Free Custom «Korean Auto Insurance» Essay Paper

1. What would be the net income of the Taejon branch as of 2007 and 2008 if the headquarters’ overhead costs were allocated by the current method? Calculate the amounts of revenue and direct and indirect costs of the Taejon branch for these two years.

Determination of the net income for Taejon branch.

Income statement for Taejon branch

2007 2008

Total revenue for Taejon branch 23.6 33.2

Direct costs 12.6 17.7

Indirect costs 23.6/203.5 (73) 8.5 33.2/227.8 (89.4) 13.0

Total cost (21.1) (30.7)

Net income 2.5 2.5

Note: in millions of dollars

1. The current overhead cost driver, branch revenue, is criticized because it lacks any logical relationship to the overhead costs allocated by headquarters. Choose more appropriate cost drivers for the 17 overhead costs listed in case Exhibit 3. You may refer to descriptions of the 17 overhead costs incurred by the five teams at the headquarters.

Cost drivers are activities that cause costs to be incurred and thus a more appropriate method that allocates costs to the cost drivers is necessary for this case. This method is referred to as the activity based costing method which states that products consume activities whereas the activities consume resources. These activities are the cost drivers and are not based on the volume of production.

Appropriate cost drivers for the 17 overhead costs in the case exhibit 3 would therefore be:

1. Using your cost drivers from (2) above, compute the net income of the Taejon branch as of 2007 and 2008. Compare your answer to the amount from (1). Do you agree that Kim’s performance in 2008 would now be evaluated more properly? Why or why not?

Computation of overhead absorption rate:

Cost Pool activities 2007 2008

Branch PC maintenance 5.3 /522=0.010/PC Unit 4.8/589=0.008/PC Unit

Headquarters IT system support 3.6/522=0.007/PC Unit 7.7/589=0.013/PC Unit

Branch IT system support 5.1/522=0.010/PC Unit 7.6/589=0.013/PC Unit

Employee training 4.4/1098=0.004/employee 4.2/1203=0.003/employee

Training of sales people 5.3/412=0.013/sales person 7.1/508=0.014/sales person

Operating performance evaluation & reporting 1.1/10=0.110/branch 0.7/10=0.070/branch

Handling traffic accident cases 11.7/512=0.023/accident 16.4/531=0.031/accident

Equity investment 7.4/203.5=0.036 7.6/227.8=0.033

Debt investment 3.6/203.5=0.018 4.2/227.8=0.018

Investment performance evaluation & reporting 0.8/203.5 =0.004 0.7/227.8=0.003

Advertisement 7.9/10=0.790/branch 8.9/10=0.890/branch

New product/new channel development 2.1/10=0.210/branch 3.8/10=0.380/branch

Payroll administration 1.6/1098=0.001/employee 1.4/1203=0.001/employee

Performance evaluation 1.7/1098=0.002/employee 1.9/1203=0.002/employee

Education & training 4.5/1098=0.004/employee 5.1/1203=0.004/employee

Headquarters building maintenance 2.3/10=0.230/branch 2.5/10=0.250/branch

Branch building maintenance 4.6/1098=0.004/employee 4.8/1203=0.004/employee

Note: in millions of dollars

Determination of overhead costs

2007

IT team 41(0.010+0.007+0.010) +82x0.004=1.435

OS team 27x0.013 + 0.110x1 + 54x 0.023 = 1.703

Investment team 23.6 (0.036+ 0.018+ 0.004) = 1.334

Marketing team 1(0.790+ 0.210) = 1.000

GA team 82(0.001+0.002+0.004+0.004)+ 0.230x1=1.132

Total cost = 6.604

Note: in millions of dollars

IT team 41(0.008+0.013+0.013) +82x0.003=1.640

OS team 27x0.014 + 0.170x1 + 54x 0.031 = 2.222

Investment team 23.6 (0.033+ 0.018+ 0.003) = 1.274

Marketing team 1(0.890+ 0.380) = 1.270

GA team 82(0.001+0.002+0.004+0.004)+ 0.250x1=1.152

Total cost = 7.558

Note: In millions of dollars

IT stands for information technology, OS stands for operating system and GA stands for general administrative.

Income statement 2007 2008

Revenue 23.6 33.2

Direct costs 12.6 17.7

Overhead costs 6.6 (19.2) 7.6 (25.3)

Net income 4.4 7.9

Note: in millions of dollars

Compared to (1), there is a difference in net income with 57% in 2007 and 32% in 2008. Besides, indirect costs in (1) are higher than in this case. This is because of the use of cost drivers in cost allocation which is a more efficient way of cost allocation.

(i) I do agree that Kim’s performance in 2008 would now be evaluated more properly. This is because the activity based costing method measures product costs and profitability more realistically, and thus it’s more efficient in controlling activities. Besides, this method gives a better insight into what drives overhead costs. Moreover, it recognizes that overhead costs are not all related to revenue and that overhead costs are a significant proportion of total costs and can be controlled by managing cost drivers.

Which cost drivers make the biggest differences between the net incomes of (1) and (3)? Do these cost drivers have anything to do with Kim’s effort in 2008?

The cost drivers making the biggest differences in the net incomes of (1) and (3) are:

The number of employees, number of accidents and revenues amount

These two cost drivers were influenced by Kim in 2008 thus increasing the net income from 4.4 million dollars in 2007 to 7.9 million dollars in 2008. Basically, Kim reduced the number of employees from 82 on 2007 to 45 in 2008, thus cutting down overhead costs. Additionally, due to Kims efforts to reduce the number of accidents through public relations and campaigns throughout 2008, and de-marketing to lessen the number of high-risk customers, accident costs reduced thus high revenues realized. Moreover, during Kims management in Taejon, insurance revenue increased contributing to increased total revenue.