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 Activity cost Activity driver Quantity of activity driver
Interview salaried client $ 60,000 No. of salaried clients 8,000
Interview business client 75,000 No. of business clients 2,000
Obtain missing data 600,000 No. of follow-up calls 8,000
Input data 120,000 No. of data entries 400,000
Print return 90,000 No. of returns 10,000
Verify return with client 180,000 No. of hours 6,000
Rectify errors 90,000 No. of errors 6,000
Submit return 30,000 No. of returns 10,000
Total costs $1 245,000
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,
maximum 150 words)

Answer 1

Activity based costing (ABC) method uses activities to determine the division of cost among different products or departments. In order to calculate the cost per product by the ABC method, we need to first calculate the cost per activity driver from the data given, which is calculated ib the below table:

		A		B	C = A / B
Sr. No.	Activity	Activity Cost	Activity driver	Quantity of Activity driver	Cost per Activity driver
1	Interview salaried client	$60,000	No. of salaried clients	8,000	$7.50
2	Interview business client	$75,000	No. of business clients	2,000	$37.50
3	Obtain missing data	$600,000	No. of follow-up calls	8,000	$75.00
4	Input data	$120,000	No. of data entries	400,000	$0.30
5	Print return	$90,000	No. of returns	10,000	$9.00
6	Verify return with the client	$180,000	No. of hours	6,000	$30.00
7	Rectify errors	$90,000	No. of errors	6,000	$15.00
8	Submit returns	$30,000	No. of returns	10,000	$3.00
	Total Costs	$1,245,000

Once, the cost per activity driver is calculated for all the activities, the cost per product can be calculated by using the information relating to the quantity of activity drivers used by each product.

a) i) The calculation of cost per wage and salary tax return is calculated in the below table:

Calculating cost per Wage & Salary tax return
			A	B	C = A x B
Sr. No.	Activity	Activity driver	Quantity of Activity driver per return	Cost per Activity driver	Total cost per return
1	Interview salaried client	No. of salaried clients	1	$7.50	$7.50
2	Input data	No. of data entries	20	$0.30	$6.00
3	Print return	No. of returns	1	$9.00	$9.00
4	Verify return with the client	No. of hours	0.38	$30.00	$11.25
5	Submit returns	No. of returns	1	$3.00	$3.00
	Total				$36.75

Therefore, the cost per wage and salary tax return by using the ABC method comes to $36.75

a) ii) The calculation of cost per business tax return is calculated in the below table:

Calculating cost per Business tax return
			A	B	C = A x B
Sr. No.	Activity	Activity driver	Quantity of Activity driver	Cost per Activity driver	Total cost per return
1	Interview business client	No. of business clients	1	$37.50	$37.50
2	Obtain missing data	No. of follow-up calls	4	$75.00	$300.00
3	Input data	No. of data entries	120	$0.30	$36.00
4	Print return	No. of returns	1	$9.00	$9.00
5	Verify return with the client	No. of hours	1.50	$30.00	$45.00
6	Rectify errors	No. of errors	3	$15.00	$45.00
7	Submit returns	No. of returns	1	$3.00	$3.00
	Total				$475.50

Therefore, the cost per business tax return by using the ABC method comes to $475.50

b) The fees charged by the firm for a wage and salary tax return is $60 per return. The cost per wage and salary tax return as calculated in the above table is $36.75. Thus, it gives a profit margin of $23.25 per return for processing a wage and salary tax return, which is a margin of 38.75%. The current fees charged for wage and salary tax return provides goods profit margin to the firm. They can still reduce the fees if it helps attract more customers as there is high profit margin from wage and salary tax return.   

The fees charged by the firm for a business tax return is $300 per return. The cost per business tax return as calculated in the above table is $475.50. Thus, it shows that the firm is incurring a loss of $175.50 per business tax return. The firm should re-access the fees charged for business tax return. They cannot charge a fee which is less than $475.50 per business tax return.