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A Case Study on Gateway Construction Company In partial fulfillment of requirements in Management Accounting (ACC535M)



Submitted by: Exiomo, Maryanne D. [11186542] Lizardo, Regina Lour [11595213] Santiago, Chamuel Michael Joseph A. [11595833] Santos, Maria Creselda B. [11573015] GROUP 4



Submitted to: Arnel Onesimo O. Uy, PhD, CMA, CFC, CPA



Synthesis Gateway Construction Company, a utility-pipe laying subcontractor for the city and state agencies in Nebraska, has had sales volume that averages $3 million, and profits that vary between 0 and 10% of sales. Due to a recession and intense competition, sales and profits have been somewhat below average for the past 3 years. Jack wants to increase the competitiveness of his company when it comes to bidding projects. He believes that the company’s current accounting system is deficient. The company’s expenses are not classified and are simply deducted to their revenue to determine the operating income. The majority of the company’s expenses comes from equipment use. Furthermore, he is having difficulty classifying his own salary because he is performing two different roles in his company. Statement of the Problem/s - How should Jack assign and categorize the costs of operating his business? - How can Jack increase the competitiveness of his company? Point of View We are taking the point of view of Jack Gateway as he is the owner and manager of the company.



Statement of the Objectives 1. To classify the costs in the income statement as (1) costs of laying pipe (production costs), (2) costs of securing contracts (selling costs), or (3) costs of general administration. For production costs, identify direct materials, direct labor, and overhead costs. 2. To identify the expenses that would likely be traced to jobs related to equipment hours. 3. To determine a strategy that will improve Gateway Construction Company’s competitiveness in acquiring projects.



Areas of Consideration



Cost is the amount of cash or cash equivalent sacrificed for goods and/or services that are expected to bring a current or future benefit to the organization. Costs are usually classified as follows: Product Costs Vs. Period Costs Product costs are costs assigned to the manufacture of products and recognized for financial reporting when sold. They include direct materials, direct labor, factory wages, factory depreciation, etc. Period costs are on the other hand are all costs other than product costs. They include marketing costs and administrative costs. Breakup of Product Costs The product costs are further classified into:



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■ Direct materials: Represents the cost of the materials that can be identified directly with the product at reasonable cost. ■ Direct labor: Represents the cost of the labor time spent on that product. ■ Manufacturing overhead: Represents all production costs except those for direct labor and direct materials, for example the cost of an accountant's time in an organization, depreciation on equipment, electricity, fuel, etc. The product costs that can be specifically identified with each unit of a product are called direct product costs. Whereas those which cannot be traced to a specific unit are indirect product costs. Thus direct material cost and direct labor cost are direct product costs whereas manufacturing overhead cost is indirect product cost. Prime Costs Vs. Conversion Costs Prime costs are the sum of all direct costs such as direct materials, direct labor and any other direct costs. Conversion costs are all costs incurred to convert the raw materials to finished products and they equal the sum of direct labor, other direct costs (other than materials) and manufacturing overheads. Fixed Costs Vs. Variable Costs Fixed costs are costs which remain constant within a certain level of output or sales. This certain limit where fixed costs remain constant regardless of the level of activity is called relevant range. For example, depreciation on fixed assets, etc. Variable costs are costs which change with a change in the level of activity. Examples include direct materials, direct labor, etc.



Alternative Courses of Action



ACA 1: Classify expenses either as product or period cost Pros: - This will tell how or why the money was spent in terms of producing the product and be able to come up with sound budgeting and analyses through comparison with period costs incurred outside manufacturing. Cons: - This classification requires accurate detail and improper classification of expenses might make decisions more vulnerable to errors.



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ACA 2: Classify expenses either as prime or conversion cost Pros: - The management will have insight on all costs related to manufacturing activities. This will help managers pinpoint cost overruns and come up with strategies to improve these costs. Cons: - Since this classification only focuses on production costs and manufacturing overhead, other factors will be left out (i.e. advertising, administrative costs). ACA 3: Classify expenses either as fixed or variable cost Pros: - This classification will greatly impact in the decision making of the management by tracking the expenses that will make planning, forecasting and bidding as easy as possible. By comparing the fixed cost versus variable cost, managers will be able to project how much pipes they need to sell/produce to earn a profit. Cons: - Classifying expenses through fixed or variable cost can cause management’s budgeting decision depend on the figures of the variable cost resulting to oversupply in inventories in case demands fall short due to some unforeseen instances (i.e. economic slowdown, change in customers’ demands).



