Sample managerial accounting Assignment with answer

Question 1 - Current System

1-1. a. What is the competitive environment at Gibson? b. What actions has the company undertaken in response ? c. What strategic issues do contemplated actions raise?

Answer a:-

With the increase in the number of service providers and the type of products in the market Gibson is facing the competition where in the profitability of the company is decreasing. Though the sales at the company are increasing but the decrease in profitability has raised the concerns over the :

  • Pricing of the products and
  • The cost of operations of the company

The company needs to increase its number of customers and sales of product in order to increase its sales and profitably.

Answer b:-

In order to increase its customer base and the assets under management (AUM), the management at Gibson has decided to follow the strategy of corporate acquisition. The corporate acquisition will enable Gibson to acquire the companies carrying on the same business. Since every company will have the products with different prices and features, Gibson will be able to increase its products and customer base.

Answer c:-

The action of corporate acquisition raises the following issues:

i. Separate financial information from the legal business unit entities as required by the industry regulation

ii. Allocation of the support function costs which are recorded at the corporate level to the different legal business units and the different products.

Since every legal business unit performs functions for different products and also in a different manner the allocation of costs accurately to the various products is a big issue for Gibson. The cost allocation will affect the decision of the company on pricing of the products and the allocation of the resources to the different products. Also the accurate information on cost of various products will help the company in compensating the sales personnel properly and identify the cost improvement areas.

Sample managerial accounting Assignment

1-2. In order for it to be practical to undertake the redesign of a company's cost accounting system, there are two general requirements. a. What are they and b. how well does Gibson meet these criteria? Explain.


a. The two general requirements to redesign the cost accounting system of the company are:

i. To identify the direct and indirect cost: The objective of the cost accounting system is to allocate the cost accurately to the products. The direct cost can be traced to the product easily but the indirect cost cannot be traced to any products and so are required to be allocated to various products and service using some equitable basis of accounting. Thus in order to redesign the cost accounting system the direct and indirect cost should be identified properly and accurately.

ii. To identify the equitable basis of allocation of cost: Another important requirement for designing the cost accounting system is to identify the cost drivers so that the cost can be allocated to the products or services on the basis of the actual activity performed on those products and services.

b. In the current system Gibson meets the first criterion as the indirect cost are identified in the corporate general ledger but do not meet the second criteria as there are a large number of cost items recording the specific cost types. All the different cost items with unique allocation means would became very difficult to implement and so there is required to define few cost pools of the cost that are of similar types and identify the cost driver for those cost pools.

1-3. Consider the CURRENT cost accounting system at Gibson which allocates support costs based on a flat rate of $82.25 per policy. What is one advantage and one disadvantage of the current system?Show and Explain


In the current cost system Gibson uses the single overhead application rate company wide. The overheads are allocated on the basis of number of policies whether new or in force at the flat rate of $82.25 per policy for all the policies under both the Annuity plans and Life insurance plans. The advantages and disadvantages of the current system are:

a. Advantage: The single flat rate is easy to implement and use. The indirect support costs are allocated to the different legal business unit and the product line at the same rate and so it is very easy to implement. For example the overhead can be applied to all the policies whether new or in force or for annuity or life insurance using the flat rate of $82.25 per policy. Thus the total cost allocated to the legal business units is the sum of all policies under the business unit multiplied at the flat rate. The new policies for the Midwest business unit under annuities are 10,000 and the policies in force are 45,000.Thusthge cost allocated to the Annuities of the Midwest can be simple calculated by multiplying the total policies 55,000 with $82.25 being equal to $4,523,750. One need not use different rates for different policies under different product. Similarly the cost for the policies for Life Insurance can be calculated and so for the while business unit.

b. Disadvantage: The disadvantage of the single flat rates is that it does not take into consideration the actual effort or support function performed for the particular product and considers each production similar way. Thus the cost of product so calculated is not accurate. The product which requires less support activities are allocated more cost and the products requiring the more support activities are allocated less cost. Thus the pricing of the products is also inaccurate which affects the marketability of the product, the management decision on the products sales and the competition in the market. Like the new policy under annuity scheme requires two major step to issue the policy while the Life insurance policy requires three more steps in additional to the two required by annuity policy. However using the flat rate applies the cost to both the policies at the same rate irrespective of the difference in the level of activities required for the two policies.

1-4 What is the total costs allocated to the three business units (Midwest, Gibson, Compton)?


Total cost allocated the three business unit is the total policies under annuities and life insurance in all the three business units multiplied by the flat rate of $82.25 per policy. The total support cost that is to be allocated to the business units is $13,920,000.

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Question 2 - Proposed Activity Based Costing System (ABC)

2-1. Consider the proposed ABC system for allocating the support costs according to the four cost categories (Gibson Case p.3). Calculate the rates for each of the four cost drivers (steps, calls, etc).Make sure to show the cost driver (i.e. $17 per set-up, not just $17).


The rates for each of the four categories are calculated by dividing the cost pools under each cost category by the total activity to be performed under the cost. The cost driver for each cost category and the activity required per policy for each type of product are as under:

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The total activities for all the new and in-force policies under the two products are calculated by multiplying the activity per policy to the total policies under each category as under:

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The rates for each of the four cost drivers are calculated as under:

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2-2. a. Give two advantages of this new allocation scheme and Explain.Use complete sentences.


The new allocation scheme is known as the Activity based costing technique. In this method the cost is allocated to the product depending upon the support activities used by the products. Thus the method gives more accurate cost of the products and services as compared to the traditional single overhead rate system. The advantages of the system are (Patrik, N., 2012):

a. Helps the management in pricing of the products competitively- With the help of accurate cost allocation to the products and the accurate cost of the products the management is able to price the products more competitively in the market. Hence the organization can gain competitive advantage over others.

b. Helps the management in product planning and cost control – With the help of accurate cost of the products, the management can identify the products which are more profitable to the business and can plan to increase their sales in future. Further the calculation of cost of various activities and resources will enable the management to identify the major cost areas and the activities responsible for those costs. The management can apply appropriate cost control measures to reduce the costs or increase their efficiency.

References: Patrik, N. (2012). ‘Activity based Costing’. Retrieved http://www.managers-net.com/activityBC.html

b. What would be one disadvantages of this new scheme or something you would change? Explain.


Though the ABC costing is very helpful in managerial decision making and is an effective tool in costing the products the biggest disadvantage with the technique is the difficulty in identifying the cost pools and the cost drivers. Since it is not possible to have a large number of cost pools and cost drivers as that would result in multiple application rates, the identical cost are to be allocated to specific cost polls and their cost drivers are to be identified. The process is difficult and time consuming. Also any mistake in identifying the cost drivers or the cost polls will result in wrong rates and the objective of the technique would be defied. Thus the method of implementing the ABC technique is complex, time consuming and costly (Nayad, N., 2011)

References: Nayad, N. (2011). ‘Pros and Cons of Activity-Based Costing’. Retrieved from http://www.brighthub.com/office/finance/articles/78752.aspx

Question 3 - Product Costs

3-1. Based on the proposed ABC system, what is the support costs per policy for the four types of products (New and In-Force Annuities, New and In-Force Life Insurance policies). Show ALL your work and use your overhead rates from Question 2. Enter final values in table below after calculating.


The activities required per policy for the four types of policies:

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The Cost pools and their activity rates are as under:

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Multiplying the Rate per cost driver with the activity level for each policy the support costs are calculated as under:

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Answers(Cost per policy)

New AnnuitiesIn-Force AnnuitiesNew Life InsuranceIn-Force Life Insurance

3-2. What is the average cost per policy for the three legal entities, Midwest, Gibson and Compton? Note: This is one number - for each company


The total policies of each of the four types under each entity are as under:

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The total cost of the four types of policies under each entity at the cost per policy (calculated in 3-1) is under:

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The average cost per policy for the three legal entities is as under:

Total Policies61,85061,77545,615
Total cost$4,038,341$4,781,457$5,100,202
Average cost per policy$65.29$77.40$111.81

3-3. a. Which company’s average policy cost under the ABC system is greatest relative to the original $82.25 per policy cost?b. Why ?Show me ALL the math and calculations here.


