Park Chemicals management

Management ACCOUNTING

Executive Summary

The following is the report for the management of Park Chemicals to assist in deciding whether or not containers department should be continued. Mr. Bywater has been approached by the management to suggest on the costs related in the decision. Mr. Bywater has been assured that his job will not be in jeopardy as a result of closure of container department; hence his suggestions can be viewed as free from prejudice.

The report is divided into two segments; Segment 1 addresses the specific needs and questions raised by the Park Chemicals management. Segment 2 is more open ended and analyzes the information needs of any organisation and how management accounting can be helpful for the same. Each segment has its own conclusion and recommendation.

I. Segment I

1. Introduction

Park Chemicals’ General Manager and Manger of Container’s department have teamed together to undertake the substantial change in the company by deciding about the fate of container’s department. Mr. Clough has asked Mr. Bywater to provide estimates and suggestions as per his experience and judgement.

Apart from seeking suggestions from Mr. Bywater, Mr. Clough has also contacted Common Containers for providing the services and deciding about the change. This has led to various decisions options that Mr. Clough could explore and select the one that fits properly to the compay’s objective.

2. Decision Options

As discussed in the preceding part, the management is posed with the dilemma of how to reach an appropriate decision regarding manufacturing of containers. The company has received price quotations from Common Containers, specialized in manufacturing containers and undertaking maintenance work. They are

Particulars

Amount (in GBP)

Containers

3000*100

300,000

Maintenance Work

87,500

(The prices quoted here are on individual basis and does not attract any discount on being taken together)

As seen from above the prices are on individual basis, so either of them can be taken or both of them can be taken. Therefore, the management has following four options to choose from

* Continue the department, manufacture containers and maintenance work.

* Close the department, outsource both manufacturing and maintenance.

* Partial close of the department, Outsource manufacturing but continue maintenance work.

* Partial close of the department, manufacture containers but outsource maintenance work.

The above options need careful consideration and thoughtful reasoning as different options have different level of outlays and benefits coupled with it in both short-term as well as in long term. The management has to decide about the issue by comparing the price quotation and the cost of manufacturing the same. The cost of manufacturing the container and running the department by itself has been given in the case study. However, the costs include various relevant and non-relevant costs, which need to be adjusted in order to arrive at the correct figure. The decision options are based only for next five years and are purely based on the understanding of the discussion between manager and general manager and prices from Common containers. The next section shall demonstrate the relevant costs applicable for different options.

3. Costs

The solution to the complexity of this case can be reached through identifying various kinds of costs such as relevant, sunk, fixed and relevant costs. We shall start with

Sunk Cost, these are the costs which have been incurred in the past and are of non-recurring nature. The containers department has Machinery cost as sunk cost because it had already been purchased and company need not spend anything on it now.

Common Cost, these are the costs which have been apportioned to the department as a result of using the facility. Normally, these cost neither increase nor decrease substantially as a result of the department. In case of containers department, apportioned general administrative overhead of £33,750 are the common costs.

Fixed costs are the costs which shall continue to be incurred irrespective of the operations of the company or department. In this case Mr. Bywater’s salary £40,000 is fixed cost because he has been assured by the management that he shall continue to serve the company irrespective of the containers department.

Relevant Costs different under different options, but following are the costs that are relevant under all options.

* Material cost is relevant, but at the price of £600 per ton for the initial three years because it had been purchased in the past and could now be resold at the price of £600 per ton. For fourth and fifth year the relevant cost for material would be £900 per ton as it has to be purchased in those years for that price.

* Pension cost for Old Savage and Teale at £5,000 each every year, if department is closed.

* The warehousing rent of £13,750 saved, if department is closed.

* The sale of machinery for £40,000 is the relevant, if not used.

* Per year usage of Purton is calculated as £150,000/£750 = 200 tons. This will last for four years including the previous year in which it was purchased, hence 200 tons / 4years = 50 ton per year.

