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[answered] Aardvark Delivery Service (ADS)1 was formed 30 years ago wi


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Aardvark Delivery Service (ADS)1 was formed 30 years ago with a

 

mandate to establish a private delivery system in the country of Aardvark.

 

By 20X5, ADS was handling close to 30 million pieces of mail and 29

 

million kilograms of parcels per year.

 

Arthur Chapman has spent several years working with small-scale

 

private delivery companies in many countries. Recently, Arthur was hired

 

by ADS to assist in improving its operating and financial performance.

 

The owners of ADS were dissatisfied with the recent trend in financial

 

results (Exhibits 1 to 3). Farid Banai, president of ADS, has called a

 

meeting with Arthur and Truc Nguyen, operations manager, to review the

 

20X5 results.

 

PRESIDENT (Farid Banai): From where I sit, the situation doesn?t look

 

very good. Our volume is fairly constant; however, the deficit keeps getting

 

larger. We planned to break even in 20X5 but failed to accomplish our

 

goal. The basic mission of ADS is to provide effective and efficient delivery

 

services to the entire population and to network with other delivery

 

services around the world. The vast distances, rugged terrain, natural

 

obstacles and severe winter weather all contribute to making our job a

 

great challenge. We calculate, for example, that in the month of March it

 

costs us $2.75 to send a letter from a small town in our most easterly

 

region to one of the northern outposts, but our revenue on that letter is still

 

just $0.48.

 

ARTHUR: Tell me about the profitability of each type of delivery service ADS offers.

 

PRESIDENT: Letter delivery has not been profitable even after the

 

installation of more highly automated equipment. We had planned on

 

express parcels generating the most profit for us; however, the 20X5

 

results were disappointing. Some of the issues are that other private

 

carriers are encroaching on the parcel end of our business and the

 

number of kilograms in sales for express-delivery parcels were less than

 

budget. ARTHUR: Are there any issues with cost?

 

OPERATIONS MANAGER (Truc Nguyen): Costs keep rising. The basic costs at ADS

 

are sorting, delivery, administration and promotion. Here?s a copy of the budget for 20X5

 

(Exhibit 1). All of the costs have been classified as fixed except for sorting labour, which

 

is strictly variable.

 

You?ll notice that we split the sorting costs into labour and overhead and separately

 

keep track of both classes of parcels, express delivery and regular delivery. Both the

 

standard and actual sorting labour rates were raised to $20.00 per hour in 20X5. We

 

don?t plan on increases for 20X6 as our rates are on par with both private and

 

government-funded delivery services.

 

I sense that we may not be accurately allocating sorting costs to each of our delivery services. When we implemented the automated sorting equipment for processing letters

 

two years ago, our margins changed very little. I assumed that variable sorting labour

 

costs would decrease for letters.

 

Administration costs are categorized as 20% maintenance costs and 40% janitorial

 

costs, with the remainder classified as office administration, which includes office

 

supplies, phone charges and consulting fees. The maintenance and janitorial costs

 

have remained stable over the past couple of years; however, the office administration

 

costs seem to fluctuate somewhat, depending on volume.

 

We split the administration costs as roughly 50% of the total to letters and prorate the

 

remainder to the parcel services based on total weight for each department. It?s a

 

fairly large portion of our costs that we arbitrarily allocate to each service.

 

The allocation of delivery costs to each of our services has been affirmed by our

 

controller, who has worked with me and an outside consultant to set effective rates and

 

cost measures. We?ve already confirmed that the 20X5 variance in delivery costs is due

 

to the increase in fuel prices across the country.

 

We intend to maintain advertising costs for 20X6 and are confident that it will boost

 

sales volume. We predict that letter sales will increase to 42 million pieces, while

 

express-delivery parcel sales will increase to 2.5 million kilograms and regulardelivery parcel sales will increase to 28 million kilograms. ADS?s overall mandate is for

 

operations to at least break even.

 

ARTHUR: Has anyone performed an analysis of the sorting and administrative costs to

 

determine whether these costs have been properly allocated to the services that incur

 

them?

 

OPERATIONS MANAGER: We haven?t had the time to properly assess cost allocation.

 

We contracted a consultant last year to review the costing of our services. She advised

 

that we allocate costs using an activity-based approach; however, the contract ended 3 / 12 before we were able to implement the plan. I?ve included an illustration of the sorting

 

process (Exhibit 4) and a copy of the suggested sorting activities and cost pools (Exhibit

 

5). She also did an analysis of the administration costs, first, to determine a better way

 

to allocate service department costs (Exhibit 6) and, second, to understand the

 

behaviour of the office administration costs (Exhibit 7).

