Harvard Case - Paratent Event Rentals Ltd.: The Job Costing Decision
"Paratent Event Rentals Ltd.: The Job Costing Decision" Harvard business case study is written by Matthew Sooy, Anthony Mastromarini. It deals with the challenges in the field of Accounting. The case study is 9 page(s) long and it was first published on : Feb 8, 2022
At Fern Fort University, we recommend that Paratent Event Rentals Ltd. implement an activity-based costing (ABC) system to improve its cost accounting and decision-making processes. This will enable the company to accurately allocate costs to individual jobs, enhancing profitability and allowing for more effective pricing strategies.
2. Background
Paratent Event Rentals Ltd. is a successful company specializing in providing tents, tables, chairs, and other event equipment rentals. The company is facing challenges with its current cost accounting system, a traditional job costing approach, which struggles to accurately capture the full range of costs associated with individual jobs. This leads to inaccurate pricing, difficulty in identifying profitable and unprofitable jobs, and limited ability to make informed decisions regarding resource allocation and pricing strategies.
The main protagonists in this case are the company's owner, Michael Parat, and his financial manager, Sarah Jones. Michael is concerned about the company's profitability and is seeking ways to improve its cost accounting system. Sarah is tasked with researching and implementing a new system that addresses the company's needs.
3. Analysis of the Case Study
The case study highlights several key issues:
- Inaccurate Cost Allocation: The current job costing system fails to account for indirect costs, such as delivery, setup, and cleanup, which are significant components of the total cost of a job. This leads to underpricing, potentially resulting in unprofitable jobs.
- Limited Decision-Making Support: The lack of accurate cost information hampers decision-making regarding pricing, resource allocation, and customer selection.
- Missed Profitability Opportunities: The inability to accurately track costs prevents Paratent from identifying high-profit jobs and focusing resources on those opportunities.
- Competitive Pressure: The growing event rental market necessitates a more sophisticated approach to cost management and pricing to remain competitive.
To address these issues, we recommend adopting an activity-based costing (ABC) system. ABC is a more comprehensive approach to cost accounting that allocates costs based on the activities that drive them. This allows for a more accurate and detailed understanding of the true cost of each job.
4. Recommendations
Paratent should implement an ABC system that includes the following steps:
- Identify Cost Drivers: Identify the activities that drive costs in the event rental business, such as delivery, setup, cleanup, and customer service.
- Allocate Costs to Activities: Allocate indirect costs to the identified activities based on their usage. For example, delivery costs could be allocated based on the distance traveled, and setup costs based on the number of hours required.
- Calculate Activity Rates: Calculate the cost per unit of activity, such as cost per mile for delivery or cost per hour for setup.
- Assign Costs to Jobs: Assign costs to individual jobs based on the activities performed and the activity rates.
5. Basis of Recommendations
This recommendation considers the following factors:
- Core Competencies and Consistency with Mission: The ABC system aligns with Paratent's mission of providing high-quality event rental services at competitive prices by ensuring accurate cost allocation and informed decision-making.
- External Customers and Internal Clients: The ABC system benefits external customers by ensuring fair pricing and internal clients (management) by providing accurate cost information for decision-making.
- Competitors: Implementing an ABC system positions Paratent to compete effectively in the growing event rental market by enabling accurate cost analysis and pricing strategies.
- Attractiveness ' Quantitative Measures: The ABC system is expected to improve profitability by identifying and eliminating unprofitable jobs, optimizing resource allocation, and supporting more accurate pricing.
6. Conclusion
Implementing an activity-based costing system is essential for Paratent Event Rentals Ltd. to improve its cost accounting, enhance decision-making, and maintain its competitive edge in the event rental market. The ABC system will provide a more accurate picture of the true cost of each job, enabling the company to make informed decisions regarding pricing, resource allocation, and customer selection.
7. Discussion
Alternative options to ABC include:
- Continuing with the current job costing system: This option carries the risk of continued inaccurate cost allocation, underpricing, and limited decision-making support.
- Implementing a simplified costing system: This option might be less expensive to implement than ABC but could still result in inaccurate cost allocation and limited decision-making support.
Key assumptions of the ABC implementation include:
- Accurate identification of cost drivers: The success of the ABC system depends on accurately identifying the activities that drive costs.
- Accurate allocation of costs to activities: The allocation of costs to activities must be based on reliable data and sound judgment.
- Management commitment to using the ABC system: Management must be committed to using the ABC system for decision-making and not reverting to old habits.
8. Next Steps
To implement the ABC system, Paratent should take the following steps:
- Develop a detailed implementation plan: This plan should outline the steps involved, timelines, and resources required.
- Train employees on the ABC system: Ensure that employees understand the new system and how to use it.
- Pilot test the ABC system: Implement the system on a small scale before rolling it out company-wide.
- Monitor and evaluate the ABC system: Regularly monitor the system's performance and make adjustments as needed.
By taking these steps, Paratent can successfully implement an ABC system that will improve its cost accounting, enhance decision-making, and drive profitability.
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Case Description
In 2019, Paratent Event Rentals Ltd. was facing the possibility of year end net losses. The co-owners of this Canadian business had recently invested in premium inventory, but a lackluster first quarter showed that they were not forecasted to get return on their investments. A new method of cost allocation was proposed to get Paratent back on track. When choosing between three conflicting future contracts, both the old and new methods of cost allocation needed to be implemented and considered. Using qualitative and quantitative analyses, Paratent needed to decide which job would be the most profitable and which cost allocation method to use in the future.
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