Question

The Company: T&K Solutions

T&K Solutions is a boutique accounting firm offering taxation, bookkeeping and advisory services to a broad range of clients across the Brisbane and Gold Coast area. The firm was established by Terry Thompson in 1998 as a small suburban accounting firm where he offered taxation and bookkeeping services to local businesses. Terry soon developed a reputation for his expertise in taxation and his client base grew considerably.

A few years ago Terry recognised a growing need for advisory services from his clients. Sincethis was not Terry’s area of expertise he searched for a partner that could provide this service to his clients. In 2014 he met Kerry Chua who was working in consulting and advisory for one of the Big 4 accounting firms. Terry was impressed with Kerry’s skills and enthusiasm andinvited her to join him as a partner and head of the advisory service. Together, Terry and Kerry rebranded the firm to T&K Solutions. They invested heavily in advertising to promote their new service and relocated the office from the suburbs to the centre of Brisbane. All of these activities added substantial fixed costs to the business but Kerry was confident their investment would pay off.

Kerry was right. Since rebranding and relocating, T&K Solutions have tripled their billable hours by expanding their services to existing clients and attracting new ones. However, despite the success and growth in revenue, Terry remains concerned by the high amount of fixed overheads. Furthermore, the most recent profit and loss statement indicates that the bookkeeping division is losing money. Terry also feels he is losing control over the budgeting process. In the past Terry spent minimal time planning, however with the rapid growth in clients and fixed costs, Terry thinks the firm would benefit from a more thorough budgeting process using flexible budgeting to identify and manage variations between actual and expected outcomes. If only he had the spare time to devote to this!

To manage individual client accounts T&K Solutions use normal job costing. Each job is assigned actual direct labour costs (i.e. hours worked by professional staff). Indirect costs are allocated to each job using a firm-wide predetermined overhead rate allocated to each job based on the amount of billable hours. Then a profit margin of 30% is added to calculate the amount chargeable to each client. This simplistic costing system worked well when Terry was the sole partner and offered only two services. However since the expansion in service and client base, along with the increase in fixed overheads, Terry has become concerned that a single overhead rate applied equally across all services is resulting in an unequitable distribution of costs and that clients are being incorrectly invoiced.

Terry has proposed the firm review their costing process and move to an Activity Based Costing (ABC) method for allocating fixed overheads. Kerry doesn’t see any point in reviewing the costallocation basis and thinks moving to ABC costing will only add administrative time, reducing the overall profitability of the firm. Moreover she tells Terry that “ABC is only relevant to manufacturing companies and has no benefit to a service firm such as T&K Solutions”.

Question

whether you think Terry and Kerry should continue to operate or drop the bookkeeping service. Analysing should include reference to your calculations from above as well as any relevant qualitative factors that T&K should consider before deciding whether to continue or drop bookkeeping services ?limited 250 words?.

DATA FOR TASK A:	2017 Profit and Loss Statement for T&K Solutions:	?	?	?	?
?	Taxation	Bookkeeping	Advisory	Total	?
?	$	$	$	$	?
Revenue	800,000	195,000	950,000	1,945,000	?
Less:  Costs	?	?	?	?	?
- Partner Salary	75,000	75,000	150,000	300,000	?
- Professional Staff Costs	320,000	120,000	400,000	840,000	?
- Office Staff	45,000	45,000	45,000	135,000	?
- Client travel costs	25,000	5,000	52,000	82,000	?
- IT Support	5,000	3,000	9,000	17,000	?
- Printing & Stationary	8,000	3,200	11,000	22,200	?
- Advertising	8,000	8,000	8,000	24,000	?
- Rent	16,000	16,000	16,000	48,000	?
- Utilities	8,000	8,000	8,000	24,000	?
- Depreciation	5,000	5,000	5,000	15,000	?
- Bad debts	2,000	3,000	-	5,000	?
Net Profit	283,000	-96,200	246,000	432,800	?
ADDITIONAL INFORMATION:	?	?	?	?	?
Partner Wages	Terry and Kerry are both paid a salary of $150k pa. Terry's salary is spread between Tax & Bookkeeping. Kerry's salary is charged to Advisory
Professional Staff	Professional Staff are paid $80k per full-time equivelent (FTE). Tax has 4 professional staff , Advisory has 5 professional staff and Bookkeeping has 3 part time staff who each work  0.5 of a FTE. If bookeeping was to close, these staff would no longer be required.
Office Support Staff	The firm has 3 office support staff each paid $45k per year. Currently their costs are spread evenly between the 3 service units. It is expected that if bookkeeping was to close there would be no change to the support staff.
Client Travel Costs	Client travel costs vary depending on the service and client needs.
IT support	IT support costs vary with the associated service unit.
Printing & Stationary	Printing and stationary costs vary depending on the client needs and service performed.
Advertising	Advertising costs are alloacted evenly across the firm. However, if bookkeeping was to close it is expected advertising costs would only reduce by 10% in total.
Rent & Utilities	Rent and Utilities are currently spread evenly across the 3 service units.  If bookkeeping was to close the additional floor space would be absorbed by the remaining services and there would be no savings in utilitity costs.
Deprectiation	Depreciation relates to shared office equipment and is charged evenly across each service unit. If bookkeeping was to close all existing equipment would remain.
Bad debts	Bad debts relate specifically to clients within that service unit.