* Relevant costs for Material, Labour, Rent, Maintenance and other expenses are explained with each option in Appendix.

4. Evaluation of Options

The management has four decision options arising from the relevant cost scenario and it has to decide about the most appropriate decision. Let’s compare all the options and advise the most appropriate one

Relevant Costs under each Option

Year 1

Year 2

Year 3

Year 4

Year 5

Total

Operate the DepartmentI

318,250

318,250

318,250

333,250

333,250

1,621,250

Close the DepartmentII

253,750

383,750

383,750

383,750

383,750

1,788,750

Undertake only Maintenance work III

225,500

355,500

355,500

355,500

355,500

1,647,500

Manufacture only ContainersIV

342,750

342,750

342,750

357,750

357,750

1,743,750

(Detailed calculations are attached as Appendix)

As seen from the table the yearly relevant cost under each option and total of relevant cost for five years under each option. There are two approaches to analyse the figures.

* Firstly, if we look at each year’s figures then there are huge fluctuations in costs between the options and even from one year to another between the same options. Therefore, undertaking only maintenance work, case III, has lowest cost in the initial year and thereafter it saturates at £355,500. However operating the department, case I, results into higher cost in the initial year, but it has lowest cost in the next years.

* Secondly, we can look at the total cost for the five years horizons, which shall give us an overall overview of the costs involved. Hence, the lowest cost is with option of operating the department whereas the highest cost is with total closure of the department.

5. Recommendation

According to the decision options and related relevant costs, I would suggest management of Park Chemicals to continue to operate the department because of two fold reasons:

1. The per year cost of manufacturing the containers as well as doing the maintenance work is low as compared to all other options except first year.

2. The cumulative cost for five years is lowest among the four options.

The other factors that would vouch the decision to continue the department are:

1. Since containers are the most important for quality of the products, hence it needs strict quality control. The company would be able to monitor the quality of manufacturing containers and maintenance work if it operates the department by itself.

2. The company can increase the manufacturing of the containers to a certain limit without incurring additional fixed cost thereby achieving efficiencies of production.

3. The company can avoid hassle of changing order size, placing new orders, waiting for the delivery and re–negotiating prices in case of increase/decrease of the demand.

4. The company can grow organically at a faster speed if it is fully equipped and self dependent in all areas.

5. The company shall be able to take advantage of the decrease in the raw material prices and additionally can explore other cheaper and better quality raw materials to manufacture the containers.

6. The partial close down of the department with either of the two works being outsourced does not seem to be a viable option. Because if company undertakes maintenance of containers, which are manufactured by third party, it has to constantly monitor its relations with the vendor that can be tedious and time-consuming job.

However, if the company opts for operating the department it would have to incur machinery cost in fifth year. The cost of same has not been included in calculation because there is no future cost given for the machinery so it can increase or decrease due to inflation and technological advancement respectively. Furthermore, machinery cost can be excluded from calculations because it shall last for many years and its benefit will accrue for longer time.

6. Conclusion

The detailed evaluation and calculations have so far suggested to reach a conclusion that management of park chemicals should operate the department and manufacture containers and perform maintenance work through the department. There are certain other benefits linked with the decision as it will allow the company to be self sufficient and explore better and more sophisticated ways of accomplishing the task and continually monitor its progress and plan its expansions.

II. Segment II

1. DANA Petroleum PLC

Dana PLC is an independent oil and gas exploration company and is a part of FTSE 250 index. It was founded in 1994. The company’ main operations involve exploration and production of hydrocarbon liquids and gas. The operations are spread over wide geography covering the North Sea, Egypt, Mauritania, Morocco, Kenya, Australia and Russia.

