Costing Systems in the Manufacturing Environment - Essay Example

COSTING IN THE MODERN MANUFACTURING ENVIRONMENT Costing Systems in the Modern Manufacturing Environment Introduction Costing systems enables firms to determine the production cost based on the revenue generated. Costing systems are essential in a manufacturing setup because it enables an organisation to establish its expenditure on production in relation to revenue generation. Modern production environment relies mainly on technology, which limits the use of Traditional Absorption costing techniques (Frost, 2005). In addition, there is minimal use of human personnel in modern manufacturing that promotes the use of more advanced costing approaches. Managers should examine and understand the advantages of the two costing systems in a modern manufacturing environment (Lembersky and Lembersky, 2005). This paper discusses the various reasons why most firms use activity-based costing methods over the tradition absorption method. There are mainly two costing methods used by companies in different manufacturing environment that include absorption and activity-based costing techniques (Needles, Powers and Crosson, 2011). The Modern Manufacturing Environment involves the use of modern technology in the manufacturing industry. The use of technology enables organisations to reduce the cost of labour and increase production rates. In addition, modern manufacturing environment entails production of large volumes of goods at a cost, which promotes the companys profitability. The primary characteristics of a modern manufacturing environment include the following. First, the manufacturing environment entails an intense competition internationally. Most of the firms that operate on modern manufacturing environment experience high levels of competition on an international platform. For example, companies operating in the automobile industry experience great competition internationally, which require them to reduce production cost in order to initiate cost, based competition strategies (Lembersky and Lembersky, 2005). Secondly, the modern manufacturing environment involves rapid innovation in production. Production innovation is essential in establishing cost effective production methods such as automation of the production line and use of digital systems to reduce the cost of power and labour (Frost, 2005). Thirdly, the environment involves the use of automated machinery, which minimises the cost of labour. Automation of the production line ensures that most of the operations of the company rely on technology, which reduces the cost of production (Lembersky and Lembersky, 2005). Finally, production in a modern manufacturing environment involves significant changes in the company’s organisational structure in order to suit the new technologies in manufacturing. The modern manufacturing environment mostly involves the use of cost effective techniques, which require adequate cost analysis techniques (Lembersky and Lembersky, 2005). Traditional Absorption Costing System Traditional Absorption costing refers to a technique for accumulating variable and fixed costs associated with the process of production and apportioning them to the cost of individual products. A particular product can,; as, absorb a wide range of production expenses in the absorption costing technique. The costs examined in the absorption method remain as an asset in the organisation until the time when the inventory is sold (Frost, 2005). The selling of the inventory involves charging the assets to the value of the sold goods. The standard accounting principles and International Financial Reporting require the firms to use absorption costing to analyse the inventory value in their financial statements. The primary costs that are assigned to products based on absorption costing system include direct materials, direct labour, and variable as well as fixed production overhead (Needles, Powers and Crosson, 2011). Activity based Costing Activity Based system of costing provides products with manufacturing overhead costs in a logical criterion. This costing technique initially assigns cost to processes and activities that are the actual contributing factors to the overhead (Frost, 2005). The costing approach then assigns the values of the activities to the products require the activities. Costing based on activities recognises that machine setups, special testing and specialised engineering are activities that lead to costs (Goektuerk, 2007). The activities cause costs by enabling resource consumption in the company. The costing system ensures the evaluation of the value of resources utilised for the specific activities. The cost of the various activities is then assigned to the products that required the activities. For example, a product that uses any aspect of machine setup, special engineering or special testing is assigned some of the firm’s costs of the specified activities. In addition, other products that utilise the activities are also assigned some of the costs (Lembersky and Lembersky, 2005). The growth of Activity Based Costing is due to an increase in costs of manufacturing overhead, lack of correlation between productive machine and direct labour hours with the costs of manufacturing overhead. Additionally, the growth in diversity in consumer demands and products as well as production of some goods in large quantities contributes to the growth of Activity Based costing approaches (Lembersky and Lembersky, 2005). There are no differences in calculating the costs of labour and material in both Activity-Based and Absorption costing methods. The primary concern is how to assign the overhead costs to the production cost. Managers in the modern manufacturing environment prefer Activity Based costing technique to the Traditional Absorption approach because of various reasons such as accuracy, logical and applicability (Goektuerk, 