2.5 Related Literatures and Researches Nowadays, as mentioned earlier, many companies have

Develop and diagram an activity based cost model using the information in the case. Provide your best estimates about the cost and profitability of Wilkerson’s three product lines. What difference does your cost assignment have on reported product costs and profitability? What causes any shifts in cost and profitability?

Activity-based costing can be defined as the managers allocate costs depending on the quantity of resources a product or service consumed in the manufacture of goods and services. The activity based

Activity-based costing is a system of accounting that puts emphases on activities performed to produce products or services (Schneider, 2012). In this costing system every activity is assigned a cost (Schneider, 2012). The goal of activity-based costing is not to allot common costs to products but to measure and then price out all the resources used for activities that sustain the production and delivery of products and services to customers (Mazumder, 2007). Activity-based costing is a cost system that is useful in business because of the fact that it does account for the cost of the products, resources used to produce the product and delivery of the product.

Glaser Health Products manufactures medical items for the health care industry. Production involves machining, assembly and painting. Finished units are then packed and shipped. The financial controller is interested to introduce an activity-based costing (ABC) system to allocate (or distribute) indirect costs to products. Indirect costs, as distinct from direct costs, cannot be unambiguously linked to specific products. The controller would like to calculate product costs based on ABC for planning and control, not inventory valuation.

This paper provides a brief presentation of Activity-Based Costing methodology, how is used as well as its short comings.

Number of skus was considered driver for Technical Support. The product weight was considered driver of resource consumption only for General & Administrative costs. Moreover, materials and direct labor were allocated based on the bill of materials and routings (exactly the way they were allocated in Standard Costing system). Finally, Material Handling & Setup, Order Processing and Production Planning were driven to products using number of orders. Consequently, ABC solves the major issue regarding the Standard Costing system: the assumption that all overhead costs can be included into one cost pool. All the drivers are summarized in exhibit 3. Exhibits 4 and 5 present respectively the ABC drivers and allocation rates.

The activity based costing (ABC) has the basic characteristic to seek to lower the misrepresentation generally occurred by the incorrect allotment of indirect cost acquired in traditional process (Stefano & Filho, 2013). Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. However in 1980’s the hospitals used to use coding system for medical tariff. Under this, medical services were divided into three number code, but due to a lot of weaknesses in tariff method a lot of hospitals started using “Diagnosis Related Group” method under which instead of fixed tariff the cost of

ABC is a method utilized by organizations to establish costs for each product or service that the business provides. The ABC method utilizes cost drivers to determine indirect cost, as well as direct costs and volumes to ascertain costs that pertain to the product or service that the business delivers (Nowicki,

Application ABC method can help employees understand the full cost involved, they can analyze costs and determine which activities bring added value and does not operate, thereby improving operational efficiency. This is a continuous improvement process starts from analyzing costs, reduce the operation does not create additional value and thereby achieve overall efficiency. ABC helps organization create better products, to meet the needs of the market with a competitive cost. Product profitability analysis and customer profitability brought by this method has contributed actively to the process of decision making at the management level;

It only uses one cost channel to allocate their indirect costs and its figures are by chance. On the other hand, MDE management should convert to an ABC system since the emphasis is on each activity of production rather than an average cost based on material and labor (“Advantages, Disadvantages of (ABC) System”).They will be able to meet the needs of MDE and benefit it to reach its growth potential. To the firm’s advantage applying ABC, applied costs will be based on specific results. Instead of random overhead costs. (Activity Based Costing vs Traditional Costing). Although traditional costing methods are easier and basic. It only uses one cost channel to allocate their indirect costs and its figures are by chance (“Advantages, Disadvantages of (ABC)

12). Objectives of the ABC cost system that the standard cost system did not cover was “to improve product cost accuracy and optimize the product mix as quickly as possible in order to help improve GEIs unsatisfactory financial performance. The long-term objective was to evolve toward the practice of Activity-Based Management (ABM). More specifically, GEI anticipated that the ABC data could be used to help its product engineers project the cost impact of product design changes, and to help its process engineers and operations managers identify and prioritize process cost-reduction opportunities” (Brewer et al., 2003, para. 13). ABC costing systems offered a better solution for GEI because, “GEI created its own customized ABC software called ACCURATE to capture the data inputs, interface with the standard cost subsystem, and calculate product costs” (Brewer et al., 2003, para. 20). After the ABC system was implemented, “There was a strong consensus across the plants that the ABC system resulted in both improved product-cost accuracy and greater product-cost visibility relative to the direct labor-based system. In spite of the lack of training, nonaccounting personnel intuitively believed that ABC captured the economics of the business better than the labor-based system. At a strategic level, this contributed to better marketing and product-mix decisions, and at the plant level, ABC improved relations with GEI

Activity Based Costing is a two stage process. First, one must identify the significant activities involved in the production of each product, called pools. In Stanley’s case, the activities are material handling, inspection, machining and assembly. Then overhead activities are assigned to each activity, making up the activity-cost pool. The second stage of AB Costing is to identify the appropriate cost driver for each pool and determine the pool rate. These pool rates are used to more accurately determine the costs associated with each product.

Nowadays, we know that activity based costing system assigns overhead costs to products or services products that using a two-stage process, which focuses on activities. ABC is a relatively new and very important topic in managerial accounting. ABC allows us to find a way that we could determine the profitability of every product, profitability of every customer we serve, and the profitability of our process. Contents in brief, first that comparing potential advantages of ABC versus traditional costing methods. The

Activity-based management, activity-based costing and continuous improvement, all these help in the improvement of the efficiency in manufacturing, better control of overhead costs and the accurate costing of products. With this in mind, We disagree with the advice that Chuck Davis, the firm’s controller, gave Leonard Bryner. The traditional way of costing produce average costs that severely overstated or understated. Without the accurate costs, the firm would not be able to price properly their products and that would be damaging to the firm. With activity-based costing and management, all costs are accounted for with the help activity-drivers and overhead costs are decreased. In turn, the costs that the firm has for their products are more accurate and pricing is much easier.

(Bowersox, D.J., Closs, D.J., and Cooper, M.B. (2010). Supply Chain Logistics Management. (3rd Edition) New York, NY: McGraw-Hill/Irwin.