Incremental costing analysis, Auditing

Assignment Help:

Fleet Bhd operates a chain of high street retail outlets selling clothing and household items. In 1995, this company was heading for a financial loss and was deemed to have lost strategic direction.

The business formula that had proved successful in the 1980s and early 1990s was no longer proving effective. A new chief executive was appointed to turn the company around. He put into effect a threefold strategy. Firstly he removed levels in the hierarchy, secondly he decentralizedthe organization and thirdly he focused on the core competencies or skills of the business.

These core skills were identified as essentially buying and selling, and from this analysis the philosophy of outsourcing was developed. The argument put forward was that the core activities have to be world class and that the organization must strive to achieve this. You also need world class support, i.e. non-core activities, but this is difficult, if not impossible to achieve in-house.

This is because you need to use people who are working in the forefront, or the core, of that industry, and by definition your people are not in the forefront because it is a non-core activity. The corporate philosophy and its outsourcing implication was thus evolved in this organization with anything that was not buying and selling becoming a potential candidate for outsourcing. For example distribution has been outsourced and has been reduced in size from 250 staff to three; quality control, packaging, and design activities have followed a similar pattern. Security and cleaning are currently in the process of being outsourced.

Detail

Outsourcing was thus the overall philosophy of the company but they would not do it just for the sake of it, they still needed to be shown that, if a particular activity was outsourced, improvements would result. In relation to IT the feeling of senior management was that IT was performing reasonably well in an operational sense but not really delivering its potential for the business. The IT department are based miles away from the business, off-site and are hard to manage. They had been fully centralized and told by the previous chief executive that they were going to be the hub and key to the smooth running of the company. Arrangements for the setting up of projects with the IT department were fairly informal and projects were tending to overrun budgets.

Fleet Bhd decided to explore the possibility of outsourcing all of its IT needs. The process involved the selection of a shortlist of vendors which the company felt to be capable of handling such a contract. The company provided a brief to these four who were invited to provide an initial response.

The selected vendor, Results Bhd., was the one that was felt to best understand the philosophy and objectives of the company, especially in the area of development. Further detailed negotiations were carried out with Results Bhd. Most of the details of the company's performance requirements in IT had been defined in detail over the past three years, especially the key requirements of their stores and for buying and merchandising. The proposal from Results Bhd is for a three year initial contract at a fixed price of RM250 000 per year.  The initial response of the IT department to the possibility of outsourcing was negative. They expressed concern over the recent large investment the company had made in replacing all its computer systems, RM100 million had been spent only last year, they expected this equipment would service the company for another three years. Obviously there was deep concern over job security. Currently the IT department has ten staff earning, on average, RM30 000 per year. The vendor had agreed to take on eight of these staff maintaining the terms and conditions they held with Fleet Bhd. Of the remaining two staff one, Charles Smith, was eager to take early retirement and the other was to be retained within Fleet Bhd, at a salary of RM30 000 to assist with management of the contract. A contract manager would have to be appointed by Fleet Bhd - this would be a new appointment, the company did not currently have anyone with those skills in-house - at an estimated salary of RM50 000.

Additional information provided by the finance director

• If Charles Smith retired two years early the company would have to pay an extra RM20 000 lump sum into the pension scheme.

• The building housing the IT department was on a three year lease and the company was committed to an annual rental of RM10 000 per year for that period. This building could be sublet if IT were outsourced generating RM4 000 in the first year, RM8 000 in the second and RM10 000 in the final year of the lease.

• Current forecasts of consumables in the IT department are RM5000, RM6000 and RM7000 over the next three years.

• The resale value of the IT equipment bought last year is RM30 000.

• Annual overheads for the IT department are RM27 000 per year. 60% of the overhead varies with staff numbers, the remaining 40% is a share of central overhead charges.

Required

You have been appointed as a consultant to prepare a report analysing the outsourcing proposal, including both the financial and non-financial effects, and give your recommendations.

Your report should include the following:

1. an incremental costing analysis;

2. the effects on reported profits;

3. discussion of other factors that need to be taken into account before a decision is made;

4. recommendations with reasons;

5. an executive summary.


Related Discussions:- Incremental costing analysis

Audit risk and business risk, Audit Risk and Business Risk We saw in ea...

Audit Risk and Business Risk We saw in earlier studies that audit risk is often categorized as the product of inherent risk, control risk and detection risk. Auditors should

INTANGIBLE ASSET, problems associated with intangible asset audit

problems associated with intangible asset audit

COBIT, Analyse the ratios in conjunction with the additional information an...

Analyse the ratios in conjunction with the additional information and identify from your analysis, implications for the audit and any particular audit steps that need to be underta

Long term contracts - audit process, Long Term Contracts - Audit Process ...

Long Term Contracts - Audit Process The authoritative document with reference to long term contracts is IAS 11: Construction Contracts and IAS 18: Revenue Recognition, and ISA

Accounting principles - intangible assets, Accounting Principles - Intangib...

Accounting Principles - Intangible Assets IFRS 3 prescribes the financial reporting through an entity whenever it undertakes a business combination. A business combination is

Common stock valuation, Common stock valuation 1. Features of common st...

Common stock valuation 1. Features of common stock (You may review common stock learned from TCA 221) a. Residual claim on income and assets (after debt holders and preferre

Concept of audit evidence, Concept of Audit Evidence The auditing is a...

Concept of Audit Evidence The auditing is an evidence gathering exercise.  It is an exercise continued out to confirm the assertions made through the management in carrying ou

Advantages and disadvantages of internal audit?, Benefits of Internal Audit...

Benefits of Internal Audit are following: It is in-expensive. No charted accounted is needed to audit internally. Faults will be removed before preparing financial stateme

The business risk approach to auditing, The Business Risk Approach to Audit...

The Business Risk Approach to Auditing In recent years the broader concept of business risk has been developed by the larger firms. It was the subject matter of the ICAEW audit

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd