale to $6.50 per parts package, justifying this increase by the division’s recent purchase of new equipment for the production process which has drained the financial resources of the division.

However, the manager of the Drone Assembly division has expressed concerns, contending that paying the elevated internal price of $6.50 would significantly reduce their profit margin from the current $2 per drone to only $0.50 per drone for the 65,000 drones they assemble and sell (Note: each drone needs one parts-package). Consequently, the manager of the Drone Assembly division has threatened to obtain the drone parts from an external supplier who has offered to supply them at a price of $5.25 per parts-package.

The incremental costs per parts package that the Tech-Parts division incurs to produce each drone are variable costs of $3. Fixed costs per parts-package related to the recent purchase of equipment are $2 per parts-package.

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REQUIRED:

Assuming you are the financial controller of Sky Tech Pty Ltd:

 

1. If Tech-Parts division has no alternative uses for its facilities. Should the Drone Assembly division continue to buy from the Tech-Parts division given the increase in the transfer price or buy from the external supplier? Show your calculation.
2. If Sky Tech decides to let the managers of the two divisions negotiate a transfer price between the two divisions, what price OR range of transfer prices should be acceptable for the two divisions?                                   
3. If Drone Assembly could use its facilities for other manufacturing operations, that would result in monthly cash savings of $200,000. What would be the advantage (disadvantage) to Sky Tech?                                                                  
4. If the Tech-Parts division has no alternative uses for its facilities and the external supplier drops the price to $2.75 per parts package, what should be the effect:
   1. The company (i.e. Sky Tech) as a whole        
   2. The Drone Assembly                                                

 

 

Part 4: Drone Pricing (20%) Waleed/Daloul/Suhail

Two weeks later, Mr. Lee met with Ms. Phua to discuss a new pricing strategy for each of the four drone models that can be built based on the report Ms. Phua had submitted which detailed the cost per unit under the newly proposed costing system (Refer to Part 1). Mr. Lee discussed his intention to set the prices for the drones based on the full cost plus a markup to achieve the desired return on investment.

Mr. Lee stated to Ms. Phua that the capital invested in each of the drone models—D100, D200, D300, and D400—is $2,000,000, $2,000,000, $4,000,000, and $4,000,000, respectively. The target return on investment for all models is set at 10%. Additionally, he informed Ms. Phua that the company operates without fixed costs and anticipates no inventory by the year-end. Essentially, the expectation is that all produced units will be sold within the current year.

Given these constraints, Mr. Lee sought Ms. Phua's assistance in determining the appropriate prices for each drone model.

 

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Required:

Assuming you are the financial controller of Sky Tech Pty Ltd :

1. Help Mr. Lee determine the target prices that should be charged for each drone model according to his pricing plan.
2. Calculate the markup as a percentage of the full cost of each drone model.
3. Calculate the operating income of each drone model based on the target prices.
4. Lastly, determine which drone model is most profitable based on the profit margin.  Explain your answer.