Callaghan and Associates is a firm of chartered accountants specialising in the

Question

Callaghan and Associates is a firm of chartered accountants specialising in the preparation of income tax returns for medical practitioners. By specialising, the firm has been able to build up expertise in the accounting for medical practices, as well as charge a healthy fee because of its in-depth knowledge in the area. Among the firm's clients are Dr Watson and Dr Holmes, two general practitioners from rural practices of approximately the same size and business structure.

Watson and Holmes were at medical school together but had not kept in touch. Recently they bumped into each other at the Australian Medical Association's Christmas party. During the evening, the conversation turned to tax, and then to tax returns. Watson and Holmes were amazed to find that they paid significantly different amounts to have their tax returns prepared. They use the same accountants and have the same billing system, roughly the same number of patients and even the same number of staff.

The next day Watson, who last year paid nearly 50 per cent more than Holmes, challenged the managing partner, C.J. Callaghan, over the charges. He assured Watson that the firm uses a very accurate costing system that tracks costs for five different categories of professional labour to individual clients. Professional labour costs are marked up by 150 per cent to cover other costs and generate a profit. He promised to investigate the problem.

Callaghan investigated both jobs and found that they had involved similar work but that Watson's job had used more senior staff because, at the time, junior staff were tied up on other projects, including completing Holmes' tax return! Both projects had also made similar use of resources other than professional labour.

REQUIRED:

Does the costing system provide a reasonable basis for estimating the professional labour costs? Costs of other resources used in preparing clients’ tax returns? Explain.

How could Callaghan and Associates improve their costing/charge-out system?

Explanation / Answer

The costing system will provide a reasonably good basis for estimating the professional labour costs because

a) The per hour labor rate can be derived of the Payroll records.

b) The billing to the clients could be made on the hours devoted on the clients work by the labor force.

c) Non- accounted costs or Overhead costs could be added to the direct costs calculated on percentage basis.

d) Profit margin could be added over and above the costs so calculated on costing basis.

Costs of other resources used in preparing clients’ tax returns includes the non-operating staff expenses and technical expenses like computers, printing and photocopying and stationary expenses. This expenses could be calculated on the actual basis and could be uploaded on the bills on the pre-determined rate basis base being the direct labor hours of the professional staff.

Callaghan and Associates could improve their costing/charge-out system by following steps:

1. Keeping the labor payroll data of the maximum employees or staff.

2. Maintanance of the log book of the hours used for the various clients work is important.

3. Maintenance of record of the other expenditures other than the labor expenses should be there.

4. These expenses must be allocated to the clients on the basis of pre-determined rate being Direct Labor Hours the base.

5. Profit margin should be added to the bill as a fixed percentage of the total costs incurred.

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