Question

Henganofi Corporation was a company that grew from humble beginnings. Its original shareholders consisted of a collection of village cooperatives in the Eastern Highlands of Papua New Guinea. Their main source of income was from growing coffee on their small plots of land. Coffee prices were very high in the 70’s and 80’s, which led this company to expand their business interests significantly to include the following: poultry farming, coffee processing, coffee exporting, a printing press, bulk fuel distributorship, fuel service stations, a mechanical workshop, paper packaging manufacturing, and plantation management services.

The Managing Director Pieter Knol originally came from Europe as a volunteer with the village cooperatives, and was integral to the growth of the business entity from cooperatives to a corporation. “Accounting records” consisted of a multi-column cashbook and a “journal” containing narratives of non-cash transactions. Money in the bank account was interpreted as a good state of financial ‘health’ , and during tougher times, low-interest government-backed loans were easily accessible via the many development banks that were set up to encourage local businesses during that era.

Zeke Anthony, a chartered accountant has been employed by Henganofi Corporation to spruce up the accounting records and overall management process, and after a prolonged analysis and study of the various business interests of the company, Zeke decided to engage the assistance of a former colleague Rob Barlow, to help with this task.

Required: In your role as Zeke Anthony, you have flagged the following two issues of concern that you intend to bring to the attention of Pieter Knol, and the Board of Directors.

Issue 2:  Since the business was started, Pieter Knol based his decisions about potential investments solely on one criteria: what interested the major shareholders and his own personal preferences.

Zeke and Rob have strong reasons to believe that such a criteria for committing valuable and scarce resources, together with a lack of understanding of the true relationship between business activity levels and how much impact levels of activities have on cost (cost behaviour) will eventually lead to the financial downfall of Henganofi Corporation.

In your report to Pieter Knol:

1. Clearly demonstrate the benefits that will be gained from understanding cost behavior, and briefly explain two (2) often-used approaches to obtain a cost formula.

2. (b) Describe in general, some of the common problems faced in the process of collecting information for analysis.

Answer 1

a. Understanding cost behavior means understanding the changes in cost due to changes in the activities carried out by an organization. By understanding the cost behavior, following benefits shall accrue:

1. It helps managers to analyze whether a potential investment is fruitful for the organization or not, whether it is adding value to the organization or not.

2. It provides information about the areas where cost can be saved.

3. Marginal Cost analysis can be done whereby managers can estimate the additional cost due to additional business undertaken and thereby assess the benefits due to economies of scale.

4. This helps to analyze variances in future and control costs thereby,

Two often used approaches to obtain a cost formula:

1. Marginal Costing: This approach focuses only on the additional costs which will be incurred because of the additional activities or business or volumes.

2. Standard Costing: Under this approach, the cost of the product or output is pre-determined based on the past trends plus/minus the effects of the current period changes.

b. Some of the problems faced in the process of collecting information for analysis:

1. The person who is responsible for collecting information lacks knowledge.

2. The data/information may be inadequate or incomplete.

3. Some unnecessary assumptions might have been taken while collecting information.

4. Information is available only for latest period and not for all the historical periods.