Case study
EziTax is a tax accounting firm. It offers an income tax preparation service for small businesses and individuals.
Individuals are charged $149 per return and small businesses are charged $399.
Individual returns are normally relatively straightforward to process and the firm uses the ATO’s free etax software to prepare and submit the returns. The individual returns do not tend to vary much in the workload required to complete them.
The processing of small business tax returns is more complex and requires a specific software package that the EziTax has purchased for an annual licence fee of $25,000 plus $2.50 for each return processed. Processing of business returns varies as to the workload each one requires.
The manager of the firm, Martine Matilda, is concerned that last year only a small profit was made despite the volume of work being higher than ever. She commented: “We are good tax accountants for our clients but we don’t seem to keeping our own house in order!”
To help improve the situation Matilda decided to recruit a dedicated management accountant with a proven track record, Katrine Pedersen.
On her first day in the job, Matilda tells Pedersen “I want you to get to the bottom of our recent poor profitability but I do not want you to buy in expensive ‘solutions’ which may quickly become out of date and are still prone to error. Also any new systems must be understandable to staff and clients, whom we must justify our price to.”
One of the first concerns Pedersen has is that EziTax’s pricing is not optimal. She has noticed that whilst the firm has been extremely busy with a record number of 9,000 small business returns last year, they have had relatively few individual returns (3,000). Katrine has also done some basic market research where she has found other tax agents charging individuals as little as $100 for a basic return.
As a starting point, Pedersen decides to use an Activity Based Costing (“ABC”) approach to help assess the cost of preparing each type of return. From the firm’s timesheet and other records she is able to access the following information for the previous year:
Activity Cost
Interview client $1,615,000
Obtain Missing data $800,000
Input data $390,000
Verify return with client $875,000
Rectify errors after ATO query $40,000
Submit return $50,000
Other information Pedersen collected is:
- On average each individual takes 20 minutes to interview and each business takes 2 hours. Last year a total of 19,000 hours were spent interviewing clients. ?
- Follow-up conversations to obtain missing data relates to business returns only. ?
- Data input took a total of 9,750 hours, with it taking an average of 15 minutes ?for an individual and 1 hour for a business. ?
- Verification of the return with the client took an average of 10 minutes for individuals and 55 minutes for small businesses. ?
- There were 1,065 returns requiring rectification and only 22 of these were for individuals. ?
- Submission time was approximately the same across all returns.?
Required: Word Limit: 1,500 words. Show all your calculations (not included in ?the word count). ?
1. Use ABC to estimate the cost of an individual and a business return. Make clear any assumptions you have made. ?
2. How might these estimates help explain the poor profitability experienced last year and what implications do they have for the firms’ pricing policy?
3. Explain the advantages and disadvantages of ABC, relating your discussion to EziTax.
4. Katrine uses the ABC approach based on the above data as a ‘starting point’. Can you suggest any other ways of altering the firm’s costing and pricing policies which will be more beneficial to EziTax?