The Costing System Used By Our Company

1440 Words Oct 18th, 2015 6 Pages
Respected Chief Executive Officer,

The objective of this note is to analyse the costing system used by our company. This article is specified in the following aspects: explaining why direct labour hour is not an appropriate basis for assigning overhead in traditional costing system, identifying the key drivers of manufacturing overhead, discussing pros and cons of using activity-based costing system and giving recommendation on product pricing.

To begin with, it is rather inappropriate to take direct labour hour as a basis for allocating manufacturing overhead to coffee products. This is the calculation of overhead costs of Java and Ethiopian using absorption costing and activity-based costing: This table shows that according to absorption costing, the overhead costs of Java and Ethiopian are exactly the same, because it is estimated that it takes the same amount of direct labour hour to produce them. However, direct labour hour cannot always determine the overhead costs. For example, the cost of purchasing depends greatly on the number of orders. Although the quantity of Java (100,000kg) is much more than Ethiopian (2,000kg), their numbers of orders are very nearly the same, which leads to similar costs. When these costs are divided by the quantity of goods, a significant difference between the overhead of the two products occurs. Material handling and quality control face the similar situation. That is to say, a smaller proportion of indirect cost should be assigned to…
Open Document