Recommendation



The group’s recommendation is that Jack should classify the expenses as product and period costs (ACA 1). If he would start properly classifying his operating expenses, he would be able to see how much he spends on every income statement line item in relation his sales (e.g. 87.3% of sales is production costs). The group suggests that Jack should develop a winning bid strategy. First, he should know their bid-hit ratio. This will give him meaningful insight into his company’s success in the bidding process. Tracking their bid-hit ratio can reveal where they should focus their bidding efforts in the future-and the projects to avoid - so they can optimize their bid strategy. Second, they should clearly understand each project true cost in order to improve both bid-hit ratio and profitability. They should get project estimates as close to the final job costs as possibly by looking at current data and related details. Furthermore, Jack can try sourcing his construction materials to other suppliers who can offer lower price yet same value or even better. As we can see in the income statement above, 46.67% of Jack’s sales is already allocated to the Pipe product cost. Third, Jack should meet face to face with the estimator since there is no substitute for personal interaction when cultivating a business relationship. Having a discussion with the potential client also allows him to know details that are not



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available in the bid documents such as the top criteria for evaluation of bids, most important aspect of the job and qualities that would make a bidder stand out. Fourth, he should differentiate what his company can offer and makes it best qualified for the job. He should highlight unique areas of expertise of his company by adding some extras to their bid such as project pictures with descriptions, customer quotes highlighting unique areas of Gateway’s expertise, special certifications and list of awards if any. Fifth, he should also be able to build bids quickly, accurately, and confidently. To achieve this, he can purchase and use modern estimating software. It will allow him to do estimates more accurately and faster by allowing him to take off directly from electronic plans, improve analysis by activity or phases, standardize estimating practices and it usually has a built-in error detection. The group also recommends for Jack to increase on his advertising expenses to improve his competitive advantage. If he uses a good marketing and advertising strategy, possible customers will be able to know his products and services. He may also promote his team, company’s experience in the field and expertise that the company has to offer.



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Assuming that a significant driver is equipment hours, the expense that would likely be traced to jobs using this driver would be the machine operator wages. Since the operator is the one in-charge of the machine, it is directly associated with the number of equipment hours that has been incurred in the construction. The cost per equipment hour for machine operator would be $ 218,000 = $ 11.98 machine operator wage per equipment hour 18,200 hours Another expense that would likely be traced to job using equipment hours would be the supervisory salaries. The more equipment hours incurred in the production, the more the supervisor needs to monitor the performance of the employees and over-all construction work-in-progress. The cost per equipment hour for mechanic salaries and supervisory salaries would be the following: $ 70,000 = $ 3.85 supervisory salary per equipment hour 18,200 hours Also, we can also add other direct labor as expenses to be traced using equipment hours. Since the nature of Jack’s business is construction company, information provided as to how many working hours these laborers incurred was not



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given. Therefore, we can use equipment hours as the next cost driver related to the other direct labor wages. The cost per equipment hour for other direct labor would be $ 265,700 = $ 14.60 other direct labor per equipment hour 18,200 hours Pipe, tires and fuel can also be traced using equipment hours. The more number of pipes used would result to the equipment to be utilized. As for tires and fuels being a component of the equipment, the use of these translates to further use of equipment as well. The cost per equipment hour for pipes, tires and fuel would be $ 1,401,300 = $ 76.99 pipe per equipment hours 18,200 hours $ 418,600 = $23 tires and fuel per equipment hour 18,200 hours Lastly, we can also trace equipment depreciation to equipment hours. The nature of the business can identify the method to be used to depreciate the asset. Aside from depreciating it using the number of useful life in years of the asset, another way is depreciating it using the number of life hours incurred. The cost per equipment hours related to its depreciation for the year would be $ 198,000 = $ 10.88 depreciation expense per equipment hours 18,200 hours



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Overall, the expense that would likely be traced to jobs using equipment hours would be: Machine operator wage



$ 218,000



Supervisory Salary



70,000



Other Direct Labor



265,700



Pipe



1,401,300



Tires and fuel



418,600



Depreciation expense



198,000



Total



2,571,600 18,200 hours $ 141.30



Implementation Plan Steps



Person in Charge



People Involved



Timeline



Set a meeting with accounting head about plans on improving on accounting procedures and bid strategy



Jack



Accounting head and Jack



1 day



Schedule series of meetings with the accounting and management department. -Identify process improvements that must be considered.



Jack



Accounting department and Jack



3 days



Review the process and identify implementation date



Accounting head



Accounting head and Jack



1 day



Purchase estimating software Training Stage -Train those who needs to be familiarized with the improved accounting and bidding procedures



Accounting head



Accounting 1 day Department and Other Business Unit Heads



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Implementation Stage



Accounting head



Accounting Department



Continuou s



Learning Points



Properly classifying the nature of expenses helps the owner to monitor how much money has been allocated to the different categories of expenses. By using percentage of sales, it is easier to analyze the data (e.g. 87.3% of sales is production costs). Furthermore, a company can increase its competitiveness through the following : ● offering a product at a lower cost for a better value ● delivering the service faster ● outsourcing materials for a low cost yet providing a good quality material that will last long ● developing your brand through spending money on advertising (e.g. utilizing social media by putting up a website, investing on videos and photos of works made) ● hiring competent professionals to analyze and supply informations that can help managers in the decision making process These are just some things a company can do that may result to a competitive edge in the business market.



References Mowen, M. M., Hansen, D. R., & Heitger, D. L. (2014). Cornerstones of Managerial Accounting (5 ed.). Mason, OH: South-Western Cengage Learning. SAGE. (2016, May). Improve your bid-hit ratio: Top five essentials of a winning bid strategy. Retrieved from SAGE: https://www.sage.com/na/~/media/sage-jobready/assets/improve-bid-hit-ratio



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