4.0 STRENGTH AND WEAKNESSES OF ACTIVITY BASED COSTING
4.1 Strength of Activity Based Costing
4.1.1 Measures profits more precisely
An organization can make better company strategies decisions on product lines, product mix, market targeting and market segmentation and pricing with precise and systematic information on product cost.
4.1.2 Make better business decision
ABC builds a clearer relationship among varies activities and the activity-driving costs. With this decision-making tool, it helps the managers to upgrade and develop the product and services that satisfy customer needs to deliver superior customer value. It also reduces unnecessary expenses in order to increase the margin profit.
4.1.3 Cut cost
The costs of every single activity performed during manufacturing is highlighted in order to identify the expenditure which be eliminated.
4.1.4 Lessen Cost Distortion
The costs related can be assigned more equitably for each individual jobs or products. In ABC Costing, the allocation of indirect cost is based on the kind of product activities and the range of the activities organized.
4.1.5 Match the manufacturing overhead costs with the product better.
The effectiveness and efficiency of each department in the company can be improved with better matching of the manufacturing overhead costs with the products. The costs differences between departments and the usage difference between jobs-better jobs of matching each department’s overhead costs to the products that use the department resources can be determined
4.1.6 Make better cost estimation of individual jobs or product
The cost of individual jobs or products can be determined more accurately by using ABC costing system. It is essential to make a good business decision ...
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...workable decision.
4.2.5 Additional work
The company needs to sustain two cost systems and accounts, one for internal use and another for external reports since the direct use of accounting method in analysis of the ABC data cannot be used. Different reports are required to prepare for different purposes in ABC costing lead to additional works that making the resources not using productively.
4.2.6 Lose sight of strategic objectives
The company might neglect their strategic objectives in their business as they pay too much attention to small, less important details. ABC costing makes the managers concentrates more on the allocation of costs on individual jobs, less on the overall allocation of budgets and resources. Excessive concern about the small savings would lead to huge losses in long term if the company benefits and business target are always ignored behind.
If done right, I believe that all of the costs can be allocated to each of the three products through both direct and overhead costs. The only direct costs that are being included currently are labor and manufacturing costs. I broke up overhead into overhead based off direct labor and overhead based on units sold.
Activity-based costing (ABC) is a costing method that is usually used as a supplement to a company’s usual costing system, and is therefore used for internal decision-making. It is designed to inform managers of costing information for decisions (strategic and others) that potentially affect capacity and consequently “fixed” as well as variable costs. In addition, ABC can also be used to pinpoint activities that would benefit from process improvements.
Based off of the data provided in the case study it would appear that under the traditional costing. Which are the cost that were incurred to produce OS-367. It appears that those cost were being allocated to GS-157 and HS-241. The cost per unit for OS-367 was $10 under the traditional costing system and the same has become $13.75 under the ABC system.
An organization costing system is a system that helps the management with the strategy planning while the system plays an important role in providing accurate cost information about the products and customers (Curtin, 2006). UPS utilizes the Activity-Based Costing (ABC) system. ABC assumes that activities cause costs and that cost objects create the demand for activities (Marx, 2009). The key to cost allocation under ABC is to identify the activities that are performed to provide a particular service and then aggregate the costs of the activities (Gapenski, 2012). This is a marked departure from the practice of sharing overheads costs equally or overheads becoming part of the overall profit-loss estimate instead of component product pricing (Nayab, 2011).
The contained paper has been prepared with objectives of elaborating over the three different costing methods namely, Absorption/Full Costing, Variable/Marginal Costing, and Activity Based accounting. The first segment of the report seeks to define and illustrate the costing methods based on the personal understanding of the writer gained through the class room and the academic readings. Part two of the report takes a form of short essay, written critically to evaluate the application of standard costing and variance analysis to any size of business, and concludes with a verdict that whether or not standard costing and variance analysis is applicable to each business with consideration of its costs and benefits of the system.
