Benefits of Activity-Based Costing for Berry Ltd - Assignment Example

Finance and Accounting Table of Contents Activity Based Costing 2 Features of Activity Based Costing3 Benefits of Activity Based Costing for Berry Ltd. 4 Analysis 4 Budgeting 5 Implication of Budgeting Process 5 Planning 6 Control 7 Performance Evaluation 7 Motivation 7 Forecasting 8 Advantages of Budgeting 8 Conflicting Roles of Budgeting 9 Reference List 11 Activity Based Costing Activity based costing is referred as the method of accounting that allow the companies to collect data about the operating costs. Costs are allocated to particular activities, for example, planning, manufacturing, or engineering and subsequently the activities are linked with different services and products. It is a method which evaluates the performance and cost of the activities which is process-related and also the cost objects. This system of costing offers an alternative method to ascertain the accurate costs. It traces the resources costs to the activities essential to carry out the operations of the company. Through focusing on the activities instead on the departments, activity based costing allows the management which is activity based, to become an active catalyst for the improvement of product quality and business procedure reengineering (Lewis, 1995). Features of Activity Based Costing It provides exactness in the costing process in relation to the end-customers of product, product line, the inventory-keeping units utilized by the organization and the category and channels which reorganize the product flow from the manufacturer to the end customer. This method better supports to understand the perception of the overhead costs which means allocation of widespread business resources because they are utilised by definite product lines as well as their relation towards exact cost driver (Lobo and Paulo, 1998). This method works best with up gradation and quality improvement programs. One special feature of this method is that it imitates the actual process of business, as the requisition of widespread pool resources occurs in the similar way as the common resources are utilised in the firm (Lobo and Paulo, 1998). Another feature of this method is that it helps in the procedure of benchmarking and it is regarded as the essential part of quality management system. It offers a more exact method of service/product costing, therefore leading towards perfect pricing decision. This method also increases the understanding of cost drivers and overheads; and makes non-value adding and costly activities more noticeable, thereby facilitating managers to eliminate or reduce them (Cgma, 2014). Activity based costing enables efficient challenge of the operating costs in order to find enhanced ways of assigning as well as eliminating overheads. It also supports the technique of performance management, for example continuous management (Cgma, 2014). Benefits of Activity Based Costing for Berry Ltd. This method will help Berry Ltd. to determine which products, resources, and services are actually increasing their productivity and which are causative to the losses. Supervisors are then capable to produce data in order to generate an enhanced budget and therefore gain a better understanding of expenses which are needed to keep the organization running smoothly. This method of costing is more beneficial when used for a long time period (Cokins, 1998). There are various benefits which could be obtained by Berry Ltd. from changing its current system of absorption costing with the system of activity based costing. By establishing the method of activity based costing, Berry Ltd. would be capable to reduce or eliminate various activities which do not add worth to its operation, subsequently reducing the product cost. It will also provide the management of Berry Ltd. the likelihood of tracing cost overheads by means of an increased altitude of reliability and accuracy. The system of activity based costing will also present an effective connection between the corporate plan and the decision making process of Berry Ltd. at the operational level. Other benefits incorporate encouragement of constant improvement as well as quality control, effectual facilitation of standards, and use of the unit cost as a substitute of total cost in order to attain better clarity level. Analysis The total indirect cost comes from the absorption costing system, for product X is 483144.13, product Y is 449763.27 and product Z is 444492.60. It has been observed that total indirect cost of product Z is comparatively less than other two products irrespective of its inelastic demand. Total direct cost of product X comes at 1,100,000; for product Y is 1,024,000; and for product Z comes at 1,012,000. Again it has been observed that the expected cost of product Z is lowest. The percentage of product X comes at 35.08%, product Y comes at 32.65% and product Z comes at 32.27%; which is comparatively lower than product X and Y. The demand of product Z is not affected by its price, so, its production and cost should be more than other two products. However, the result is opposite and also the direct resources which are engaged in product X and Y is more than product Z. Those direct resources may remain idle because their demands are elastic. Therefore, it is recommended that the management of Berry Ltd. should switch to activity based system of costing because the absorption costing system is not providing the appropriate result. Under the activity based costing method, number of purchase orders of product X comes at 160, product Y comes at 100, and product Z comes at 220. Also the total number of machine hours of X is 30,000; Y is 20,000; and Z is 30,800. The total number of purchase orders and machine hours of product Z is more than other two products which means that Berry Ltd. is engaging more labour and machines for product Z. The total indirect cost comes at 492,848 for X, 307,945 for Y, and 576,607 for Z; which is more than other two products. The percentage of Z which comes as a means