Cost Management Systems Report

This report delves into the cost management systems utilized by Adairs Company, emphasizing the importance of accurate cost estimation in the product life cycle. It compares traditional costing methods with activity-based costing (ABC), highlighting the benefits and drawbacks of each approach. The report includes a detailed analysis of Adairs' business processes, product categories, and the implications of cost management on profitability. Through various examples and a thorough examination of the company's operations, the report aims to provide insights into effective cost management strategies in retail.

Running head: COST MANAGEMENT SYSTEMS 1
Cost Management Systems
Student Name
Institution

COST MANAGEMENT SYSTEMS 2
Executive summary
Cost management is one of the most important phenomena in the product life cycle that
determines the profitability of every product. In order for the product to yield profit, the product
cost should be accurately estimated based on specific cost estimation method. Two most
common costing estimation methods are traditional costing method and Activity Based Costing
(ABC) method. For a proper understanding of the two costing methods a model company is used
and this is Adairs Company. Adairs Company is a retail store that is a major trader of homewares
and furniture. Adairs Company has a headquarters is in Scoresby, Victoria from where it has also
spread to various parts of Australia. Currently, the company has its branches in Victoria,
Northern Territory, New South Wales, Queensland, Western Australia and South Australia. The
product category includes bed ware, bathroom ware, giftware and the recently incorporated
furniture. The organization has many operational processes that form better part of the value
chain for the company's products. These operational activities can be used to calculate the cost of
a single item using activity-based cost method of cost estimation. The activities within this
product value chain are divided into stages categorized as activity cost pools. Digging deeper
into each activity cost pool there are drivers for the cost that are also used in allocating cost to
products. These activities give the elements of price calculation that is used in calculating both
direct and indirect cost that are part of the product cost (Cooper, 1990). Activity-based costing
(ABC) can also show both benefits and disadvantages when used in calculating the cost of
products sold at Adairs Company.

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Table of Contents
Executive summary.....................................................................................................................................2
Introduction.................................................................................................................................................3
Part 1 – Business Processes.........................................................................................................................3
Value chain analysis................................................................................................................................3
1. Characteristic of Adairs Company...............................................................................................4
2. Sources of the products sold at Adairs Company.........................................................................4
3. Operations....................................................................................................................................5
4. Marketing and sales.....................................................................................................................5
Part 2 – Costing System..............................................................................................................................6
Activity Based Costing............................................................................................................................6
1. Activity-based costing and traditional costing method................................................................6
2. Benefits of using Activity Based Costing in Adairs Company.....................................................7
3. Presentation of product costing system........................................................................................8
Part 3 – Product Costing............................................................................................................................11
Example 1: Mattress topper activity unit pools and cost drivers............................................................12
Example 2: Spot Flannelette activity units pools and cost drivers.........................................................13
Calculating profitability.........................................................................................................................15
Conclusion.................................................................................................................................................15
Reference...................................................................................................................................................16

COST MANAGEMENT SYSTEMS 4
Introduction
Understanding of cost management system of an organization is important for estimation
of the internal management cost for an organization such as Adairs Company. There are various
factors that are used in cost estimation and this mostly considers organization characteristics and
value chain. Another factor that also plays a critical role in price estimation is the operational
processes that add the overhead cost to each product. With this respect, there are two commonly
used costing methods and these are traditional and activity-based costing. Traditional costing
method involves estimation of overhead cost based on the volume of product produced. Activity-
based costing takes into account all the activities that attribute the cost of products when
estimating indirect cost on the product. Well, these two cost calculation methods have both
benefits to the business and disadvantages (Hansen & Mowen, 2006). The main focus of this
report is exploring the cost management system as applied in calculating the cost of production
of Adairs Company.
Part 1 – Business Processes
Value chain analysis
When looking at the company's value chain it is important to explore the various aspects
of the company starting from the product acquisition to the sales. This, of course, takes into
account the characteristics of the company and other operational processes leading to the
availability of the product.
1. Characteristic of Adairs Company
Adairs Company is an independent retail store that deals in homeware and home
furnishings. The company has both online and in-house stores where it sells its many products.

COST MANAGEMENT SYSTEMS 5
The company’s head office is situated in Victoria’s Scoresby. The company has also expanded
its product range to include other furniture that the company did not sell. By this, the retailer has
diversified its products also to consist of general homeware and children ware. This has also led
to the formation of another product portfolio called giftware that generally consists of various
gifts (Adairs Retail Group, 2017a).
2. Sources of the products sold at Adairs Company
The value chain for Adairs is complex and in order to understand the value chain, it is
good to explore sources of the products. Adairs Company value chain can be described as
consisting of operations, organization characteristics, and actual products, marketing and sales
and after sale services. The products that are sold within the Adirs are acquired from
manufacturers such as Abode Living at a price before it is transported to a warehouse for the
company (Abode Living, 2017). For instance, Abode Living is good at manufacturing better and
quality bed linen. These products are purchased by the company and sold in its many stores
including an online shop.
Products
The company deals in homewares that include bedroom products, bathroom products and
other home products such as beddings, soft furnishing, children furnishing and furniture. The
organization sells has recently started selling furniture that is part of bedroom furnishing and
occasionally other general furniture. The store retails in bedroom products such as sheets,
pillows, mattress covers and many other bedroom products. The company also sells bathroom
products such as towels, bath mats, laundry products and robes. In addition, the retailer also sells
giftware such as gift cards, home fragrances (Adirs Company, 2017b).