Dana Petroleum’s major exploration activities started in the year 2001 when they added huge gas reserves from Indonesia to their portfolio. In the same year Dana Petroleum also escalated there reserves in the North Sea. They purchased the oil field Goosander which was previously operated by Shell. They also acquired the oil field called Conoco (UK) in the same year. In the year 2002 they started drilling operations in Western Australia and Ghana. The first oil exploration well was started at beginning of the year 2003 at Mauritania and in the same year they acquired Kittiwake and Mallard oil fields. They discovered a hydrocarbon column at Mauritania during the exploration process. To enhance the business opportunities they entered into an agreement with woodside energy in the year 2004. This agreement helped them to expand their oil exploration program in Australia, Mauritania, Kenya and Ghana. For the exchange of 12% stake in their Indonesian fields Dana acquired 28% of stake in Hudson oil field from Amerada in the year 2005. To develop an existing position in Morocco Dana entered 2 separate agreements in the year 2006. This agreement allowed Dana to acquire 15% and 50% working interests in Tanger-Larache and the exploration resulting from Bouanane Reconnaissance contract respectively. In the year 2007 to enter Egypt and expand the business all over Egypt they signed an agreement with Devon Energy Corporation. Hydrocarbon gas was discovered in their first oil exploration well in Egypt in the year 2008 located near the Gulf of Suez. Recently in April 2009, Dana acquired Bow Valley Energy an oil and gas exploration company.

In the financial year ended on 31st December 2008 Dana Petroleum recorded revenue of £518 million which was 66% higher than its previous fiscal. The earnings per share were up by 51%. The major shareholder’s in Dana Petroleum PLC are Schrorder Investment management with 12% stake, Blackrock MLIM with 5% stake, L&G investment management with 4% stake, Newton asset management with 3.54% stake and Aegon asset management with 3.28% stake. The major competitors for this Plc are

· BP Plc

· ExxonMobil Corporation

· Esso UK Ltd

· Shell Oil Company

· Royal Dutch Petroleum Company

2. Role of Management Accounting

Management accounting begins at the top most level of the value chain. It helps organization to implement and set the long term and short term goals. It makes a road map to build effective strategy and helps management to take tactical decision which can be in line with the long term goals and strategy. The management accounting also helps organization to collect the information about the external and internal factors which affects the company’s business performance.

In the new technology era management accounting systems play vital role in organizations success. There are three types of decisions to be made in the organization Marketing, Production and Financial. Management needs real time, relevant and specific information to make the right decisions at right time. Management accountants and the accounting systems help management to take right decisions. There are various types of management accounting tools available in the literature each tool provides unique information to make a specific decision about alternative available. For example for a asset like “Cash” the strategic decision to be taken is about the “Risk” of maintaining the cash in particular investment the tactical decision is to be made regarding the “Minimum balance amount needed” the management accounting tool used to make the decision is “Cash budget” and make the correct cash budget management needs information about the “Cash inflows” and “Cash outflows”.

In case of firm like Dana Petroleum from the annual report it is clearly evident that the company is driven by expectation of the various stakeholders to reduce cost, improve service and comply with the wide range of regulations from health and safety, environment protection and financial institutions. Following are the critical factors on which Dana Petroleum needs continuous information and knowledge and these are the only key factors which contributed to Dana’s business performance

* Health, safety and environment protection program.

* Production growth and reserves growth.

* A dynamic exploration program.

* Business development and human capital.

* Corporate social responsibility.

The management accounting role here is to generate right timely information to make maximum utilization of the resources and there by maximising the shareholders wealth which is a long term vision of the company.

3. Analysis of the Organizations’ Information Needs.

Above factors can be classified in two broad categories as internal factors and external factors. To manage the performance of the above factors it is necessary for management to make critical decisions at right time. The only way management can make right decision is by efficient use of the information and knowledge available with the management. Dana Petroleum’s accounting department is the primary source of information which is necessary to make the right decision.