of indirect cost is also more than other two products which signifies that Z will increase the productivity of company. It shows that it is a correct method of costing because the demand for Z is inelastic; which means that if the company will increase the cost of Z then also its demand will not be affected. So, the resources engaged in product Z will not remain idle and the company will also be able to improve its financial performance through improved sales as the improved cost control method of activity based costing would lead to increased profitability. Budgeting A budget is considered as a means for assessing expected expenses and income. The three types of budgets are cash budget, expense budget, and capital budget. Cash budget is defined as a budget forecasting for anticipated cash disbursements and cash receipts. This kind of budget follows cash flow i.e. where the money of business goes, where it comes from, and ultimately how much. Expense budget is prepared in order to analyse where the money of business is spend and therefore it is helpful in tracking the expenses. It is usually not concerned with repayment or appreciation of liabilities. Capital budget suggests a plan in order to pay a huge amount of future expense, through the combination of borrowing and saving money (Gnucash, 2014). Implication of Budgeting Process A budget is considered as a crucial tool of management for planning, controlling, performance evaluation, motivation, and forecasting. It approximates the expenditure and income for a definite time period for the organization. Preparation of budgets serves various purposes such as monitoring the expenditures and incomes for the specific time frame of the project; helping to decide whether adjustments required to be done in goals and programs; estimating expenses and incomes incorporating the timing as well as availability of the income; providing a base for transparency and accountability (Worldbank, n.d.). Budgeting provides the execution route for the plans which comprises of detailed, short term, and operational view. It outlines what is actually expected from company, based on the agreed annual plan. The process of budgeting is mostly focused on the four main components which are: gross or sales margin budget, headcount budgets, budgets of capital expenditure, and budgets of operating expenses. Planning An efficient planning gives the overall process and venue for shaping the financial objectives and direction of the organization (Radkte, 2011). Through the planning process, Berry Ltd. could put together the annual plan which is the part of larger premeditated plan of the organization, usually covering two to four years. Then the senior managers can put down their idea for what is achievable. The overall picture of planning is commonly comprised of three major components which are: strategic plans, annual plans, and long term plans. The purpose of strategic plans is to set by and large long term objectives and goals. Most frequently, both are quantitative and qualitative in nature. The long term plans can generally help the managers of Berry Ltd. to set the financial targets over a two to ten year horizon. The annual plans are typically considered as the first year of long term plan and also provide the targets of high level in order to direct the budget (Radkte, 2011). Other components of planning are discussed below: Strategic planning: This process of planning will quantify the vision of Berry Ltd. and therefore will help the management to decide what is achievable. Information is generally at a high level, and is driver as well as scenario focused. It incorporates impacts of complete financial statement and produces plan of long term (Ima, 2012). Financial planning: It has a responsibility of building the forecast and budget and in broad terms is also regarded as the top-down edition of budget. The output which comes from financial plan is usually the input to operational plan. Stress testing, scenario analysis, analysis of working capital and the re-forecasting of entire financial statement are some of the main elements of financial planning (Hansen, Mowen and Guan, 2007). Operational planning: It is the source for allocation of top-down plans and is also at the least level of point (Cifalino, 2014). Control Control as a part of budgeting ensures that the goals and objectives developed by the company are being accomplished. It often engrosses a comparison between the budgets and the actual performance as well as the application of budgets for the purposes of performance evaluation (Jackson, Sawyers and Jenkins, 2008). Within Berry ltd. the responsibility of budget controller will be to direct and control the entire budgeting process. After that, it is the responsibility of budgeting committee to supervise the process of budgeting that includes reviewing of the budget, providing budgetary goals and policy guidelines, resolving dissimilarities that may take place when the budget is set; and approving the ultimate budget. At this point of time, final budget turns into the plan for upcoming year. Then budget committee will examine the actual presentation of the company. They ensure whether the budget is connected to the tactical plan of the company. Control is presented through the comparison of main results against the budget plan. Then the departures from the budget can be inspected and the causes for the dissimilarities could be divided in non-controllable and controllable factors (Scarlett, 2009). Performance Evaluation It is the method through which Berry Ltd. will measure how well the given business unit or a definite project or a capital budget is executing or has executed. There are several purposes of performance evaluation. First purpose is that, it serves as a means through which Berry Ltd. will consider the ongoing worth of the existing businesses and projects. Second, it is used to implement incentive schemes and compensation which is performance based, therefore, designed to concentrate on the agency problems as well as to prompt managers