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3. Operations
Adairs Company has categories its operation into product design, development, sourcing,
and distribution and retail operations. Firstly, product design is consist of the branding of the
products so that it forms the major brands of the company. Over 90% of products sold by the
company is sold in company’s private brand with only less than 10% sold under third-party
national brands. Secondly, retail operation consist of over 130 stores spreads throughout
Australia. These stores are under the name of Adairs, Adairs Kids, Adairs homemaker, Adairs
Outlets, and UHR. Within these stores, products are displayed with the intention of selling to any
customer interested. Thirdly, Adairs also has an online store that offers the display for all
products that are sold to the company. The distribution of the products to various Adairs outlets
is done through the distribution department and also ship the products to any customer especially
those customers that purchase a product through the online shop. Other operations include online
shop maintenance and inventory management. These operations take into consideration various
platforms that the company uses to market and sells its products (Adirs Company, 2017b).
4. Marketing and sales
The organization markets their products through various avenues that include an online
shop, social media, and online website. Social media is one place that the organization exploits
for advertising its products for many online users with Australia and beyond. Moreover, the
retailer uses its fully equipped website to market its product which is also connected to the online
shop. The company has an online shop where the company sells its many products with the
ability to do online payment. The company has in-house stores spread in places such as Victoria,
Northern Territory, New South Wales, Queensland, Western Australia and South Australia
(Bloomberg, 2017).

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Part 2 – Costing System
Activity Based Costing
Activity-based costing is one of the cost-calculating methods that is used by
manufacturers to estimate the cost of item produced within an organization. Activity-based
costing (ABC) involves the determination of the cost of every activity used in the manufacturing
of an item and therefore determines the cost of an item manufactured based on the cost of every
activity used in production. This implies that when using the activity-based costing method in
assigning of the cost of the product, the cost of the product is the cost assigned to a particular
activity used in production (Cleland, 2004).
1. Activity-based costing and traditional costing method
Activity-based costing method differs significantly from the traditional cost calculation
method. Activity-based costing allocate price based on the cost of activities involved in the
production of an item and this differs from traditional costing method that pre-estimate the
overhead cost based on the volume of cost drivers. Traditional costing method uses cost drivers
such as machine hours or direct labor that causes the cost to incur and this differs from activity-
based costing that uses the cost of activity involved in the production to allocate the cost of item
produced (Barrett, 2005). Traditional costing aligns to the generally accepted accounting
principles and therefore easy to implement as compared to activity-based costing. One
disadvantage of the traditional costing method is the traditional costing may negate other cost
drivers when calculating the cost of an item (Hansen & Mowen, 2006).

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2. Benefits of using Activity Based Costing in Adairs Company
When ABC is applied in calculating the cost of products of Adairs, there are some
benefits that can be realized within the organization. Firstly, ABC offers accuracy when
determining the cost of various items sold within the organization. For instance, Adairs have
branches spread across the Australia and using ABC as cost calculating methods enable the
organization to accurately determine the cost due to distribution as an activity. This ensures there
is no loss when selling items within branches of the organization. Secondly, ABC method
ensures that there are no irrelevant costing when determining the cost of an item. The method
allows the true cost calculation with minimal overestimation of cost. Thirdly, ABC costing
method ensures the Adairs management understands the overhead cost which is very important
for estimating internal management cost (Velmurugan, 2010).
Disadvantages of using Activity Based Costing in Adairs
There are also some disadvantages of using the ABC costing method in calculating the
cost of homeware sold at Adairs. Firstly, the implementation of the costing method itself requires
many resources to be in place to ensure that the costs of various activities that are used in the
production of items are allocated. For instance, when estimating the cost of pillow that is
transported from Sydney to New South Wales will require the management of the company to
estimate the cost of various activities and this requires resources to calculate. Secondly,
interpreting the costing method is sometimes difficult for users. This is also common in online
Adairs shopping since customers see the cost of items as overpriced though the cost takes into
consideration all activities involved. This can, therefore, drive away customers who feel that the
price estimated is high as compared to other companies (Friedman & Lyne, 2013).

