Financial Statement Analysis

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Question:

Which method provides the best advantage to evaluate Kim’s performance?  Why?

Answer:

Comparative Income Statement:

Comparative Income Statement:
   Taejon Branch
 Whole CompanyTraditional MethodABC Method
Particulars200720082007200820072008
Revenues$203,500,000$227,800,000$23,600,000$33,200,000$23,600,000$33,200,000
Total Direct Costs  ($12,600,000)($17,700,000)($12,600,000)($17,700,000)
Indirect Costs:      
IT Team Overhead-      
Branch PC Maintenace$5,300,000$4,800,000($614,644)($699,561)($416,284)($325,976)
Headquarter IT System Support$3,600,000$7,700,000($417,494)($1,122,212)($417,494)($1,122,212)
Branch IT System Support$5,100,000$7,600,000($591,450)($1,107,638)($591,450)($1,107,638)
Employee Training$4,400,000$4,200,000($510,270)($612,116)($328,597)($157,107)
OS Team-      
Training of Sales People$5,300,000$7,100,000($772,432)($1,034,767)($347,330)($489,173)
Operating Performance Evaluation & Reporting$1,100,000$700,000($160,316)($102,019)($110,000)($70,000)
Handling Traffic Accident Cases$11,700,000$16,400,000($1,705,180)($2,390,167)($1,233,984)($957,439)
Investment Team-      
Equity Investment$7,400,000$7,600,000($1,078,490)($1,107,638)  
Debt Investment$3,600,000$4,200,000($524,671)($612,116)  
Investment Performance Evaluation & Reporting$800,000$700,000($116,594)($102,019)  
Marketing Team-      
Advertisement$7,900,000$8,900,000($1,151,361)($1,297,103)  
New Product/Channel Development$2,100,000$3,800,000($306,058)($553,819)  
GA Team-      
Payroll Administration$1,600,000$1,400,000($233,187)($204,039)($119,490)($52,369)
Performance Evaluation$1,700,000$1,900,000($247,761)($276,910)($126,958)($71,072)
Education & Training$4,500,000$5,100,000($655,838)($743,284)($336,066)($190,773)
Headquarters Building Maintenance$2,300,000$2,500,000($335,206)($364,355)  
Branch Building Maintenance$4,600,000$4,800,000($670,413)($699,561)  
Total Indirect Costs  ($10,091,364)($13,029,324)($4,027,653)($4,543,761)
Total Branch Cost  ($22,691,364)($30,729,324)($16,627,653)($22,243,761)
Branch Operating Profit  $908,636$2,470,676$6,972,347$10,956,239
Operating Profit Margin  3.85%7.44%29.54%33.00%

Analysis Of The Income Statement:

Kim had tried to reduce the branch overhead costs by controlling various cost drivers. He had reduced the numbers of employees and number of accidents for savings various employee related expenses and costs for handling accident cases. However, as the company used to allocate the overheads on the basis of branch revenues, more the branches would generate revenues, more it would have to bear the overhead costs. Therefore, Taejon branch could not enjoy the benefit of reduction of various cost drivers, inspite of increase in revenues.

Under activity-based costing method, the overhead costs are allocated on the basis of individual cost drivers. The individual cost drivers are closely related with the cost activities. Therefore, the overhead allocation process under this method provides effective outcomes, which can evaluate the branch performance more efficiently (DRURY, 2013). 

From the above table, it is clearly visible that the efforts, given by Kim to reduce the overhead costs, have failed to increase the branch profits under traditional method. On the other hand, income statement under activity-based costing method exhibits that the effort of Kim has been able to reduce some of the overhead costs successfully. Moreover, it does not incorporate many headquarter overhead expenses, which do not have any relation with the branch operation. As result, the profit margins for both the years under this method are significantly higher than that of the traditional method (Simons, 2013).

Hence, it can be stated from the above discussion that the activity-based costing method provides best advantage to evaluate Kim’s performance.

Workings:

Overhead Cost Allocation under Activity-Based Costing (ABC):
  Whole CompanyTaejon Branch
TeamActivity2007200820072008
ITNos. of PCS5225894140
 Branch PC Mainteance$5,300,000$4,800,000$416,284$325,976
 Revenue$203,500,000$227,800,000$23,600,000$33,200,000
 Headquarter IT System Support$3,600,000$7,700,000$417,494$1,122,212
 Branch IT System Support$5,100,000$7,600,000$591,450$1,107,638
 Nos. of Employees109812038245
 Employee Training$4,400,000$4,200,000$328,597$157,107
 Total IT Overhead$18,400,000$24,300,000$1,753,824$2,712,934
OSNos. of Sales Person4125082735
 Training of Sales People$5,300,000$7,100,000$347,330$489,173
 Nos. of Branches101011
 Operating Performance Evaluation & Reporting$1,100,000$700,000$110,000$70,000
 Nos. of Accidents5125315431
 Handling Traffic Accident Cases$11,700,000$16,400,000$1,233,984$957,439
 Total OS Overhead$18,100,000$24,200,000$1,691,314$1,516,612
GANos. of Employees109812038245
 Payroll Administration$1,600,000$1,400,000$119,489.98$52,369.08
 Performance Evaluation$1,700,000$1,900,000$126,958.11$71,072.32
 Education & Training$4,500,000$5,100,000$336,065.57$190,773.07
 Total General & Administrative Overhead$7,800,000$8,400,000$582,514$314,214

Reference & Bibliography:

DRURY, C. M. (2013). Management and cost accounting. Springer.

Kaplan, R., & Anderson, S. R. (2013). Time-driven activity-based costing: a simpler and more powerful path to higher profits. Harvard business press.

Simons, R. (2013). Performance Measurement and Control Systems for Implementing Strategy Text and Cases: Pearson New International Edition. Pearson Higher Ed

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting. John Wiley & Sons

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