The most important factor in case of Dana Petroleum was the success of their Health, Safety and Environment (HS&E) management program. For the company like Dana it is one of the most pressing regulatory requirements to manage the HS&E program as this program helps to uphold a credible, responsible and professional company reputation. With a well directed management initiative Dana should look at this program as an opportunity rather than as a burden. The key information in management of the HS&E program is the “mobility aspect”. Dana’s management need to trace and track movements of people off shore and in and around the facility so as to avoid possible hazardous situation. They also need to track the expensive equipments and collect the real time data (like pressure, temperature and volume) from the equipment. They need efficient internal management information systems and communication devices which can trace all possible errors occurring in and around the oil fields. The annual report of Dana petroleum indicates that they are investing good amount of capital to improve these systems. Recently they have purchased a fire retardant coverall for all the shop level employees. They have also purchased ship identification radar equipment which informs the shore manager about the movements of oil carrying ships. Due to investment in such information systems management can save lot of money which can further be invested elsewhere. This management accounting system will also relieve some pressure from tight operating budget and will help them to achieve the required standards required by their “licence to operate” regulation.

Dana’s Management also in need information about the cash inflows and out flows because for production growth and for determining new reserves Dana Petroleum often invests into fixed assets. Also to manage the HS&E program efficiently new equipments are required. Few of these new equipments are technology and regulations based and hence have short life. Company’s management should make a strategic decision whether to purchase such equipments or lease them. After these strategic decisions the management should decide upon the depreciation methods which will impact the bottom line of the company. Management accounting tools such as capital budgeting helps the firm to decide whether to invest in the assets or not to invest and management accounting tools like incremental analysis helps them to decide upon which depreciation method to be used for different plant, property and equipments.

To further undertake the dynamic exploration program Dana’s management need information about the return on investments and cost of capital data. Management accounting tools such as incremental return on investment analysis and cost of capital analysis can help Dana’s management to decide whether or not they should finance the program internally by means of retained earnings or they should leverage. Based on these analysis management can strategically assess the internal financing risk and then can make tactical decisions about the dividend payment methods and amount of dividends.

Management also needs the information about the petroleum demand and the crude prices in the market as these factors majorly affect sales of Oil and Gas Company. Management accounting tools like Cost-Volume-Price (CVP) analysis and cost behaviour analysis will help management to make decision about the number of barrels of oil to be produced. This will also give management fair idea about the current market share of the company. From the annual report we also discovered that the company also needs skilled labour to work on the facilities wage rates and productivity rate information is required by the management to decide about the direct labour required on the plant per shift. CVP analysis and incremental cost analysis tools can help management appoint optimal quantity of labour.

4. Strengths and Weakness of the Analysis

The report describes the firm’s background and achievements in a very short and crispy manner. Above analysis is done after thoroughly reading the annual report for the financial year ended 31st December 2008. So the information available in the report is very authentic, real and applied. The management accounting tools suggested in the report such as improved management accounting IT systems, capital budgeting, CVP analysis etc. are practical and they are used by the companies in this sector. Hence if Dana Petroleum PLC uses these tools they can further improve their bottom line.

Appendix I

Spreadsheets

Case I: Operate the Department

Year 1

Year 2

Year 3

Year 4

Year 5

Material

30000

30000

30000

45000

45000

Other Material

62500

62500

62500

62500

62500

Labour

175000

175000

175000

175000

175000

Total Direct Cost

267500

267500

267500

282500

282500

Other Expenses

31500

31500

31500

31500

31500

Maintenance

6750

6750

6750

6750

6750

Rent

7500

7500

7500

7500

7500

Total Cost

313250

313250

313250

328250

328250

The above spreadsheet extract depicts the costs under the option of operating the department, therefore manufacturing containers and undertaking maintenance work.

* The material cost is taken as £30,000 in initial three years because it had already been purchased in the past and now it can be sold for £600 per ton, which is relevant to us. However, the stock shall last only for three years and for next years it has to be purchased. In the absence of any future rate for Purton, the existing rate of £900 per ton has been taken for year 4 and 5.

* The other Material is taken as £67500 = £100,000 – £37500, which is assumed to be used for making containers and undertaking maintenance work.

