Activity Based Costing

This Assignment is designed to give you an opportunity to:

1.   integrate traditional, contemporary and advanced theoretical and technical management accounting knowledge for planning, control and evaluation, as well as decisions making;
2.   critically apply traditional, contemporary and advanced theoretical and technical accounting knowledge and skills to solve emerging and/or advanced management accounting problems that require planning, control and evaluation, as well as decision making from a strategic perspective; and
3.   demonstrate information literacy and numeracy skills required by accountants to access relevant data from research and business literature sources and use contemporary and advanced analytical techniques.

Required:

One of the traditional responsibilities of the management accountant is to provide cost information. Activity-based costing (ABC) is the process of allocating costs incurred in supplying the product or service based on the amount of activity required to produce it.

1. Calculate the profitability of the three products (including a total of all three) using an activity-based costing approach. Show all workings.
2. Analyse and explain the differences between the current costing approach and the ABC approach for each product. (max 500 words)
3. Based on relevant research (max 1500 words):

i. Identify and explain key practical issues that need to be discussed and considered prior to any implementation of an ABC approach applicable to this company.

ii. Summarise how the ABC information may be used to improve managerial decision- making (activity-based management (ABM)).

Introduction

This paper details the various accounting and costing principles, which have been, applied to my privately owned leisure goods company, a small- to the medium-sized enterprise where I work as a management accountant. As stated the company has two manufacturing plants located in Brisbane and Melbourne, Australia. The company is highly competitive and it relies on a regular launch of new products in the market, which is critical to its success. As the situation and fact state, the company is expanding. Even though the sales increase the profitability is not increasing in the same proportion. This might be because of the fact that the company's accounting system has not been updated for 10 years, and the staff has had limited training and development over the last five years. As suggested by the owner of the firm, Bob Spikes, I have recalculated the costs as per the activity-based costing method. This method is being used by most of the companies of all sizes and has helped them to understand the reasons for their lesser growth and profits. To. This report discusses the uses and purpose of ABC and ABM methods, with special emphasis on how the company should allocate the costs on the basis of activities and include their employees in the decision making process, as well as provide adequate training to them. 

Analysis

After going through the accounts and the costing methods I realized that the company has been using the traditional method of costing of allocating the overheads. Almost all the activities are performed manually in a traditional manner and indirect (overhead) costs are accumulated into one indirect cost pool and allocated to each product type based on the machine hours. This method is simple but the method of allocation might lead to under or over-application of overheads. Indirect overhead form an important part of finding out the costs, selling price and profitability of any product. In the current situation, there are three products having their individual allocation for direct material and labour. However, the manufacturing overhead, which amounts to $1,573,000, needs to be allocated in a more appropriate method so that the costs reveal the actual amount of resources used. For example, when we use Activity Based Costing method for allocating the overheads, product 3 is most profitable as compared to product 2 as per the current system of costing. Although the total profit remains the same as $22,27,000, irrespective of the method of allocating costs, per product overhead and profits change. Following the current method might lead to either continuing a product, which is making losses, or even stop producing a few products thinking that they are making losses. 

Product wise analysis

The owner or the accountant might have chosen this approach around 10 years ago because they believed that the usage of machine hours are used in proportion to the overheads and would be an easy method to be applied for allocation of indirect costs. However, now that times have changed, the company is making new products to be at par with the competitors, and they might have noticed they are not selling the products in the manner they use to. This report discusses the uses and purpose of ABC and ABM methods, with special emphasis on how the company should allocate the costs on the basis of activities and include their employees in the decision making process, as well as provide adequate training to them. Product 1with 3/10 machine hours has lesser purchase orders and administrative expenses as compared to the other products. Similarly, product 2 and 3 have a higher or lower proportion of other drivers as compared to the machine hours. As each cost should be allocated on the basis of how they are used, it is better to find the relevant and the most appropriate base cost driver and make decisions accordingly.