Besides, an organisation can adopt a technique of activity-based costing (ABC) as an approach to support its sustainability objectives. ABC system is a technique of assigning overhead costs to products and services by identifying the cost drivers. ABC technique will first identify each activity cost that is involved in the process of production, then assign the cost to each product and service on the basis of each activity consumption in the production of each product and service (Drury, 2012, p. 253). ABC system is an effective method to account for costs of products and services. This is because ABC system allocates indirect costs based on a cause-and-effect relationship (Drury, 2012, p. 269). ABC system allocates overhead costs to cost
Activity-based costing is used as a supplement of traditional cost accounting in a company to support manager in internal decision making. It focus on assigning the indirect cost to direct costs in order to get a more accurate cost on products. Activity-based costing uses several cost pools instead of one in traditional cost accounting. The system is easy to implement and it provides many benefits, it allows the company to respond to inefficiency by reallocating resources to more profitable activity from areas that absorb too many resources. It also allows the company to respond to manufacturing overhead cost and assumes a more accurate selling price on products in order to make more profits. Company that do not have internal expertise to conduct activity-based costing analysis may think to hire one or ask company that provides this kind of services for help.
As we see that process costing only concentrates on what happens in the departments, unit cost information in this type of cost comes directly from the department accounting office, while in job costing the unit cost information is derived from the job cost sheet (Walther, L. M. & Skousen, C.J.
"Both methods estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The differences are in the accuracy and complexity of the two methods" (1) , Now we will discuss why ABC can result in more reliable products costs than conventional labor based product costing system . In recent years, the nature of industrial production has fundamentally altered; we will discuss their characteristics. First we have machine production and capital intensive, Now machines are the main tool and at the heart of production; labors maintain machines and supervise them, and machines are the ones that dictates the pace and rate of production. The second characteristic is high level of overheads relative to direct cost; in modern businesses they tend to use overheads in different ways for example: some products need engineering time and some products require machine time so that products will use overheads differently. The third characteristic is highly competitive international market, transportation including fast freight and relatively cheap; one of the advantages is the use of internet ensures that customers can easily and quickly reach and find products and also cheaply, this environment is highly competitive so companies need to know accurately their range of prices in order to use this information to gain competitive advantage over other
The overall purpose of cost accounting is to advise top administration and the management team on the most suitable and cost effective methods and actions to employ based on cost, capability and efficiencies of a given product or service. It can be defined as the method where all the expenditures used during execution of business activities are gathered, categorized, examined and noted down (Horngren & Srikant, 2000). Once these numbers are gathered and recorded the information is used to determine a selling price and/or to identify possible investment opportunities. Although the principal aim or function of cost accounting is to help the business administration with their decision making and business planning process, the cost accounting data
Since more than 40 years, Toyota Company was thinking how to develop the traditional process costing system and the production system. Some of the companies believe that the increasing of the production is a big profit, while Toyota proved the opposite. The more you increase the products out of the need of the market, the more losses you are going to gain. This kin...
In management accounting, cost management has a crucial role and finds its foundations in understanding “cost behaviour”. “Cost behaviour analysis” can be defined as “the study of how cost changes when there is a change in an organisation’s level of activity”. (Definition https://www.accountingcoach.com/blog/what-is-cost-behavior).
Cost optimization: Determine the product costs by tracing detailed cost using analytical tools. To maximize profit by detect precise cost of products, optimize margins by inventory valuation.
Of greater importance, job-order costing system needs to accumulate three types of information which include direct materials, direct labor, and overhead. These factors are highly important essentially because of the significant variations in the products produced. Hence, each product or batch has a job identification number and costs are accumulated by a job number. All the more, job-order costing systems requires detailed accounting information and thus the total cost of all jobs is accumulated in one work-in process inventory control account; details of the cost materials, labor, and overhead for each job are kept in subsidiary records called job-order cost sheets (Edmonds, Tsay, & Olds,
From the A12 redesign proposal, it shows that the current standard cost system is unable to link the reduction in the number of parts to activity reductions and cost savings. The labor-direct-based standard cost system reflects the cost of A12 is distorted. Using the ABC system, according to the activities of A12 allocate the overhead cost to A12 that could find that the current overhead cost of A12 was overstated by the standard cost system. At last, A12 Junction Box could be identified it is an attractive and profitable product, at the same time, it demonstrates the value of ABC.