2007). The Activity Based Costing mechanism utilises both non-volume and volume-based drivers of cost. On the other hand, Traditional Absorption Costing approach is limited to volume-based drivers of costs such as output units, machine and labour hours. Non-volume-based cost determiners include inspection of production, level of machine setup and the number of acquired stock (Goektuerk, 2007). Activity-Based Costing system focuses on the cost of activities, which is distributed to specific products that demands the activities (Needles, Powers and Crosson, 2011). This costing system promotes accuracy in evaluating the overhead cost of manufacturing because it associates the costs of the outputs to the cost of the activities that leads to its production. This costing system also enables manufacturers to examine the overall cost of production using the costs of a specific product (Lembersky and Lembersky, 2005). Activity Based costing technique promotes accuracy in determining the products contribution to the overall profitability of the company. It also helps in identifying specific products and activities that promote growth in the company, which is not possible with the Traditional Absorption costing system (Goektuerk, 2007). The Activity-Based Costing system allows the managers of a manufacturing firm to examine the activities that require innovation in order to reduce the cost of each activity. This initiative promotes creativity and adoption of technological approaches in manufacturing process, which is highly applicable in the modern manufacturing environment (Needles, Powers and Crosson, 2011). The Activity-Based Costing system is highly preferred in the modern manufacturing environment because it is useful in evaluating larger overheads than the Traditional Absorption costing technique. The modern manufacturing environment relies mainly on the machines, which has increased the production overheads proportion to direct costs. The Activity-Based Costing system is, for this reason, useful in estimating the overhead production per unit, which is not possible with Traditional Absorption costing system. In addition, the Absorption costing system relies mainly on volume-based cost determiners. This dependence on volume-based drivers of cost leads to inaccurate results, when used in a modern manufacturing setup (Needles, Powers and Crosson, 2011). The current manufacturing environment has minimised the use of a large number of human personnel and utility cost due to production costs. These direct costs are useful in evaluating the revenue of a company based on the production costs in the Tradition Absorption costing system. This utilisation of the direct costs such as utility bills, labour and raw materials limits the use of Traditional Absorption costing system in the modern production setup (Goektuerk, 2007). However, the use of the activity costs to evaluate the cost of production is highly effective in the modern industrial setup, which depends heavily on advanced technology (Needles, Powers and Crosson, 2011). The modern manufacturing environment promotes production of large volumes of products, which makes poses difficulties in evaluating the overall production costs (Lembersky and Lembersky, 2005). The manufacturing techniques have changed in various industrial setups worldwide. The changes in the nature of production promote competition among organisations. This high levels of competition in various products’ markets leads to the production of highly diverse and complex products. Production of complex and diverse products in industries results from various innovations initiatives in the manufacturing environment (Lembersky and Lembersky, 2005). This complexity and diversity of products limits various manufacturing firms from using Traditional Absorption costing systems to identify the cost of producing the specific type of product. On the other hand, manufacturing companies use Activity-Based Costing system to establish the contribution of a particle product to the overall revenue of the company (Frost, 2005). In addition, it enables the management to identify cost effective productions resources for specific products in a particular company (Needles, Powers and Crosson, 2011). Activity-Based Costing system also enables the organisations to establish specific activities that promote profitability. Additionally, the manufacturing companies can adopt production activities and resources that enhance productivity through reduced costs (Frost, 2005). This costing system is also crucial in determining competitive market prices for specific products in a company. The modern manufacturing environment depends highly on machinery and mass production whose product costs can be effectively evaluated using Activity-Based Costing system (Needles, Powers and Crosson, 2011). Conclusion Activity Based and Tradition Absorption costing systems are useful in evaluating the revenue of an organisation based on the costs of production. The Traditional Absorption costing system relies on volume-based cost determiners, which are highly scarce in the modern manufacturing environment. Contrarily, Activity-Based Costing system utilise both volume and non-volume-based drivers of costs, which are applicable in the modern manufacturing environment. In addition, the nature of the modern manufacturing environment promotes competition, product diversification and complexity, which hinders the use of Traditional Absorption costing systems. References Frost, W. 2005. ABCs of Activity Based Management. New York: iUniverse, Inc. Goektuerk, H. 2007. Activity-Based Costing (ABC) - advantages and disadvantages. München: GRIN Verlag GmbH. Lembersky, M. and Lembersky, L. 2005. Modern manufacturing technology & cost estimation. Indiana: AuthorHouse. Needles, B., Powers, M. and Crosson, S. 2011. Financial and managerial accounting. Mason, OH: South-Western Cengage Learning. Read More