PROFESSIONAL MBA WEEKEND DELIVERY
Company presentation
Established in Albacina, Italy in 1930, Merloni TermoSanitari S.p.A.-MTS is a leading global provider of water heaters, boilers, burners, and related components. Major brands include Ariston,Chaffoteaux & Maury and Thermowatt..
MTS Group, with a turnover of over € 1 billion euros, employs 7100 people worldwide and manufactures 5.6 million products annually.
With 19 brands and 20 manufacturing units worldwide it has a global presence 424r1716e in over 150 countries. The MTS Group operates through 6 product lines namely; boilers - water heaters - air conditioners - burners – services - electric and electronic components.
The mission of the company is to improve the quality of people’s life at a global level allowing them to enjoy an accessible confort. The objective is to obtain constantly the recognision of being a worldwide leader in what the confort of the home is concerned.
„Merloni is the most global company in the heating sector
80% turnover from outside Italy
24 factories in countries
47 subsidiaries in countries
150 countries with sales network
Leader in key emerging markets (China, India, Vietnam, Russia)
Leading position in mature markets”
In Romania, the company is distributing water heaters, burners and air conditioning from the brands of Ariston, Chafoteaux & Maury, Radi, Simat and Sitam.
By its main 5 marks ARISTON, CHAFFOTEAUX & MAURY, Radi, Simat and Sitam, at which there are added 5 services, make in Italy 35% of the groups turnover.
The Italian company has 6 big plants that produce both for the Italian market as well as for the foreign ones. These plants, due to continuous investments in research and development have reached a high degree of automatization.
Merloni produces equipments of highly advanced technology, realised with superior quality materials, made to last in time and bring more utility and confort in the home of the clients.
The company also offers a complex range of services having as purpose the information and the upgrading of installer’s knowledge, of the sellers and the professionals in the area, trying to achieve with them a strong partnership that has as a common goal: the satisfaction of the customer.
Merloni has branches all over the world. The company also acquired other companies or merged with them. The foreign companies were not totally englobed in the mother company, but mostly managed as separate companies with their own accounting and operations, as well as with separate results.
The companies were however linked to the other companies inside the group. Only a few of the companies have plants while others only deal in reselling or only in services. The ones that do not produce buy products from the companies that have plants and resell them on their home market, also insurinng the necessary after sale support.
„ Costs represent money measurements of the efforts that an organisation has to make in order to achieve objectives. Consequently, costs play a very importanty decision in management decision making.”
Each company is interested in keeping a record of all the various movements it is making. The cots present a particular importance for a company as they show how resources available to the company are being used. When comparing costs to revenues we can also see the efficiency of a company’s activity and determine its profits.
The costs allow a company to calculate its entire expense, but also its costs per product or activity.
MTS is a relatively big group with various businesses and products. These aspects had to be considered when deciding upon a costing system that would fairly and efficiently reflect the costs incurred by the company.
On the other hand the company has evolved during time and it has changed and innovated production and servicing technology.
The company has chosen to use the Activity Based Costing, as it reflected the newest and most efficient way to calculate costs and it is an attempt to apply costs to the activities which cause them.
A company is particulary suited for the use of ABC if:
the company produces a wide variety of tailor made products or serviceswhich are targeted at different market segments,
the company has high overhead costs that are not proportional to the unit volume of individual products
the company has a highly automated system”
Our company is a producer of a vast range of products, water heaters, boilers, burners, and related components, and for each of the products it has also a variety of models, from cheaper to more expensive ones, from more simple to more complex ones.
The company has high overheads as it does not produce only the heaters, but it also transports them to buyers, services them during their life time, transports them and their components across Europe, from countries where they produce them to the final selling point. MTS has its own selling points, but relies mostly on specialised domestic appliances stores.
MTS has highly automated plants that allow complex products to be built and put together in ordre to obtain their high quality. Also, in 2001 it introduced an information system that related all the parts of the company.
So, MTS is highly suited for an ABC costing system and this is the one that will beneficiate it mostly.
The company looks at costs in terms of long and short term, and takes decisions on a longer period of time, starting from one year.
During the increase of the company its complexity also increased. The costs are now varying more in accordance with this complexibility of the company and the activities and not necessarily with volume.
When costs are allocated on a volume base, products with the highest output will have allocated the biggest costs. This might not always be corect as smaller volumes might take a lot more time and costs, but will only be allcated a small part of the suuport costs.
One of the most used as basis for absorbtion are the labour hours, even if for some products this represents only a small amount of the total cost.
