1
11
Table of Contents
Introduction 3
Conceptualization of Scenario
4
Benefits of Using Activity-Based Costing System 8
Conclusion 10
References 11
Activity-Based Costing
Introduction
Calculating the actual costs of a product can be a complicated affair depending on the technique used to cost the product. Costs are very crucial to any business as they will affect the profitability and cash flow of the company. If the costs are calculated in a wrong manner, it might result in loss and the business reporting the erroneous data. It is, therefore, essential for an accountant to understand the costs involved in the activities and processes involved in a company to create a product. One important element one should realize cost drivers that influence the level of charge.
The most common technique for allocating overheads for a long time has been traditional costing, also referred to as full costing. In this method, the whole amount of manufacturing overhead is taken and spread across the volume of products produced. This method does not consider that some products might be responsible for higher costs form certain activities than others. The process assumes that overheads are a function of volume only.
Another method of analyzing business costs is Activity Based Costing. In this technique, the overheads of a business are determined by assigning values to the products or jobs that use these activities (Fei & Isa, 2010). The implication is that activities that are not included in a product or service are not included in its overhead cost. This technique generates a more accurate cost analysis to be used for decision making. As modern-day business become, more and more complex Activity Based Costing is being adopted by most companies that want to generate accurate overhead cost information. Introduction should be brief about what is assignment about its too big.
Conceptualization of Scenario
Calculating the overhead cost per unit for each of the three sizes of machine (Small, Medium and Large) using the current approach of traditional costing absorbing overhead on the basis of Labour Hours. It’s mentioned here labour hour
Overhead cost = Total Overheads/No of units produced
Overhead cost = 187,000/ (1500+1500+2000)
Overhead cost = 37.4 per unit Overhead should be based on Labour hours not based on units
The overhead cost per unit for Small, Medium and Large photocopiers will be 37.4. This is because traditional costing absorbing overhead assumes all the units will utilize the same amount of overhead costs.
Calculating the overhead cost per unit for each of the three sizes of machine (Small, Medium and Large) using activity-based costing suggested by the Management Accountant.
Calculating the overhead rate
Overhead name column missing product column not required
Basis are used incorrectly
Overhead Cost(OMR)
Small photocopiers
Medium photocopiers
Large photocopiers
Total
overhead rate
Number of machine hours required
56,000
1200
400
1400
3,000
18.66
Number of purchase orders
44,000
3
2
6
11
4000
Number of Deliveries required
42,000
10
30
20
60
700
Number of labour Hours
45,000
3000
4000
3000
10,000
4.5
By using the overhead rate we can calculate the overheads for each type of photocopier by multiplying the overhead rate by the cost drivers of the given overhead.
Small photocopiers
Medium photocopiers
Large photocopiers
overhead rate
small photocopiers overhead
medium photocopiers overhead
large photocopiers overhead
Number of machine hours required
1200
400
1400
18.67
22400
7466.67
26133.33
Number of purchase orders
3
2
6
4000
12000
8000.00
24000.00
Number of Deliveries required
10
30
20
700
7000
21000.00
14000.00
Number of labour Hours
3000
4000
3000
4.5
13500
18000.00
13500.00
Total
54900
54466.67
77633.33
From the table we get the overheads for each individual photocopier and now we divide by the number of units to get the overhead per unit.
Running error- check again- tables is not correct. Avoid unnecessary column
Small photocopiers = 54900/1500
= 36.6
Medium photocopiers = 54466.67/1500
= 36.31
Large photocopiers = 77633.33/2000
= 38.82
From the costs we can see that the large photocopiers have the highest overhead cost per unit compared to the medium and small photocopiers.
Traditional costing systems are likely to report distorted cost in the calculation of overheads. In the Photoshop manufactures example above we can see how the three types of photocopiers have different overhead costs per unit, unlike in the traditional costing technique that generalizes the overhead costs. By assuming that the overheads are utilized evenly in the production process, the conventional costing technique does not put into account that the different products might require different labour hours, machine hours, delivery times and purchase orders.
Shows unders tanding of basic issues/theory of cost distortion using absorption costing
For instance, the traditional technique would have assumed that the same machine hours are used in hours are used in the manufacture of photocopying machines. Still, in reality, the hours are very different. The small photocopiers require 22400 the medium ones need 7466.67 while the large ones 26133.33. The difference between the small and medium photocopying machines hours is 14933.33. Shows table of difference of overhead cost using ABC and absorption
When we look at the number of deliveries required we see that the small photocopiers require 7000, the medium 21000 and the large computers need 14000. The difference between the three copiers is 7000. Traditional costing technique could have assumed that the three photocopiers would require the same number of deliveries.
Benefits of Using Activity-Based Costing System
Activity-Based Costing System will generate more accurate product cost. The technique focuses on the cause-effect relationship of an activity to determine its cost allocation. It acknowledges that the activities are the ones which bring about cost in a product and the product, in turn, utilizes the cost. In the case of full costing system errors in the determination of product cost as the absorption method is generalized to all products.
Activity-Based Costing System provides good intelligence about cost behaviour. By alienating the activities of a product, it is possible to study the nature of cost behaviour and identify the businesses that do not add value to the product. Information about fixed overhead costs becomes transparent and can be monitored and controlled more effectively. With ABC, it becomes easy to trace the overhead costs to various areas such as departments, management, customers and processes (Ittner et al., 2002). This is useful in seeing how costs are expended.
Activity-Based Costing System helps reduce costs and utilize excess capacity. By identifying cost drivers, it is possible to identify areas for cost reduction. It is also possible to identify spare capacity in production by analyzing the resources that are in use in an activity.
Activity-Based Costing System provides an excellent base for sound decision making. There are many decisions to be made in a business such as setting the selling price, make or buy decision or even to continue or stop production. All these decisions are made prudently when accurate information about the overhead costs is available. The most profitable products are also easily identified, allowing for the creation of the right product/service mix and design decisions (Hoozée & Hansen, 2018).
Activity-Based Costing System assists the service industry to determine their overheads more effectively. Some industries, such as banks do not have a direct cost, most of the expenses are overheads that cannot be held as stock. ABC ensures that the service industry gets accurate overhead cost information for planning and decision making.
Major facts understood about benefit of ABC, be more specific and brief
· Introduction should be brief its too big.
· Word limit is too high. Stick on word limit.
· Check the text comment in the assignment
· Part a is incomplete overhead cost for three products not done using Absorption
· ABC – So many mistake – do your work carefully !
Conclusion
Traditional costing technique might have been effective in the past, but with the complexity of modern production processes, it might provide false information. The cost of cost should not be more than the benefits we derive from costing. Activity-Based Costing System is a very accurate technique of casting as it breaks down broad indirect costs to direct costs of production. Using this information, it becomes easier to use the information for decision making. ABC has the potential to help a business in cost management and effectively influence its performance. I would recommend all companies to implement the technique.
References
Fei, Z., & Isa, C. (2010). Factors Influencing Activity-Based Costing Success: A Research Framework. International Journal Of Trade, Economics And Finance, 1(2), 144-150.
Hoozée, S., & Hansen, S. C. (2018). A comparison of activity-based costing and time-driven activity-based costing. Journal of Management Accounting Research, 30(1), 143-167.
Ittner, C. D., Lanen, W. N., & Larcker, D. F. (2002). The association between activity‐based costing and manufacturing performance. Journal of accounting research, 40(3), 711-726.
No need of total overhead in this table
In this table you should write the comment