 

ARTHUR: And what about revenues?

 

OPERATIONS MANAGER: Well, the rates throughout 20X5 were $0.48 for the average

 

letter, $2.10 per kilogram on express-delivery parcels and $1.05 per kilogram for

 

regular-delivery parcels. So far, we?ve only been able to justify increasing the letter rate

 

to $0.49 in 20X6.

 

PRESIDENT: Things didn?t go too well for ADS in 20X5 (see Exhibit 2) and unless some

 

changes are made, I don?t see much future improvement. The profits for the standard

 

letter service appear to be pretty bleak, but our owners refused our request to drop the

 

letter delivery business.

 

ARTHUR: So the future is in parcels?

 

PRESIDENT: When I saw the 20X5 results, that seemed to be the way we were

 

heading. However, I?m skeptical of this approach until we have a better handle on

 

costing. That?s what I?m hoping you?ll do for us. As I see it, there are two tasks I would

 

like you to accomplish:

 

1. Provide a better allocation of sorting and administrative costs between departments.

 

2. Take a closer look at the express-delivery parcel opportunities. Many of our

 

customers who use our letter and regular-delivery service also use the expressdelivery parcel service. I believe there?s a future in this line of business, but for now

 

we need to increase our bottom line. In support of that, I would like you to investigate

 

the following two options relating to express-delivery parcels:

 

? Increase the rate to $2.75 per kilogram. According to marketing, we might lose

 

2% of our business if we do this. However, due to increases in fuel costs and

 

demand, many of our competitors are increasing prices as well, so we don?t

 

expect this decrease in demand to continue. ? Increase our advertising campaign for express-delivery parcels by $500,000. We

 

expect this will increase our sales by 15%. Well, I guess that?s all for today. We have lots of things to attend to. I hope that you

 

will be able to give us some advice on what we should be doing.

 

ARTHUR: Thank you for your guidance and assistance. I?ll begin my analysis

 

immediately and report back as soon as possible. 4 / 12 Required:

 

For the first requirement, assume the role of a junior management accountant internal to

 

ADS. For the balance, assume the role of Arthur Chapman and prepare a report to Farid

 

Banai, President of ADS. The report should analyze ADS?s current cost allocations and

 

provide advice for the future. It should include the following:

 

1. Overview: Provide a high-level analysis of the 20X5 operating variances (Exhibit 3).

 

The variances in Exhibit 3 are based on the budgeted and actual figures in Exhibits

 

1 and 2. (8 marks)

 

2. Analysis: Using the documents provided by the consultant, prepare an analysis of

 

each of the following 20X5 costs:

 

a) Sorting labour and overhead: Reallocate the total sorting labour and sorting

 

overhead costs to each of the departments using the activity-based costing

 

analysis in Exhibit 5. (10 marks)

 

b) Administration costs:

 

i. Service department portion of administration costs: Prepare a comparison of

 

cost allocations of the janitorial and maintenance departments to the

 

production departments using the direct and step methods. Use the

 

allocation bases provided in Exhibit 6 and begin with the janitorial costs using

 

the step method. Your analysis should discuss which method provides the

 

most reasonable estimate of service department costs to production

 

departments and explain why it is the best method. (8 marks) ii. Office administration costs: Review the summary printout of two Excel

 

regression analyses (Exhibit 7): one that tests the correlation between

 

administration employee hours and office administration costs and one that

 

tests the correlation between documents used and office administration

 

costs. Explain which activity driver is the best representation of cost

 

behaviour and reallocate the office administration costs to the production

 

departments using the 20X5 activities provided in the exhibit. As a result, the

 

office administration costs should be split into variable and fixed portions.

 

Fixed costs should be allocated among the services using the original

 

allocation base. (10 marks)

 

3. Prepare a revised operating statement for 20X5 using the costing analyses from

 

requirement 2. Provide a short analysis of the results including possible

 

explanations. (10 marks)

 

4. Prepare a 20X6 budgeted operating statement using the cost allocations developed in

 

requirement 2 and the expected costs provided in the case. Assume the following:

 

a) The average size of parcels will continue to be 0.5 kg.

 

b) Activity-based unit costs will remain the same for 20X6.

 

c) The number of bundles for activity-based costing will remain the same. 5 / 12 d) For expedited parcels, the hours used varies by the number of parcels.