„ Direct labour and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources differently, some sort of weighting is needed in the cost allocation process. The measure of the use of a shared activity by each of the products is known as the cost driver”
So, whenever direct labour and materials are used to produce the company knows how o allocate them to the products it is manufacturing. In the case of waterheaters, boilers and burners the company can calculate the material cost by presenting in detail the components of each product, in this way finding aut how much of each component was used. For exemple in a water heater there enters steel, paint, electric circuits.
In what the labour costs are concerned it is enough to know how many of each type of water heater was produced per day and how manyworking hours were spend during the day to calculate proportionaly on each type of product.
The problem of calculating the costs rises when other spendings are incurred, such as administrative salaries.
The basic premise of the ABC system is that activities consume resources and products consume activities. ABC assumes that it is activities which cause cost, not products.”
Activity cost centers are assigned to each type of product by using cost drivers. In our company the production overheads are allocated based on specific criteria calculated by the company. These criteria are the ones that allocate costs to the normal capacity of production facilities. For example we have a pool of selling costs which pool to the selling activity. This activity is incurred to a certain percentage for every category of product. Or we have a certain amount of transportation costs as related to the transport activity, this impacting by a predetermined weight each product.
Our company adds up the costs incurred by each activity by using cost centers and then assign these pools of costs to each product or service produced.
Let us take per exemple the transportation costs. There is transport for raw materials, production not finalised and marchandise. Each of them has a cost center that the cost incurred is allocated to. After allocating the total monthly or yearly cost to these cost centers, each of them will be allocated further. Transport for finished goods will be allocated to the total of goods, per each category transported, the cost for raw materials to raw materials and so on.
Another exemple might be the costs incurred by the company’s tehnicians with their transportation, such as car lease and carburant. Each tehnicien or group of tehniciens has a cost center as depending to the type of product he services. Than, after the costs pool in the cost center, they are allocated to each product produced. These are considered as product costs when the product in in guarantee, which has one account and when they no longer are in guarantee. The product in guarantee costs are allocated to products based on a percentage of machines expected to be broken and on each type of machine. The other ones are allocated to services based on number of re[arations made.
„The cost driver is that action or transaction or transaction that results in costs being incurred. In many instances the cost driver will be measured in terms of volume of transactions under-taken.”
Such is the case also for our company as presented in the example presented above. Each of the cost centers has its own cost driver, the costs incurred being allocated differently to products or services. This is a positive aspect of the Activity Based Costing system, as it increases its accuracy of calculating product and services costing.
Each of the activities has allocated to it the respective costs, the cost drivers to allocate them to products being different for each of the items produced, being products or services.
The cost centers for the activities, the ones that pool all the costs to allocate down to products must be kept under control. It is an important thing because this way the company can keep the costs of goods under control and calculate a future profit.
„ It is necessary to be able to set targets and then be able to compare performance accurately against them. Without this process it is impossible to determine whether the business is functioning properly. In addition, where differences do occur it is possible to investigate them and take remedial action. Budgetary control involves everyone in the organisation and it is therefore an excellent way of communicating and ensuring they are aware of what is expected.
The company in this way sets targets based on the history and on the expected results to be obtained. The people in charge carefully follow the budget during the entire year, carefully adapting it quarterly to the changes that occur. This way they try to achieve the objectives of the company.
In our company the costs pooled in cost centers are only the ones for services, leading to service cost centers. Service cost centers accunulate for our company both prime costs as well as overheads.
„ Companies are able to monitor their sales performance, expenditure levels, capital expenditure projects, cash flow, and asset and liability levels. Corrective action will be taken to reduce the impact of adverse trends.”
Budgets give companies an estimate of the activity over a certain period of time. Usually budgets are pretty accurate and the reasons for non-confirmity of the cost centers must be very well checked. This instruments insures a fair amount of costs to be incurred in the period of production and not in a future period.
The moment of incurring the cost is also an important aspect. We want our products from february to cost as much as we spent in february and not incurr costs from january or march. Also a product should have aproximately the same cost during a year, changes in the costs being justified only by big events such as energy cost or water cost increase.
This is why budget can be used in checking the costs on every account and cost center. When costs are within the sums allocated, with very little differences, things are good.
The problem arises when the costs depass the budget or are below it. In this situation costs are carefully checked. The mistake that might arise are from costs previously incurred but accounted only in this period. Under these circumstances there is nothing more to be done. The previous products’ costs have been underevaluated. The other case is when costs are future to the production moment. These costs must absolutely be registered to the cost centers in the future moments and impact future production.
