The week four individual paper addresses the implementation of Activity Based Costing (ABC) by Super Bakery, Inc., a virtual corporation founded by Franco Harris. Specifically, management strategies, the reasoning behind an ABC system, and the alternatives of a job order cost system or a process order cost system are assessed for this enterprise.
“Companies can choose to use the accounting job order costing method when they have a single product line or numerous products to manufacture. However, it is less costly and less time-consuming if they elect to use process costing when calculating the manufacturing of a single product line. With similarities
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.
Under a traditional system, overhead cost is allocated to an activity based on hours or rates for direct labor or machine usage. However, this approach does not clearly indicate how much overhead cost will be needed in order to complete a job through a particular function. ABC methodology is to be used as an alternative to traditional accounting where a business 's overhead costs (indirect costs such as electrical energy consumption for heating or cooling, or indirect cost associated with marketing) are allocated as a proportion of direct costs, to an activity. This approach is unsatisfactory because there can be cases where two activities could absorb the same direct costs
Traditional Cost method is defined as “The traditional method of cost accounting refers to the allocation of manufacturing overhead costs to the products manufactured. The traditional method (also known as the conventional method) assigns or allocates the factory 's indirect costs to the items manufactured on the basis of volume such as the number of units produced, the direct labor hours, or the production machine hours. We will use machine hours in our discussion. By using only machine hours to allocate the manufacturing overhead to products, it is implying that the machine hours are the underlying cause of the factory overhead. Traditionally, that may have been reasonable or at least sufficient for the company 's external financial statements. However, in recent decades the manufacturing overhead has been driven or caused by many other factors. For example, some customers are likely to demand additional manufacturing operations for their diverse products. Other customers simply want great quantities of uniform products. If a manufacturer wants to know the true cost to produce specific products for specific customers, the traditional method of cost accounting is inadequate.” AccountingCoach. (n.d.).
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.
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)
JDCW employed a traditional standard costing system throughout its operations. This form of costing permeated the industrial era, which was categorised by low overhead costs and the production of a limited variety of goods. Standard costing involves allocating overheads to cost objects using volume based cost drivers, such as machine or labour hours. Albeit easy to implement and understand, this system frequently results in over costing and under costing.
In addition, it wrongly allocated its indirect costs at volume bases. The use of process technology mentioned in the case led to an increase in factory overheads Since direct labor hours was not a cost driver of them, allocating its large proportion of fixed factory overheads and other indirect batch-level costs on the basis of DLHs in this cost system did not accurately measure how resources were being used. As a result, these inaccurate allocations would have significant costs to Elkay. Moreover, it disregarded its cost structure in which most costs were “fixed” that would not vary in the short run and should be allocated based on its practical capacity. By using the “actual sales volume” as the allocation base for allocating its large corporate overheads, this standard costing system in fact over-pricing its products for its actual productivity was lower than the practical capacity under the intense competition. As a consequence of all problem within the standard costing system, PPD urgently needed an accurate costing system.
Hence we can Estimated Indirect (overhead) cost per unit is quite different for each product, unlike the traditional costing where indirect costs per unit were the same for all four products. This approach recognizes that product W uses more activity pool resources than product X , product Y and product Z .
In the traditional management system, the main emphasis is on the volumes allocated to overhead costs and overhead items. The main costing element under it is the Activity Bases Costing (ABC). ABC tries to utilize cost drivers in terms of both volume and nonvolume of activities and raw materials. Managers
The purpose of this memo is to discuss and evaluate our traditional cost based system versus the new activity based or discrete product costing system. I am going to highlight some of the positive aspects of the new system, discuss future scope and improvements along with some deeper analysis into our unprofitable products and customers.
The traditional budgeting model is built on an erroneous understanding of the overhead apportionments. Mostly, the companies use the labour hours, and the machines hours to allocate the overheads into different cost units. In reality, a single cost driver like the labour hours and the machine hours does not affect the incurrence of the overheads. The rate of consumption of the materials or the labour hours differs among the various product lines and the departments. Some products lines may consume a little amount of a given type of an overhead compared to another. When the absorptions rate used is not the real costs driver of the overhead used in a given product line, the costs will be either over or underestimated (Richards, 2011, p.78). The use of overall absorption rate produces information that is unreliable for use by the managers. They have to come up with strategies to control costs and compete effectively in the market.