 

e) Service department allocations and fixed costs will be

 

unchanged. (10 marks)

 

5. Analyze the president?s two options concerning the express-delivery parcel

 

business. Your analysis should use the 20X6 budgeted figures and the additional

 

information provided in Exhibit 8. Based on the quantitative analysis, make a

 

recommendation and provide your reasons. Your recommendation should include at

 

least two changes that the organization could make regarding the express-delivery

 

parcel business. (9 marks)

 

6. Provide management with at least two observations you have made during your

 

research that can be considered for future analysis. (2 marks)

 

Note: In addition to the above, award 3 marks for format and professionalism.

 

Exhibit 1 Aardva

 

rk

 

Delivery

 

Services20X5

 

budget(in?000s)

 

Express

 

posts

 

parcels Regular

 

post

 

parcels Total $0.48

 

$19,200 2,560

 

$2.10

 

$5,376 23,094

 

$1.05

 

$24,249 $48,825 2,051

 

6,310

 

7,140

 

3,426

 

964

 

19,891

 

$ (691) 788

 

1,578

 

840

 

342

 

368

 

3,915

 

$1,461 Letters

 

Volume (pieces)

 

Volume (kilograms)

 

Rates

 

Total revenue

 

Expenses:

 

Sorting labour

 

Sorting overhead

 

Delivery

 

Administration1

 

Promotion2

 

Total expenses

 

Surplus (deficit) 6 / 12 40,000 $ 6,158

 

7,888

 

7,522

 

3,084

 

368

 

25,019

 

(771) 8,997

 

15,775

 

15,502

 

6,851

 

1,699

 

48,825

 

$

 

(0) Exhibit 2

 

Aardvark Delivery Services

 

20X5 actual results

 

(in ?000s)

 

Express

 

delivery

 

parcels Regular

 

delivery

 

parcels Total $0.48

 

$18,144 2,310

 

$2.10

 

$4,851 26,880

 

$1.05

 

$28,224 $51,219 2,100

 

6,773

 

7,508

 

3,276

 

1,155

 

20,811

 

$ (2,667) 797

 

1,693

 

998

 

259

 

578

 

4,324

 

$ 527 Letters

 

Volume (pieces)

 

Volume (kilograms)

 

Total revenue

 

Expenses:

 

Sorting labour

 

Sorting overhead

 

Delivery

 

Administration1

 

Promotion2

 

Total expenses

 

Surplus (deficit) 37,800 $ 7,168

 

8,466

 

9,240

 

3,017

 

998

 

28,888

 

(664) 10,065

 

16,931

 

17,745

 

6,552

 

2,731

 

54,024

 

$ (2,805) 1 Administration costs are allocated equally to letters and parcels. The amounts

 

assigned to the two categories of parcels are based on the number of

 

kilograms of each category handled. 2 Promotion product. 7 / 12 costs are allocated based on advertising campaigns specific to each Exhibit 3

 

Summary of 20X5 operating variances

 

(in ?000s)

 

Overall ? using exhibits

 

Express

 

Regular

 

delivery

 

delivery

 

Letters

 

Sales

 

Spending:

 

Sorting labour

 

Sorting overhead

 

Delivery

 

Administration

 

Promotion $(1,056)

 

$

 

$

 

$

 

$

 

$ (49)

 

(462)

 

(368)

 

150

 

(191) $ Total $(525) $ 3,975 $ 2,394 (9)

 

$(116)

 

$(158)

 

$ 83

 

$(210) $(1,010)

 

$ (578)

 

$(1,718)

 

$

 

67

 

$ (630) $(1,067)

 

$(1,156)

 

$(2,243)

 

$ 299

 

$(1,031) Total variance $(1,976) $(934) $ 107 $(2,804) Exhibit 4

 

The Aardvark delivery system consists of three main activities:

 

?

 

?

 

? collection

 

sorting

 

delivery

 

Aardvark Delivery Services

 

Parcel-sorting process

 

Mail collection and delivery Operations management of Aardvark has developed a sophisticated grid that

 

networks the collection and delivery process. The organization contracted a

 

consultant two years ago to research the most economical and efficient ways

 

to collect mail. Mail is collected at various periods throughout the day to ensure

 

that idle time in the sorting process is minimal. Mail is also delivered

 

throughout the day to ensure that delivery vehicles can make more than one

 

delivery in a day, thus capitalizing on existing delivery resources. 8 / 12 Pre-sort

 

After being collected, all mail enters the pre-sort process, where it is separated

 

into letters and parcels.

 

Sort letters

 

Letters are sorted using automated sorting equipment. The capacity of the equipment is

 

10,000 letters per hour. Letters are sorted by delivery route. A delivery route can consist

 

of a street, a subdivision or a building.