Appendix II

Spreadsheets

CASE II : Close Department

Year 1

Year 2

Year 3

Year 4

Year 5

Container Cost

300000

300000

300000

300000

300000

Maintenance Cost

87500

87500

87500

87500

87500

Total to pay to Vendor

387500

387500

387500

387500

387500

Extra Costs

Pension Cost

10000

10000

10000

10000

10000

397500

397500

397500

397500

397500

Less:

Warehouse Rent Saved

13750

13750

13750

13750

13750

Sale of Machinery

40000

0

0

0

0

Sale of Material

90000

0

0

0

0

Total Relevant Cost

253750

383750

383750

383750

383750

* The pension cost is for Old savage and Teale each at £5000 per year.

* The sale of material has been calculated as material purchased worth £150,000 last year and it shall now last for three years, which means it will last for four years in totality. Hence, 150,000/ 750 = 200 tons divided by 4 years gives us 50 ton per year usage.

This means that company has now 50 tons * 3 years stock = 150 tons, which can be sold at price of 600 per ton giving us 90,000.

Appendix III

Spreadsheet Extract

CASE III : Undertake only Maintenance

Year 1

Year 2

Year 3

Year 4

Year 5

Containers’ Cost

300000

300000

300000

300000

300000

Maintenance Cost

Material

10000

10000

10000

10000

10000

Labour Cost

35000

35000

35000

35000

35000

Rent

7500

7500

7500

7500

7500

Other Expenses

13000

13000

13000

13000

13000

365500

365500

365500

365500

365500

Less: Savings

Sale of Machinery

40000

0

0

0

0

Sale of Material

90000

0

0

0

0

Other Savings

10000

10000

10000

10000

10000

225500

355500

355500

355500

355500

* The material cost is taken as 10,000 because it is 10% of total cost of material of department as whole, which is 100,000.

* The Labour cost is 20% of existing labour cost of 175,000.

* It has been mentioned that if only maintenance work is undertaken, the machinery will not be used. Therefore, it has to be sold at the market price.

* Since the option is only for maintenance, hence it is obvious that material has to be sold to be sold at the price of 600 per ton.

Appendix IV

Spreadsheet Extract

CASE IV : Manufacture only Containers

Year 1

Year 2

Year 3

Year 4

Year 5

Material Cost (Purton)

30000

30000

30000

45000

45000

Material Cost (other)

52500

52500

52500

52500

52500

Labour Cost

140000

140000

140000

140000

140000

Maintenance Cost

87500

87500

87500

87500

87500

Maintenance Cost of Machinery

6750

6750

6750

6750

6750

Other Expense

18500

18500

18500

18500

18500

Rent

7500

7500

7500

7500

7500

342750

342750

342750

357750

357750

* The material cost is taken as 30,000 for initial three years, which is its resale cost.

* The Material cost (other), Labour cost and Other expenses has been calculated by adjusting it with the amount used exclusively for maintenance.

* The other material cost

52,500 = 100,000 (total material) – 37,500(Purton)-10,000 (maintenance material)

* The Labour cost:

£140,000 = £175,000 (total labour) - £35,000 (labour on maintenance)

* The Other expenses:

£18,500 = £31,500(total other expenses) - £13,000 (other expenses on maintenance)

* There will be no saving of warehousing rent because we continue to manufacture the containers, which shall need space to store them.

References

1. Drury, C. (2004). Management and Cost Accounting. London: Thompson Learning.

2. Garrison, & Noreen, (2000). Managerial Accounting. New York: Thompson Learning.

3. Abdel-Maksoud, A., Dugdale, D. and Luther, R. (2004), “Non-financial performance measurement in manufacturing companies”, BRICMAR working paper, Bristol University, Bristol.

4. Chenhall, R. and Langfield-Smith, K. (1998b), “The relationship between strategic priorities, management techniques and management accounting: an empirical investigation using a system approach”, Accounting, Organization and Society, Vol. 23 No. 3, pp. 243-64.

5. Dana Petroleum PLC annual report 2008.

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