Why ABC System Results in More Accurate Costing - Example

Management Accounting Table of Contents Table of Contents 2 Introduction 3 Discussion 4 Explanation about Why ABC System Results in More Accurate Costing and Better Information for Decision Making 4 Discussion about the Wrong Decisions that Could Be Made as a Consequence of Current Costing System 5 Discussion of General and Specific Limitations of Sunny Power’s Proposed System 6 Recommendations to Eva Green 7 Conclusion 8 References 9 Appendix 10 (A) (1) Product Cost of Panel A 10 (A) (2) Product Cost of Panel B 11 (B) (1) Classified Profit Statement by Region for Panel A 12 (B) (2) Classified Profit Statement by Region for Panel B 12 (C) (2) Activity Based Costing for Product Panel B 14 (D) (1) Activity Based Costing for Product Panel A Region Wise 15 (D) (2) Activity Based Costing for Product Panel B Region Wise 16 Introduction Costing is a subdivision of management accounting, which is usually practiced by the organizations with the aim of identifying the costs involved during the manufacturing procedure. At the same time, costing enables in recognizing the expenses incurred on a segment basis that encompass prime cost, factory overhead cost, administrative cost and advertising along with sales related costs among others. Additionally, it can be affirmed that management accounting procedure helps an organization to make decisions for the future (Mason, n.d.). In this regard, it is witnessed that the organization Sola Systems as per the case study provided has utilized traditional costing system for calculating its profitability level while dealing with the business of selling two sorts of solar panels i.e. Panel A and B in two of the regions. In relation to the above context, the prime intent of this assignment is to provide a better understanding about the costing systems, challenges as well as substitutes to the Chief Executive Officer Ms. Eva Green of Sola Systems based on the provided case study. With the aim of fulfilling the above stated objective, various calculations including product cost of each panel by using current as well as ABC method and classified profit statement by region using the similar mechanisms have been made. Apart from these, certain general and specific limitations of the proposed system of Sunny Powers have been discussed and suitable recommendations are made regarding the improvement in the same with due focus on the calculations made. Discussion Explanation about Why ABC System Results in More Accurate Costing and Better Information for Decision Making In general, ABC method is regarded as a specific accounting tool, which identifies the distinct activities conducted within an organization and likewise assigns the involved expenses to each of such activity in a precise manner. In this regard, it can be claimed that ABC method helps an organization to analyze the business related costs more accurately, which usually assists organizations to take decisions while incurring any expense towards any operational segment. While explaining to Ms. Eva Green about why the ABC method results in more accurate costing of the regions and better information for decision making, it is to be affirmed this particular method is articulated in a general ledger manner wherein each overhead cost is viewed to be assigned with the respective operational segments in a precise manner of an organization. In this similar context, with the inclusion of ABC method, such organizations can attain a better idea about how and when the costs need to be incurred for reaping several significant benefits. These benefits can be measured in the form of enhancing profitability in terms of market share and attaining superior competitive position as compared to other chief business market competitors (Mason, n.d.). According to the viewpoint of Mason (n.d.), huge figure of organizations have concentrated on cost accounting process with the intention of determining the product costs including the expenses incurred while purchasing raw materials and employing labor force. By taking into concern the profit statements (see Appendix) prepared in relation to the case of Sola Systems, it can be found that in case of trading costing procedure, the production cost of Panel “A” is ascertained to be approximately $33,709.8, whereas based on the ABC method, the same has been accounted to $22,103.2. The representation of this information by the ABC system may support the company to identify the actual costs incurred by it and make necessary adjustments in gross profit margin. Based on the above analysis, it will be vital to mention that the depiction of the results by the ABC system in a more accurate manner will certainly aid the company i.e. Sola Systems to calculate its profitability level in a precise manner. Discussion about the Wrong Decisions that Could Be Made as a Consequence of Current Costing System While calculating profit statement by region of Sola Systems based on the provided case study, it can be found that that the company faced a loss of $2687.3 and $383.9 in south region relating to Panel A solar type. Similarly, in case of solar type of Panel B, the company has experienced a profit of around $13,095.6 and $6,547.8 in South and North region respectively. Based on the above scenario, it can be argued that through the help of audit cost accounting, an organization can identify the expected revenue margin and according to that, it can make decisions about segmenting its product line for ensuring maximum profitability. In this similar manner, it has been quite clear from the calculations based on the current costing system (see Appendix) that the company faced certain difficulties in case of product Panel A in the form of financial loss. In order to highlight the wrong decisions that could be made