Unit Cost Allocation Accounting Systems - Assignment Example

Unit Cost Allocation Accounting Systems Name Instructor Course Code Institution Due Date Unit Cost Allocation Accounting Systems I. Introduction: Costing Systems The market environment that firms have to operate in is frequently undergoing change with continually rising rivalry. Therefore organizations have to manage costs much more proficiently to ensure optimization of product margin above production costs. Accounting is largely involved with giving information to management and those who make decisions. Therefore it is imperative that measurement of the cost items be accurate in allocating cost for each unit of product. Brilliant Accents Company uses the traditional way to cost management referred to as full costing as is evidenced in their unit costs accounting. Using this means, total cost is divided into direct plus indirect costs. Direct costs can be attributed directly to unit product while indirect costs/overheads include other elements of cost which cannot be attributed directly to units of product but are a result of general operation of the firm (Hermanson, Edwards and Ivancevich, 2007). For firms producing more than one brand or product type, allocation of overheads to a particular unit produce becomes more of a problem because all units cannot be allocated equal unit cost. For a business like Brilliant Accents Company, one of the systems that can be used for allocation of overheads to particular unit product is by viewing overheads as service renderers for individual cost units (Atrill and McLaney, 1995). Since unit cost is not to be allocated equal portions of overheads, managers must identify observable measures for use as allocation basis. Brilliant Accents uses a system of allocation of overheads per hours used up in production between the two products. Although there is no totally accurate method for allocating overheads to unit cost, the level of accuracy in measurement of unit cost should uphold the Accrual Concept. The Accrual Concept requires that all costs associated in production of a particular unit of a commodity be apportioned to it in the accounts (Mongiello, 2012). The system in use for allocation of overheads in Brilliant Accent falls short of acceptable levels of accuracy in that allocation of machine costs between Brass and Chrome product types is ambiguous in respect to machine repairs and maintenance. Manufacturing overheads other than machine costs seem to be arbitrarily allocated between the two product types and the method used to arrive to this allocation is not explicitly displayed in the accounts. A more accurate system under the full/absorption costing employed by Brilliant Accent would be allocation of overheads by cost center apportionment. Full costing, however, has been criticized over its use of past cost and restriction of future costing to outlay cost only. II. ABC System for Unit Cost Allocation The traditional cost management systems that were employed by organizations in the past have proven to be inadequate in the modern management context. Therefore there is need for a more accurate cost allocation base of overheads for unit produce in multi-product firms like Brilliant Accent. Changes in the operating environment and increasing market competition have led firms to pay closer attention to overhead allocation. In firms producing more than one brand product, failure to accurately account overheads to unit cost may mask the actual performance of individual products in contributing towards profitability of the firm (Mongiello, 2012). The firm might actually be holding unprofitable products in their production lines at the expense of more profitable ones. Activity-Based Costing (ABD) system adopted in modern cost accounting practices aims to overcome such problems by tracking the costs of support activities making up overheads costs directly to particular production units. In attributing overheads, ABC requires: establishment of an overhead cost pool for each activity; allocating the total costs for each support activity to the relevant cost pool, and; charging the total cost in each pool to the particular product output using the relevant cost driver (Atrill and McLaney, 1995). In keeping with the above, the ABC system proposed by Brilliant Accent’s controller allocates overheads to unit costs of the two products based on activity centers involved in the procurement, production and supply processes. In the proposed system, overheads have been allocated under allocation bases for soldering, machine power, machine setups and quality control activity centers in actual production, and shipments and purchase orders activity centers (John and Barbara, 2007). For soldering, number of solder points has been used as a measure for allocating soldering overheads, number of inspections for quality control, machine hours for machine power and number of setups for machine setups. Number of shipments has been used as a measure for allocating overhead costs for shipments while number of orders is the measure for quality control activity overheads. Through the proposed ABC system, Brilliant Access’ controller has sought to establish a more accurate cost allocation for each unit of the two products. A more accurate cost allocation system should help the top management make a clearer decision concerning whether to face out the brass line of product or not. It would also enable decision on which product to concentrate on and which one needs to be improved for higher profitability, while providing a basis for making better pricing decisions for the individual products (Mongiello, 2012). By breaking up the overhead costs into the various support activities and related costs, management will gain a better understanding of their particular business sector, which would enable a better cost control mechanism for improved efficiency. The proposed ABC system of cost allocation would also place Brilliant Access in a better position for assessing likely effects of introduction of new processes and products on production activities and their related costs. III. ABC Cost Allocation: Calculation of Unit Cost, Gross Margin & Gross Margin Percentage The figures indicated in the proposed ABC system for Brilliant Accent Co. can be used to calculate the Unit Cost, Gross Margin and Gross Margin Percentage for the two individual products to complete the ABC cost allocation analysis. Using the ABC cost allocation approach, the various activity-base costs are calculated below. The formula for cost per unit for the two products for each activity center is: Unit Cost for Activity Center = Units for the Cost-Allocation Base = for each Activity Center x Total Activity Centre Costs Total Units for each Activity Center The above formula has been used in the table below to calculate the individual unit costs for each activity base for the two products. Activity Base Total Activity Cost Bases