Costing and Cash Analysis for Cleaning Services

MANAGEMENT
ACCOUNTING
STUDENT ID:
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PROJECT 1
1. Profit Analysis
With regards to revenue, it is apparent that for 20X6, there has been an increase of about 12%
on a y-o-y basis. Also, the actual revenue for 20X6 is about 5% higher than the budgeted
amount for the same year. This clearly augers well for the company and implies that the
revenue performance of the business has exceeded expectations in 20X6.
The concerning aspect for the company is with regards to direct expenses in 20X6. Even
though on a y-o-y basis, there has been an increase of 12% in the sales, but the increase in
wages, transportation costs, cleaning supplies have increased by more than 25% due to which
there has been a significant decline in the gross margin. As a result, absolute gross margin in
20X6 is lower than the corresponding figure in 20X5 even though the revenue in 20X6 is
higher. Also, all the items under the direct expenses are exhibiting unfavourable variance
over their budgeted cost in 20X6 which highlights the higher direct expenses seen in 20X6
are unexpected by the company also.
With regards to indirect expenses as well, it is apparent that each of the item has an
unfavourable variance which reflects that the actual expenses have exceeded the budgeted
expenses. A noticeable unfavourable deviation is with regards to training and administration
costs which are higher by more than 10% from the budget estimates. Also, as compared to
last year, there has been a 33% increase in the promotional expense which may have been
responsible for the rising revenues. Thus, it is apparent that based on exhibit 1, the business
should be worried about the unfavourable deviation in expenses (especially in direct
expenses) which has led to erosion of profit margins.
2. Costing Analysis
a) It is apparent that the overhead costs comprise of costs related to cleaning supplies,
operation manager salaries along with transportation costs. The actual costs for the above
items for 20X6 are listed below.
Cleaning Supplies (20X6) = $88,541
Transportation Costs (20X6) = $30,281
Salaries of operations managers (20X6) = $120,000
Total overhead costs (20X6) = 88541 + 30281 + 120000 = $238,822
Total direct costs (20X6) = $292,184
Number of hours of direct labour = 292184/13.2 = 22,135.15
Actual overhead rate = 238822/22135.15 = $ 10.79 per direct labour hour

However, the overhead rate considered is $ 10 per labour hour. Hence, under the current
practice of applying $ 10 per direct labour hour as the overhead rate, the overhead rate is
underapplied as the actual overhead rate exceeds the currently applied rate.
b) Based on the regression results summary highlighted in Exhibit 3, it is apparent that there
is weak linear relationship between transportation costs and direct labour hours. This is
apparent from the R2 value of 0.13697 which implies that changes in direct labour hours
are capable of offering explanation to only about 13.7% of the changes in transportation
costs. Also, the slope of the regression line does not seem significant as is apparent from
the t value of the slope which would lead to a p value in excess of 0.05 (assumed
significance level). Thus, it is apparent that direct labour hour is not a reliable estimator of
transportation costs.
With regards to regression result between cleaning supply costs and labour hours, it is
apparent that the linear relationship is strong. This is reflected from the R2 value of 0.6963
which implies that changes in direct labour hours are capable of offering explanation to about
69.63% of the changes cleaning supply costs. Further, this is also supported by the
corresponding t stat of the slope which would lead to a p value of lower than 0.05 (assumed
significance level). Hence, it would be appropriate to conclude that direct labour hour is a
reliable estimator of cleaning supply costs.
On the basis of the above, it may be appropriate to conclude that transportation costs should
not be linked to direct labour hours which would enable better prediction of the overhead
rate.
c) The requisite regression equation for cleaning supplies is as highlighted below.
Cleaning supplies cost = 5922. 62 + 0.78922*Direct labour hours
Clearly from the above equation, the fixed cleaning supplies cost would be $5,922.62 while
the variable supplies cost would amount to $ 0.78922 per direct labour hours.
Direct labour hours (20X6) = 22,135.15 (as computed in part a)
Hence, cleaning supplies cost = 5922.62 + 0.78922*22135.15 = $23,392. 12
Thus, total overhead costs (20X6) = 23392.12 + 30281 + 120000 = $173,673.1
Thus, revised overhead application rate = 173,673.1/22135.15 = $7.85 per labour hour
Therefore, the computation above reflects that the current application rate of $ 10 per direct
labour hour is higher than the computed rate above. Hence, there is over-application of the
overhead rate based on the above calculations.