The removal of non-traceable costs in the income statement will direct a substantial increase in net income of all the departments concerned in this case study. Indeed, the divisions in which the highest percentage movement is outlined are those that have the greatest billing revenue. These comprise the New York and Paris Departments. This argument is sustained by the fact that the gross profit on sales of the New York division increased by 122. 22%, while that of the Paris section rose by 1,066. 67% when non-traceable expenditure are not allocated in the profit statement.
Question 3 A salient objective of an organisation, that puts in practice a decentralization strategy like Creative Consumer Consultants Limited is to achieve goal congruence. Goal congruence encompasses the alignment of the individual aims of people working in the organization, namely management in line with the strategic objectives of the business enterprise. In the case at hand, the allocation of non-traceable expenditure is limiting the firm in attaining the objective outlined above. This is further compounded by the bonus scheme enacted in the organization.
This bonus system entails that office managers are rewarded a bonus income on the net income generated from operations. The main goal of such bonus is to stimulate effectiveness in the corporation. However, since non-traceable costs are apportioned to divisions on the basis of sales revenue, there is the potential risk that office managers limit the rate of orders in order to control such expense. This issue mainly applicable to the Paris department, which is presently incurring net losses of $1,000,000, materially stemming from non-traceable expenditure.
This allocation problem will therefore refrain Creative Consumer Consultants Limited in attaining goal congruence and be effective as top management necessitates. In fact the premise of the joint allocation problem stems from the concept that each department benefiting from a joint action should share the non-traceable cost, leading to the aforementioned problem. The allocation of non-traceable costs to the profit statements of the section also imposes a demotivating effect on office managers.
If the performance of the section will not be penalized from non-traceable costs, which are usually outside the control of office managers, such management will strive to work harder to enhance the billings revenue, which will ultimately increase the net profit of the section and lead the attainment of the bonus. This will thus enable the main objective of the company, which is goal congruence. A suitable pricing technique, such as transfer pricing should be adopted in Creative Consumer Consultants Limited in order to further stimulate goal congruence.
If pricing decisions are left unattended in the hands of departmental managers, there is the potential risk that a low price sufficient to cover the traceable expenditure is selected with the aim to penetrate the market. This will be conducted with the sole objective to boost the bonus. Therefore this agency cost may direct towards a weak financial performance for the organization. This also stems from the fact that non-traceable expenditure is neglected in the pricing decision.
Therefore it is critical that top management consistently monitors the prices charged and adopt a good pricing technique like the above mentioned in order to enhance that attainment of goal congruence. For example, let us hypothetically assume that a 10% bonus is provided on the department’s profit made and all the sections were capable to reach a profit of $16,000,000. The reduction of the non-traceable costs, which are similar to the case presented and bonus expenditure would lead to the net income portrayed below:
Total Divisional Profit $16,000,000 Non-Traceable Consulting Costs $10,000,000 Non-Traceable Other Costs $ 2,500,000 Manager’s Bonus ($16,000,000 x 10%) $ 1,600,000 Overall Net Profit $ 1,900,000 Such computation portrays that even though divisional managers increased the total division profits by $500,000 ($16,000,000 – $15,500,000), the overall net income for Creative Consumer Consultants Limited will be $1,100,000 lower ($3,000,000 – $1,900,000).
The above computation therefore further highlights that non-traceable costs should still play some importance in the decision making process of management. This thus requires the need of developing and maintaining appropriate cost systems to ensure that the aforementioned problems are mitigated. References: Drury C. (1996). Management and Cost Accounting. Fourth Edition. New York: International Thomson Business Press. Lucey T. (2003). Management Accounting. Fifth Edition. Great B
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