Whithout a budget there would be very hard to check and avoid the mistakes of costs incurring time.
Documents that are used to track the flow of activities and costs include the sales order, purchase request, receiving report, vendor’s invoice, shipping document. These are the documents the company relies on to register costs. The problem that appears is that accounting departments do not have access to all of them, but mostly to invoices, that have a delay in arriving. This is why the responsible with the budget must make the connection between the documentation and the costs. The costs that the accountants are not aware of are checked and accrued at the indications of the budget controller.
This is a sensitive operation and responsibles must be careful not to increase the costs of a certain period without a reason, as they can impact the final result negatively.
Another measure of control is appointing cost centers responsibles. These people ae in our company in charge with approving acquisitions. Or they are very careful or even reluctant in signing any more orders if there has been a budget depass. They are the ones that everyone asks about the differences with the budget, as they are in direct relation with the suppliers. The responsibles usually know if prices have increased and at which services.
It is the budget that influences the cost behaviour, pricing strategies, testing product or department economic viability, production plan, make or buy decisions.
The budget influences all the above by giving the guidelines to which every responsible must stick to. This makes the responsibles realise that resources are limited and they must use hem efficiently in order to achieve the objective of the company. They must always be very careful in assesing the products of what they buy and the costs they inccur, in order to avoid to depass the budget, or, if this happens to have very good reasons for doing so.
Also the behaviour is influenced by the amounts budgeted, in the sense that a too little amount of money for research must cost in the long term a company its strategic advantage. This is why the amounts must be big enough to allow a normal activity but small enough to prevent ressources waist.
The activity based costing is an improvement in allocating costs as compared to the theories developped before. However there are also some inconvenients of this theory.
Although activity based costing is a more accurate method of allocating costs, its major weakness lies in its complexity. You need a considerable amount of information before activity based costing can apply. For instance, we needed to know the number of orders, the components produced, the components inspected, etc. All this information may be difficult to obtain and may also be inaccurate. The result is that costs may be apportioned on an incorrect basis. It is likely that only large companies will resort to activity based costing techniques.”
There is a lot of information to be processed inside MTS and it is very important to store it in the right way.
MTS has a long experience in what costs are concerned, as it has been on the market since 1930. This allowed the company to set a standard cost and a standard of calculating it. The company also beneficiated of the implementation of a centralised informational system in the scope of improving is performance.
However the company must insure that the people that input information into the system are well trained and understand the effects of their actions. It is very easy to put less material at the same cost, or to input the wrong cost center in the system This changes absolutely the entire calculation. The effect of only one mistake can multiply over the time and increase its impact.
What should be put into place is also a control at the first level of activity and not only at the level of cost centers. Each of the people that order services should check if at the end of the month the costs incurred per activity and cost center are correct.
Even in activity-based costing, some overhead costs are difficult to assign to products and customers, for example the chief executive's salary. These costs are termed 'business sustaining' and are not assigned to products and customers because there is no meaningful method. „
There are indeed difficult costs to assign, the allocation of which the company must decide upon arbitrary. However when deciding this the company must take into account also the mistakes that such a allocation might induce and take them into account at the final cost calculation and its interpretation.
Merloni TermoSanitari S.p.A.-MTS is a leading global provider of water heaters, boilers, burners, and related components.
With 19 brands and 20 manufacturing units worldwide it has a global presence in over 150 countries.
The company has chosen to use the Activity Based Costing, as it reflected the newest and most efficient way to calculate costs and it is an attempt to apply costs to the activities which cause them.
The ABC system seems aappropriate due to the size and complexity of the business.
Activity cost centers are assigned to each type of product by using cost drivers. In MTS the production overheads are allocated based on specific criteria calculated by the company.
Activity cost centers are assigned to each type of product by using cost drivers. In our company the production overheads are allocated based on specific criteria calculated by the company.
The cost centers for the activities, the ones that pool all the costs to allocate down to products must be kept under control and this is made by making a budget.
It is the budget that influences the cost behaviour, pricing strategies, testing product or department economic viability, production plan, make or buy decisions.
The major weakness of the ABC system lies in its complexity. You need a considerable amount of information before activity based costing can apply and this information must be accurate.
This is why the company must insure that the people that input information into the system are well trained and understand the effects of their actions on the final results. This should be backed by an extra check of the information by people directly involved in the purchase of services.
1. Managerial Accounting-study manual
2. en.wikipedia.org/wiki/Activity-based_costing
Accounting Theory and Practice, MWE Glautier, Prentice Hall, 2001
4. Class notes
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