of Appointment Cost per Unit, Brass Cost per Unit, Chrome Soldering 23,500 No. of points 1,185,000 x 23,550 1,570,000 = 17,775 385,000 x 23,550 1,570,000 = 5,775 Shipments 21,500 No. of Shipments 16,200 x 21,500 20,000 = 17,415 3,800 x 21,500 20,000 = 4,085 Quantity Control 31,000 No. of Inspections 56,000 x 31,000 77,500 = 22,480 21,300 x 31,000 77,500 = 8,520 Purchase orders 23,760 No. of Orders 80,100 x 23,760 190,080 = 10,012.50 109, 980 x 23,760 190,080 = 13,747.50 Machine Power 1,440 No. of Hours 176,000 x 1,440 192,000 = 1,320 16,000 x 1,440 192,000 = 120 Machine Setups 18, 750 No. of Setups 16,000 x 18,750 30,000 =10,000 14,000 x 18,750 30,000 = 8,750 Totals 120,000 79,002.5 40,997.5 From the above, the total cost per unit product for the two products is obtained as follows: Brass Chrome Direct Materials 5.20 14.60 Direct Labour 0.45 1.05 Machine Costs 3.60 1.80 Manufacturing Overheads 5.00 2.50 Overheads 3.59 10.25 Total Unit Cost 17.84 30.20 The selling price for Brass is $22.50 per piece, while that of Chrome is $28.50 per piece. The margin on price is calculated as follows: Gross Margin = Selling Price – Unit Cost Gross Margin % = Gross Margin x 100 Unit Cost Therefore, the return on unit sales is obtained as follows: Brass Chrome Selling Price 22.50 28.50 Total Unit Cost 17.84 30.20 Unit Gross Profit Margin 4.66 (1.7) Unit Gross Margin Percent 26% -5.6% IV. Key Findings under ABC Cost Allocation From the above calculations based on the ABC system, it is evident that the previous full costing system was not accurate in its overheads allocation to unit cost and consequently did not bring out the true profitability for the two products. Considering the cost of overheads obtained using the ABC system with the previously recorded, it is evident that the overheads allocation for Brass had been overstated while that of the Chrome model understated. Consequently, the contribution of the Brass model to profits of Brilliant Access Co. had been masked by inaccurate unit cost allocation, such that the product seemed to be making significantly lower profit than the Chrome model. In addition, the Chrome model is being sold at a price lower than its production unit cost. Therefore the product had been raking losses for the company, which was not evident using the traditional cost allocation approach. In light of these findings, the management would be gravely wrong in facing out the Brass model from its production line. Concentration of marketing efforts on the Chrome model was ineffective considering that the selling price for the product was not favorable. Management therefore ought to consider raising the price of the Chrome product or facing it out altogether (Kren, 2005). Marketing effort needs to be concentrated on the brass model owing to its role in profit contribution. V. Reflection Concerns raised by the division president at Brilliant Accent about the feasibility of using the ABC system are not founded on sound managerial accounting basis. Her concern that management may consider facing out the Chrome model instead of the Brass model shows attachment to the Chrome model for reasons other than concern for the company’s profitability. Her suggestion to use number of hours for machine setup and quality control inspection is not sound since, compared to the base of appointments used, this would yield more inaccurate results than those obtained in the ABC system. Her statement that the figures ought to be changed to reflect a more favorable market position for the Chrome model is unprofessional since accounting management’s main aim is the provision of accurate and sufficient information for basing management decisions. However, her concern over measurement issues is of significance since not all costs can be easily identified with a particular activity. For instance, the cost of machine repairs and maintenance can not be specifically attributed specifically to any of the two products. The inclusion of all production activities of Brilliant Access Co. in the ABC system may also not be readily possible considering that it would make the system to be time-consuming, complex and costly (Atkinson, Kaplan, Matsumura, and Young, 2011). VI. Ethical Issues The controller for Brilliant Access Co. should consider better communication with the division president to better bring fourth his concern for cost-allocation accuracy and the need for change over to the ABC system. This would entail going through the report creation process with the participation of the division president. In the event this fails to convince the division manager, the controller should consider bypassing her authority and showing the report to the top management in good faith for the company’s welfare (Ireland, 2005). Accounting profession ethics require that the controller does not yield to Masons demands for changing the cost figures in favour of the Chrome model. Instead, he should endeavor at all times to provide accurate accounting information to facilitate sound managerial decisions. VII. Conclusion Full costing is mostly applicable to companies which have only one product or whose products have similar production processes. The difference in the figures obtained using full costing and those obtained using ABC show that Brilliant Access should consider the ABC cost allocation system (Cokins, 2006). Other modern costing systems exist in accounting practice including Total Life-Cycle costing, Target costing, Quality Control costing and Kaizen costing (Haider Ali and Shaukat, 2011). In the case where further internal investigation reveals the inapplicability of ABC, Brilliant Access Co. should consider changing their costing system to any of the other systems and doing away with the traditional full-costing approach. References Atrill, P and McLaney, E 1995, Management Accounting for Decision Makers (6th Ed.), Prentice Hall: London. Cokins, G 2006, Implementing Activity-Based Costing, Institute of Management Accounting. Montvale: New Jersey. Hermanson, Edwards, and Ivancevich, 2007, Accounting Principles: Managerial Accounting. Textbook Equity, Inc. EBook, Retrieved from http://www.textbookequity.com/ Ireland, J 2005, Principles of Accounting, University of London Press: London. Mongiello, M 2012, Management Accounting, University of London Press: London. Haider, S and Ali, M and Shaukat M 2011. Strategic Management Accounting – A messiah for Management Accounting? Australian Journal of Business and Management Research: Australia, Vol. 1, No. 4 [01 - 07] July, 2011. Kren, L 2005, Managerial Accounting, University of Wisconsin – Milwaukee: Maryland. John, J, W, Barbara, C 2007, “Cost Allocation and Activity-Based Costing Systems”, in Management Accounting, Information and Decisions, Irwin/McGraw-Hill: Boston. Atkinson, A, Kaplan, S, R, Matsumura, M, E, Young, M, S 2011, Management Accounting: Information for Decision Making and Strategy Execution, Pearson Education: London. Read More