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3. Presentation of product costing system
Adairs Company has three product categories and these are bedroom products, bathroom
products, and giftware.
Direct and indirect costs associated with the product category
Looking at the product categories for the organization, there are both direct and indirect
costs that are associated with the product. Some of the direct costs that are associated with
products are acquisition cost, distribution cost, labor cost, marketing cost, operation cost and
after sale services. The direct cost includes the cost of acquiring the products from Abode Living
(Hansen & Mowen, 2006). The products that are sold within the organization are acquired from
manufacturers such as Abode Living at a price before it is transported to a warehouse for the
company. Products are then taken through various value addition activities that add cost to the
products. Another cost is the distribution cost that often results from moving these products from
the warehouse in Victoria to another warehouse in Sydney. Labor cost though is part of operation
cost can also fall on independent indirect cost. Operation cost is another indirect cost that
includes all the cost that is incurred for management and maintenance of both facilities and
various operational processes within the business. Operation cost is also added to the cost of
items especially when calculating item cost based on ABC costing method (Kaplan & Anderson,
2004).
Identify the relevant activity cost pools
The activity cost pool within the costing of the organization at the manufacturing is
divided into the design; manufacturing and finishing while at the operation process is divided
into product classification and product price estimation, product distribution and product

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marketing & sales. The manufacturing activity cost pool is often not considered since the
company purchase product after the price has been set and only activity cost pool within the
company is often considered (Larson & Kerr, 2007). Within the company, the first division of
the product activity cost pool is product acquisition and is followed by the product classification
into bedroom ware, bathroom ware or gifting ware. Secondly, price estimation is another
activity cost pool that brings nearly all department together to determine the cost of a single item
that will be used for the final consumer. Thirdly, distribution of these products to various
company branches spread throughout Australia. This also consists of very many activities each
bearing cost that is transferred to the overall product cost (Leahy, 2004). Finally, marketing and
sales are the last activity cost pool that is also used in calculating the cost of a single item. This
includes activities such as advertising, personal selling, online shopping and after sale services.
Being the final product cost pool, the marketing also factors in the after sale activities that
influence the cost of the product (Maher & Rahan, 2005).
Cost drivers for activity cost pool
Each activity cost pool has many drivers that are used to allocate cost to a product.
Firstly, product acquisition has drivers such as units of the product, quality; type and size of the
product purchased are some drivers that are used to determine the cost of each item. Another cost
driver within this activity cost pool is labor and machine maintenance as this two drivers are part
of the process (Meelah & Ibraham, 2007). Secondly, product classification has drivers such as
labor, number of units and equipment used in the process. Since price estimation is also
classification cost pool, this activity cost pool has drivers such as labor and equipment. Fourthly,
distribution has drivers such as transportation, labor, equipment, and carriers. Distribution also
includes the machines that are used to load and offloading products into the tracks that mostly

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charge in terms of hours used. Finally, marketing has drivers such as labor, equipment, and
information system and facility maintenance. The labor within this activity cost pool includes
personal selling and advertisement labor charges (Blocher & Juras, 2016).
Cost hierarchy
It is important to classify activity cost pool for Adair’s Company in unit, batch, product
or facility activity cost pool. Firstly, acquisition of the products from the manufacturer is product
activity cost pool. The system that is used by the company can take any form since the
acquisition of products though are made from another manufacturer, the product manufacturing
can also be factored into the system at unit hierarchy (Omiri & Drury 2007). Within this cost
pool, there are activities such as stocktaking, determination of the number of products purchased
and this also involves many different machines. Secondly, classification of these products within
the company warehouse is facility activity cost pool. This is due to the operational processes that
are performed on the product during classification (Sandison, Hansen & Torok, 2003). For
instance, at the classification stage is where products are also branded to add value to the
product. Thirdly, marketing and sales are classified into unit activity cost pool since it only
considers the number of units that are sold. The marketing as activity cost pool is concerned with
the number of units that are purchased. Moreover, at the marketing, the department is also
conversant with the number of units that are available for sale at various branches throughout the
Australia. Fourthly, distribution is classified as product activity cost pool since it mainly focuses
on the cost of moving product from one place to another (Rad, 2002).

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Part 3 – Product Costing
When using the ABC costing method, there are many things to consider. The data that is
used to calculate the cost of products sold at Adairs factor in units produced and sold, sales
revenue and direct cost (Krumwiede, 1998). When calculating the cost direct and indirect cost of
various activities in the Adairs is used to estimate the cost of items. In addition, cost pool
activities provide the basis for calculating the cost of all activities that are tied to indirect
operational cost especially at manufacturing of the product or general cost estimation of products
in Adairs. Calculation of direct cost that is associated with the product at the Adairs is as shown
below using two products which are Mattress topper and Spot Flannelette (Adirs Company,
2017a). This can be summarized in a table as shown below
Table 1
Product Compared Mattress topper Spot Flannelette Total
Units produced and sold 1100 2030 3133
Selling price per unit $96.89 $18.99
Direct labor cost per unit $ 2.5 $ 1.5
Direct materials cost per
unit
$ 3.50 $ 3.0
Sales revenue $ 106579 $ 38549.70 $ 145128.70