Harvard Case - Project Sparrow: Applying Costing Methods
"Project Sparrow: Applying Costing Methods" Harvard business case study is written by Ian Dunn, Kaitlyn Oh. It deals with the challenges in the field of Accounting. The case study is 5 page(s) long and it was first published on : Mar 1, 2021
At Fern Fort University, we recommend that Project Sparrow adopt an Activity-Based Costing (ABC) system to accurately allocate costs and improve decision-making. This will involve a comprehensive analysis of the project's activities, resource consumption, and cost drivers. By implementing ABC, Project Sparrow can gain a deeper understanding of its cost structure, identify areas for cost reduction, and make informed decisions regarding pricing, resource allocation, and project profitability.
2. Background
Project Sparrow is a new venture by Fern Fort University, aiming to develop and launch a revolutionary online learning platform. The project faces challenges in accurately allocating costs across its various activities, leading to difficulties in determining profitability and making informed strategic decisions. The current cost accounting system, based on traditional methods, fails to capture the complexity of Project Sparrow's operations and resource consumption.
The main protagonists in this case are Professor James, the project leader, and Emily, the finance manager. Professor James is passionate about the educational potential of Project Sparrow and is eager to see it succeed. Emily, on the other hand, is concerned about the project's financial viability and the lack of accurate cost information.
3. Analysis of the Case Study
The case study highlights the limitations of traditional cost accounting methods in capturing the complexities of modern projects, particularly those involving significant technology and innovation. Project Sparrow's activities are diverse and require a more sophisticated approach to cost allocation.
The current system, based on direct labor hours, fails to account for the significant overhead costs associated with activities like software development, content creation, and marketing. This leads to an inaccurate representation of the project's true cost structure and profitability.
Key Issues:
- Inaccurate Cost Allocation: The current system underestimates the true cost of certain activities, leading to distorted profitability assessments.
- Limited Decision-Making Information: The lack of accurate cost information hinders informed decision-making regarding pricing, resource allocation, and project viability.
- Potential for Cost Overruns: The inaccurate cost allocation can lead to unexpected cost overruns, jeopardizing the project's financial sustainability.
Framework:
This analysis utilizes the Activity-Based Costing (ABC) framework, which provides a more accurate and comprehensive approach to cost allocation by identifying and analyzing the activities involved in a project and their respective cost drivers.
4. Recommendations
To address the challenges faced by Project Sparrow, we recommend the following:
- Implement an Activity-Based Costing (ABC) System: This involves identifying and analyzing the project's key activities, their resource consumption, and cost drivers. This will provide a more accurate representation of the project's cost structure.
- Develop a Cost Driver Database: This database will track the resource consumption for each activity, providing a comprehensive understanding of the cost drivers.
- Allocate Costs Based on Activity Consumption: Costs will be allocated based on the actual consumption of resources by each activity, rather than traditional methods like direct labor hours.
- Conduct Regular Variance Analysis: This will help identify and analyze deviations from planned costs, allowing for timely adjustments and cost management.
- Integrate ABC into the Project Management System: This will ensure that cost information is readily available for decision-making and performance monitoring.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: Implementing ABC aligns with Fern Fort University's mission to provide high-quality education and innovation. It enables the university to make informed decisions regarding resource allocation and project viability.
- External Customers and Internal Clients: ABC will provide a more accurate understanding of the costs associated with delivering online learning experiences, enabling Project Sparrow to develop a competitive pricing strategy and attract external customers.
- Competitors: By gaining a deeper understanding of its cost structure, Project Sparrow can better compete in the rapidly evolving online learning market.
- Attractiveness ' Quantitative Measures: ABC can improve the accuracy of financial performance indicators like profitability and return on investment (ROI), enabling Project Sparrow to attract investors and secure funding.
- Assumptions: The success of this recommendation relies on the accurate identification of activities, cost drivers, and resource consumption. It also assumes the availability of data and resources to implement and maintain the ABC system.
6. Conclusion
By adopting an Activity-Based Costing system, Project Sparrow can gain a more accurate understanding of its cost structure, improve decision-making, and enhance its financial performance. This will enable the project to achieve its goals of developing and launching a successful online learning platform.
7. Discussion
Alternative Options:
- Continuing with the current system: This option carries significant risks, including inaccurate cost allocation, poor decision-making, and potential cost overruns.
- Adopting a hybrid system: This involves combining elements of traditional cost accounting with ABC. However, this approach can be complex and may not provide the same level of accuracy as a fully implemented ABC system.
Risks and Key Assumptions:
- Data availability and accuracy: The success of ABC relies on accurate data regarding activities, resource consumption, and cost drivers.
- Implementation costs: Implementing ABC requires significant upfront investment in resources and time.
- Resistance to change: Employees may resist adopting a new cost accounting system.
Options Grid:
| Option | Advantages | Disadvantages |
|---|---|---|
| Implement ABC | Accurate cost allocation, improved decision-making, enhanced financial performance | Implementation costs, data availability, resistance to change |
| Continue with current system | Simplicity, low implementation costs | Inaccurate cost allocation, poor decision-making, potential cost overruns |
| Hybrid system | Combines benefits of both systems | Complexity, may not provide the same level of accuracy as ABC |
8. Next Steps
- Form a project team: This team will be responsible for implementing the ABC system.
- Identify and analyze key activities: This involves mapping the project's activities and their resource consumption.
- Develop a cost driver database: This will track resource consumption for each activity.
- Pilot test the ABC system: This will allow for adjustments and refinements before full implementation.
- Train employees on the new system: This will ensure that all stakeholders understand the new cost accounting methodology.
- Monitor and evaluate the system's effectiveness: This will involve regular performance reviews and adjustments as needed.
Timeline:
- Month 1-3: Project team formation, activity identification and analysis, development of cost driver database.
- Month 4-6: Pilot testing of the ABC system, employee training.
- Month 7-9: Full implementation of the ABC system, monitoring and evaluation.
By following these steps, Project Sparrow can successfully implement an Activity-Based Costing system and achieve its financial and educational goals.
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Case Description
In 2019, the pricing manager at the US manufacturing facility for Sparrow GmbH (Sparrow), a chemical manufacturer based in Germany, asked the project manager at Roland Berger, a global management consulting firm, to provide her opinion on the pricing for Sparrow's bid on a basic chemicals contract with Impendium Chemicals. The basic chemicals industry was a highly competitive and commoditized environment; as a result, pricing decisions with respect to formulating bids were very important. Although the company had traditionally relied on the estimates of salespersons for pricing, it needed to develop a more refined approach to its pricing strategy. The project manager had to decide which costing method was most appropriate for this contract and recommend a price for the bid.
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