by the management of Sola Systems as a consequence its current costing system, certain important facts need to be taken into concern. In this regard, one of such facts can be learned as that the organization has produced the product Panel A in an extensive manner. According to the observation (See Appendix), it is revealed that this product does not have the opportunity of exploring larger profit in northern and southern marketplace, as this faced loss. In this regard, through the incorporation of “Activity Based Costing” approach, the organization Sola Systems can improve its position or profitability margin by a certain level. In this regard, it can be claimed that ABC costing method helps an organization to identify and understand the true costs as well as the productivity of the capital equipment. At the same time, it can be argued that ABC costing supports an organization to recognize the most profitable products from the execution of varied options, which usually assists in raising sales and productivity of such products (Brimson, 1997). On the other hand, in relation to the profit statements (see Appendix), it can be found that the profitability level of product panel B of the company is better than that of product panel A. Thus, in this regard, the management could make wrong decisions on investing more on product panel A under its current costing system. Discussion of General and Specific Limitations of Sunny Power’s Proposed System With regards to highlight the specific and general limitations of the system proposed by Sunny Power, it can be claimed that cost accounting procedure helps an organization to identify varied expenses by considering the prevalent accounting system. In this regard, it is highly essential for the organizations to gather reliable data regarding the business related items with the aim of preparing the reports of cost involvement along with profit or loss statement. In this regard, based on the case study provided, it can be inferred that Sunny Power did not gather relevant data regarding the resource and raw materials of the products, which might make the organization i.e. Sola Systems to face considerable challenges. At the same time, it can be argued that articulating an effective and proper cost accounting technique is quite essential to drive revenues attained from product sales and likewise raise the profitability level by a considerable level (Cokins, 1998). Apart from this, it is also necessary to identify the allocation of expenses regarding raw materials and resources. In this regard, it can be found that Sunny Power did not consider the aforementioned factors while proposing the system. These can be certain specific as well as general limitations of Sunny Power’s proposed system. Specially mentioning, this can be improved by the execution of ABC costing technique or method. For example, the use of this particular technique will aid the organization to identify the actual costs required to expend in each segment for fulfilling its desired objective. This factor will certainly make the organization to allocate expenses under each operational head in an effective manner, resulting in smooth tracking of the expenses incurred, product sales and more importantly determining profit margin. Recommendations to Eva Green By taking into concern the above discussed facts as well as figures, it can be inferred that the ABC approach is deemed to be one of the most suitable methods, based on which, it is possible for an organization to scrutinize and assess its operational performance. It will be vital to mention in this similar context that an organization can observe along with measure its operational performance effectively by various ways. These ways include identifying the resources to be used while producing any product and most vitally recognizing the direct costs involved in the procedure along with segregating the same in diverse operational segments in a uniform manner (Cokins, 1998; Brimson, 1997). Thus, based on this notion, it can be recommended to Ms. Eva Green that instead of using its current costing method, the organization can opt for the ABC method in order to reap the above stated benefits and likewise can determine and enhance its profitability level as per the desired level. Conclusion From the above analysis and discussion, it has been quite clear that an effective execution of ABC system results in more accurate costing of the regions in the form of allocating resources and costs in different operational segments precisely. Based on the calculations made in accordance with ABC method, it can be found that the organization Sola Systems might determine its profitability level especially relating to the products of Panel A & B by ascertaining the costs involved while producing such products and also allocating the resources in an efficient manner. Thus, in conclusion, it can be affirmed that the ABC system would prove to be highly beneficial for the organization as compared to its current costing system, which would aid in appropriately calculating the profitability for each region wherein it operates. References Brimson, J. A., 1997. Activity Accounting: An Activity-Based Costing Approach. Wiley. Cokins, G., 1998. ABC Can Spell a Simpler, Coherent View of Costs. Computing Canada, Vol. 24, Iss. 32, pp. 34–35. Mason, W. H., No Date. Activity-Based Costing. Affirmative Action, pp. 1-3. Appendix (A) (1) Product Cost of Panel A (A) (2) Product Cost of Panel B (B) (1) Classified Profit Statement by Region for Panel A (B) (2) Classified Profit Statement by Region for Panel B (C) (1) Activity Based Costing for Product Panel A (C) (2) Activity Based Costing for Product Panel B (D) (1) Activity Based Costing for Product Panel A Region Wise (D) (2) Activity Based Costing for Product Panel B Region Wise Read More