to follow only those projects and capital budgets that result in the value creation of the shareholder (Culp, 2011). Motivation The process of budgeting concerns principally individuals, not the numbers. Preparing the budgets will motivate the employees of Berry Ltd. to perform as the budgets are targets or standards for employees to achieve. If the people were not motivated towards executing the budget, then it will probably fail (Maher, Stickney and Weil, 2007). Motivation is a significant underlying means to the budget success. One of the motivational characteristics of budgeting process is that it provides a specific and measurable goal (Finkler and McHugh, 2008). Forecasting Berry Ltd. can make use of the definite performance data in order to plan the remaining performance of the current year. Forecasting will assist the Berry Ltd. to know what is occurring from an income statement and revenue perspective. The methodologies of forecasting are: tops-down, bottoms-up, and hybrid forecasting. Tops-down forecasting is about focusing on operational conditions and current demand translated into the revenue predictions. Bottoms-up forecasting is about the proportional allocation of budgets. Berry Ltd. can make use of bottoms-up forecasting for proportional allotment of budgets. It relies on the business supervisor to enter specific and current details of line item per the budget of revenue. Hybrid forecasting is the combination of tops-down and bottom-up forecasting (Shah, 2007). Advantages of Budgeting The advantages of budgeting are discussed below: The process of budgeting formulates communication to happen throughout the business. It compels the management towards focusing on the future prospects and not be diverted by the regular crisis in the company. Thinking in context with the future prospect is most significant feature of budgetary planning as well as control system. The process of budgeting forces management to set out thorough plan in order to attain the goal for each operation, department and manager, to predict and provide the company rationale as well as direction. It clearly defines the responsibility areas and requires budget managers to be accountable for attainment of budget objectives for the operations. It helps the management to identify and also to deal with possible constraints or bottlenecks before they turn into the major problems. The process of budgeting can enhance the harmonization of the activities of organization and also help to facilitate the goal congruence. Executing goal congruence signifies that the goals of supervisors are strongly related with the objectives of the company. It can identify specific objectives and goals that become standards or benchmarks of performance, especially for evaluating the future performance (Jackson, Sawyers and Jenkins, 2008). It provides a base for the performance appraisal. Budget is regarded as a measure against which real performance is considered and assessed. It also enables corrective action to take place as variations emerge. The process of budgeting motivates employees through involving them in the locating of budget. It also improves the scarce resources allocation (Jackson, Sawyers and Jenkins, 2008). Conflicting Roles of Budgeting The motivation and planning roles might disagree with one another. Demanding budgets which might not be accomplished may be suitable to motivate most of the performance, but they may be unsuitable for the planning purposes. Therefore, a budget must be placed based on more realistic and easier targets which are supposed to be met (Weil and Maher, 2005). Furthermore, the performance evaluation and planning roles might also disagree with one another. For the purposes of planning, budgets are placed in advance of the period of budget and they depend on the predictable set of environment or circumstances. On the other hand, performance evaluation depends on an evaluation of main performance with the adjusted budget in order to reflect the situation under which the managers truly operated. It may be possible that Berry Ltd. will compare the actual presentation with the new budget, even though the managers have no control on any changes towards the environment or circumstances that were envisaged when the financial plan was set. Reference List Cgma, 2014. Activity-based Costing. [online] Available at: [Accessed 20 Dec 2014]. Cifalino, A., 2014. Course of Management Control System. Italy: EDUCatt Publishing. Cokins, G., 1998. Learning to Love ABC. Journal of Accountancy, 1(1). Culp, C.L., 2011. Structured Finance and Insurance. New Jersey: John Wiley & Sons. Finkler, S.A. and McHugh, M.L., 2008. Budgeting Concepts for Nurse Managers. Netherland: Elsevier Inc. Gnucash, 2014. Basic Concepts – Budgets. [online] Acailable at: [Accessed 20 Dec 2014]. Hansen, D., Mowen, M. and Guan, L., 2007. Cost Management: Accounting and Control. United States of America: Cengage Learning. Ima, 2012. Wiley CMA Learning System: Financial planning, performance and control. New Jersey: John Wiley & Sons. Jackson, S., Sawyers, R. and Jenkins, G., 2008. Managerial Accounting: A Focus on Ethical Decision Making. United States of America: Cengage Learning. Labo, Y.R.O. and Paulo, C.L., 1998. A New Approach to Product Development Costing. CMA – The Management Accounting Magazine, 1(1). Lewis, R.J., 1995. Activity-based Models for Cost Management System. California: Greenwood Publishing Group. Maher, M., Stickney, C. and Weil, R., 2007. Managerial Accounting: An Introduction to Concepts, Methods and Uses. United States of America: Cengage Learning. Radkte, J., 2011. What’s the Point of Planning, Budgeting and Forecasting? Association for Financial Professionals, 1(1). Scarlett, R., 2009. CIMA Official Learning System – Performance Operations. Netherland: Elsevier Inc. Shah, A., 2007. Participatory Budgeting. Washington: World Bank Publishing. Weil, R.L. and Maher, M.W., 2005. Handbook of Cost Management. New Jersey: John Wiley & Sons. Worldbank, n.d. Budgeting [online] Available at: [Accessed 20 Dec 2014]. Read More