TASK A SCHEDULE 1:	2017 Profit & Loss - If T&K Drop Bookkeeping	?	?	?
?	Taxation	Bookkeeping	Business Advisory	Total
?	$'000	$'000	$'000	$'000
Revenue	800,000	-	950,000	?
Less:  Costs	?	?	?	?
- Partner Salary	75,000	75,000	150,000	300,000
- Professional Staff Costs	320,000	-	400,000	720,000
- Office Staff	45,000	45,000	45,000	135,000
- Client travel costs	25,000	-	52,000	77,000
- IT Support	5,000	-	9,000	14,000
- Printing & Stationary	8,000	-	11,000	19,000
- Advertising	7,200	7,200	7,200	21,600
- Rent	16,000	16,000	16,000	48,000
- Utilities	8,000	8,000	8,000	24,000
- Depreciation	5,000	5,000	5,000	15,000
- Bad debts	2,000	-	-	2,000
?	?	?	?	?
Net Profit	$283,800.0	-$156,200.0	$246,800.0	$374,400.0
?	?	?	net profit of last year	$432,800.0
If bookkeeping was closed, the net change in profit for T&K solutions would be :				-$58,400

Answer 1

2017 Profit & Loss - If T&K Drop Bookkeeping	Taxation	Business Advisory	Total	Analysis
	$'000	$'000	$'000
Revenue	800,000	950,000	1,750,000	-195,000	Loss of Revenue
Less:  Costs		?	?
- Partner Salary	150,000	150,000	300,000	0	Remains same
- Professional Staff Costs	320,000	400,000	720,000	120,000	Avoidable costs
- Office Staff	67,500	67,500	135,000	0	Remains same
- Client travel costs	25,000	52,000	77,000	5,000	Avoidable costs
- IT Support	5,000	9,000	14,000	3,000	Avoidable costs
- Printing & Stationary	8,000	11,000	19,000	3,200	Avoidable costs
- Advertising(24000*(1-0.10)/2)	10,800	10,800	21,600	2,400	Avoidable costs
- Rent	24,000	24,000	48,000	0	Remains same
- Utilities	12,000	12,000	24,000	0	Remains same
- Depreciation	7,500	7,500	15,000	0	Remains same
- Bad debts	2,000	0	2,000	3,000	Avoidable costs
Total expenses	631,800	743,800	1,375,600	136,600	Avoidable costs
Net Profit	168,200	206,200	374,400	-58,400	Net loss of revenue
If bookkeeping was closed, the net change in profit for T&K solutions would be : (374400-432800)=				($58,400)

As seen from the above analysis column, closing the book-keeping division, results in net loss of revenue to the extent of $ 58400 , as costs saved is less the revenue lost.
Also, it is to be studied if, there will be continuous clientele for taxation & advisory services.
Basing allocation of fixed Ohs on the basis of activity metric,ie total hrs. spent for clients will provide more accuracy in their allocation, rather than equal allocation.

Currently, it is advisable to continue with the Book-Keeping division.

Referring to the analysis column--

Avoidable costs can be avoided , if the division is closed.

The below-mentioned costs need to be incurred irrespective of whether the book-keeping division is continued or not:

Partner salary

Support-staff salary

Rent

Utilities

Depreciation

The revenues from the book-keeping division, contributes to meeting its share of these costs , which when closed down, eats into the profits of the remaining divisions

The profits of these 2 divisions which was previously 283000+246000=529000 comes down to 168200+206200=374400, when the book-keeping is closed.

Thus, as long as the book-keeping's revenues contribute to some portions of the overall fixed overheads, it is not advisable to close the division, so as not to burden the profitability of the remaining divisions.

Thinking Qualitatively,

Some percentage of clients who come for book-keeping services, may bring in tax & advisory business also-- which may be lost ,if the former is closed down.

The company may try to break down the activities as per ABC system of costing ---and charge fixed costs on the basis of the various activities involved & attribute costs according to the pertinent time taken .by the individual activity ,in different divisions-- so that profitabilities of the 3 divisions can be assessed more accurately---- that may ,perhaps,turn the tables about the book-keeping division's profitability.