Question

Week 5

Mel Snow is the manager of a firm, Taxation Matters, which specialises in the preparation of income tax returns. The firm offers two basic products: the preparation of income tax returns for wage and salary earners, and the preparation of income tax returns for small businesses. Any clients requiring more complex services are referred to Snow’s brother Roger, who is a partner in a large firm of chartered accountants.

The processing of wage and salary tax returns is quite straightforward, and the firm uses a software package to process data and print the return. A software package is also used to prepare returns for small businesses, although more information is required, particularly about business expenses.

Snow has only recently joined Taxation Matters and he is concerned about the firm’s pricing policy, which sets flat fees of $60 per return for wage and salary clients and $300 for small businesses. He decides to use activity-based costing to estimate the costs of providing each of these services.

At the end of the year, Snow reviewed the firm’s total costs and activities, resulting in the following list:

Activity

Interview salaried client Interview business client Obtain missing data Input data

Print return

Verify return with client Rectify errors

Submit return

Total costs

Activity cost

$ 60,000 75,000 600,000 120,000 90,000 180,000 90,000

30,000

$1 245,000

Activity driver

No. of salaried clients No. of business clients No. of follow-up calls No. of data entries No. of returns

No. of hours No. of errors No. of returns

Quantity of activity driver

8,000 2,000 8,000 400,000 10,000 6,000 6,000 10,000

In identifying the activities required for each type of return, Snow noted the following:

Clients are interviewed only once per return.

 All follow-up calls to obtain missing data relate to business returns; on average, each business tax

return requires four follow-up calls.

 Processing a wage and salary tax return requires 20 data entries, whereas a business return

requires 120 data entries.

 On average, it takes 22.5 minutes to verify a wage and salary tax return, whereas it takes one and

a half hours to verify a business return.

 All errors relate to business returns; on average, there are 3 errors per business return.

Required:

a) Use activity-based costing to estimate the cost of preparing:

i A wage and salary tax return.

ii A business tax return.

b) In the light of your answers to requirement 1, evaluate the firm’s pricing policy. (3 marks,

Answer 1

Activity	Activity cost ($)
Interview salaried client	60,000
Interview business client	75,000
Obtain missing data	600,000
Input data	120,000
Print return	90,000
Verify return with client	180,000
Rectify errors	90,000
Submit return	30,000
Total costs	1 245,000

Activity driver	Quantity of activity driver
No. of salaried clients	8,000
No. of business clients	2,000
No. of follow-up calls	8,000
No. of data entries	400,000
No. of returns	10,000
No. of hours	6,000
No. of errors	6,000
No. of returns	10,000

a)

(i) Wage & salary tax return

Details	Per Return($)	Amount($)
Interview Cost	60000/8000 =7.5	60,000
Input Data	120000/400000*20 =6	6*8000 =48000
Verify return with client 6000hours=360000 minutes	180000/360000*22.5 =11.25	11.25*8000 =90000
Print return	72000/8000 =9	90000*8000/10000 =72000
Submit return	24000/8000 =3	30000*8000/10000 =24000
TOTAL	36.75	294000

(ii)Busuness tax return

Details	Per return($)	Total Amount($)
Interview business client	75000/2000 =37.5	75,000
Obtaining missing Data(by Follow up calls)	600000/2000 =300	600,000
Input Data	120000/400000*120 =36	36*2000 =72000
Verify return with client 6000hours=360000 minutes	180000/360000*90 =45	45*2000 =90000
Rectify errors	90000/2000 =45	90,000
Print return	18000/2000 =9	90000*2000/10000 =18000
Submit return	6000/2000 =3	30000*2000/10000 =6000
TOTAL	475.5	951000

b) The firm currently uses a Flat Rate Pricing Policy, a policy that sets flat fees of $60 per return for wage and salary clients and $300 for small businesses. This type of pricing policy is usually good for manufacturing organizations, rather than an organization providing service. Usage of Flat Rate Pricing Policy in business providing services can only be used if the type of service provided is the same to each and every customer.

In the given case, the firm provides the service of preparation and submission of the tax returns of the clients. Such a service requires different activities for different types of clients. As given in the question, there are 2 different types of clients. The wage and salary type of tax returns are comparatively easy and require fewer activities than the tax returns of businesses. The same is the reason why both types of returns re given different Flat Rate fee.

But after calculating the costs of both the returns by using activity-based costing, it is clear that the cost of the Business return is way more than the actual fee charged from the client such difference is of $175.5(475.5-300)

This means that no matter the total cost and revenue will remain the same but the accounting of such costs and revenue in the business type of return will always show a loss.

Hence the existing Pricing Policy of the firm is not correct. Rather, the best method in such situation is the Cost plus Margin method of Pricing.