Average cost per policy under the ABC system for all the three companies are:

Total Policies61,85061,77545,615
Total cost$4,038,341$4,781,457$5,100,202
Average cost per policy$65.29$77.40$111.81

The original rate was $82.25 per policy.

It can be observed that the Average cost per policy of Compton is greatest as related to the original $82.25 per policy rate.

b. The average rate per policy is greatest for Compton because it has been observed in the cost per policy for all the four types of policies that the cost of new policies under Life insurance is highest. Also the cost of insurance policies is more than the annuity policies

s(Cost per policy)

New AnnuitiesIn-Force AnnuitiesNew Life InsuranceIn-Force Life Insurance

Further the number of policies by type and business units classification shows that the Compton have more Life insurance policies as compared to the annuity polices.

The composition of policies at Compton is as:

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Since the policies comprises mainly of the high cost insurance polices the average cost per policy at Compton is higher as compared to other companies.

Question 4–ABM

NOTE: *** Assume that all of the ABC costs are variable ***

4-1. [20 points]. Assume that the average new life insurance policy lasts three years (issue year plus two years “in-force”). The life insurance premium billed to customers is determined based on the expected support costs, sales commissions and claims payout.

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Using the ABC Costs, what would be the life insurance premium we would charge PER YEAR? Show ALL Math!


The support cost for the three years period of the Life insurance policy will comprise of the new insurance policy cost in the first year and the in- force policy cost in the second and the third year.

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4-2 Suppose that Gibson was to introduce a referral program where customers could get a reward for referring a new annuity customer. Assume that the referred customer only requires one sales and marketing call to successfully sell them an annuity. All other support costs are unchanged. What is the maximum amount of a cash reward we would pay for a referral?Show ALL Math & Calculations and Explain!


The maximum amount of reward that the company can pay to the referral is the saving of the support cost for the new annuity policy that will be achieved by the company in the case of referral customers. The cost of the new Annuity policy is $221.52. The various activities and the activity rate involved in New annuity policy are as under:

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Cost of referred new annuity customer = one sale and marketing contact + all other support costs

Cost savings = 9 sales and marketing calls (10-1) = 9*$10.02 per contact = $90.18

Thus the maximum amount of reward that the company can pay to the referral is $90.18Question 5 - Additional Issues

5-1. In the case we areestimating customer service cost rates using the prior year volumes from Exhibit 3.What possible concerns do you have and Why? (Remember answers must use facts and Causality!)


The concerns in estimating the customer service cost rates using the prior year volumes are:

a. Change in the costumer service calls: With the increasing competition and customer oriented market the customer service is increasing in terms of quality and quantity. Thus it is possible that the customer service calls are different and have increased in the current year as compared to the earlier years.

b. change in the types of policies: The customer service cost is different for each of the four types of policies depending upon the calls required. It is possible that the composition of the policies is different in earlier years as compared to the current year. The change in total customer calls for all the policies will result in different cost rates.

c. Difference in the number of claims: The customer service level will change with the number of policy claims. The possibility of higher claim is more in later years as the policies grow older and so the total activity for each policy might change resulting in different cost rates.

5-2 Assume that the average life of a life insurance policy is three years. The support costs of a life insurance policy is far greater under the ABC system than under the flat-rate $82.25 system. a. Consider whether Gibson should increase their rates to recover these costs. b. What are two pieces of additional information(not in the case) that you would find useful in evaluating this situation?


a. Practically Gibson should increase the rates to recover the higher cost of insurance policies. However the decision requires many other factors to be considered before the rate increase is made.

b. The additional information that should be considered in evaluating the situation are :

i. The rates charged by other competitors: Gibson needs to consider the market rate of the insurance policies and the rate charged by its competitors as considered, it won’t be able to sell the policies at a price higher than its competitors.

ii. The market prospects in the Insurance policies: The future market prospects will also be required to evaluate the increase in rates. If there is demand in the market for the life insurance policies, the company can increase its rates and still sell the policies. In case the demand is low, it will not be able to sell its policies at higher price.