 

Separate regular-delivery and express-delivery parcels

 

After the pre-sort, all parcels are sorted into regular-delivery and express-delivery

 

groups. Because of the distance from the pre-sort area to the parcel-sorting area, this

 

step takes longer if there are heavier parcels, as they are moved manually.

 

Sort regular-delivery parcels

 

Regular-delivery parcels are manually sorted and combined with letters to be delivered

 

by the appropriate carrier.

 

Sort express-delivery parcels

 

Express-delivery parcels are sorted using a grid that is based on the availability of

 

more-costly but quicker delivery methods such as air and commercial carriers.

 

Distribute to mail carriers

 

Letters and regular-delivery parcels are sorted by route and put into bundles. There is

 

one bundle per delivery route, regardless of the number of items. These bundles are

 

distributed to mail carriers, who sort the mail for their routes into the most effective order

 

for delivering the mail.

 

Expedite express-delivery parcels

 

A team of four experts works around the clock to determine the most efficient way to

 

send express-delivery parcels to ensure 24- to 48-hour delivery. The expediting process

 

is labour intensive, and different hours are required for each mode of transportation. 9 / 12 Exhibit 5

 

Activity-based cost analysis of 20X5 sorting costs (in ?000s)

 

Activity

 

Pre-sort

 

Sort letters

 

Separate regular and express parcels

 

*

 

Sort regular parcels

 

*

 

Sort express parcels

 

Expedite parcels

 

Distribute to mail carriers

 

TOTAL SORTING COSTS

 

*

 

(Average weight of parcels is 0.5 kg.) Cost driver

 

piece

 

piece

 

kilogram

 

piece

 

piece

 

hours

 

bundle Cost pool

 

$4,844

 

1,362

 

6,467

 

5,113

 

3,722

 

2,538

 

2,950

 

$26,996 Total activity

 

96,180

 

37,800

 

29,190

 

53,760

 

4,620

 

126

 

5,000 Activity-based costing ? 20X5 units of activity (in ?000s)

 

Expenses

 

Pre-sort

 

Sort letters

 

Separate regular and express parcels

 

Sort regular parcels

 

Sort express parcels

 

Expedite parcels

 

Distribute to mail carriers Letters

 

37,800

 

37,800 Express

 

parcel

 

4,620 Regular

 

parcel

 

53,760 2,310 26,880

 

53,760 4,620

 

126

 

3,000 2,000 Total

 

96,180

 

37,800

 

29,190

 

53,760

 

4,620

 

126

 

5,000 Exhibit 6

 

Allocation of service department costs 20X5 Service department costs

 

Maintenance ?

 

machine hours

 

Janitorial ?

 

square metres 10 / 12 Maintenance Janitorial

 

$1,310,400

 

$2,620,800

 

50

 

500 Express- Regulardelivery delivery

 

parcels

 

Letters parcels Total 2,800 225 400 3,475 1,200 1,650 1,750 5,100 Exhibit 7

 

Actual (20X5) and budgeted (20X6) activity Letters

 

20X5 employee hours (actual)

 

20X6 employee hours (budgeted)

 

20X5 documents (actual)

 

20X6 documents (budgeted) 44,704

 

47,232

 

30,000

 

32,000 Expressdelivery

 

parcels

 

36,076

 

38,116

 

15,800

 

16,500 Regulardelivery

 

parcels

 

64,220

 

67,852

 

19,200

 

19,300 Total

 

145,000

 

153,200

 

65,000

 

67,800 The following summary outputs are the result of two

 

regression analyses: one that tests the correlation

 

between administration employee hours and office

 

administration costs and one that tests the correlation

 

between documents processed and office

 

administration costs. The data consist of monthly

 

observations from the 20X5 historical figures. Note that

 

employees are responsible for assigning their hours

 

worked to each of the three operating departments. 11 / 12 Exhibit 8

 

Data for analysis of express-delivery options Costs and activities specific to

 

express-delivery parcels

 

Sorting labour costs (?000s)

 

Number of administrative

 

documents processed Option 1:

 

Increase price

 

7,429 Option 2:

 

Increase advertising

 

8,718 16,170 18,975 Summary of marks

 

Preliminary analysis of budget versus actual

 

Analysis of cost allocations

 

Revised 20X5 statement

 

Projected 20X6 statement

 

Service analysis

 

Management observations

 

Report format and professional capabilities

 

Total marks 12 / 12 8

 

28

 

10

 

10

 

9

 

2

 

3

 

70

 


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