Activity Based Costing - Assignment Example

Business Management xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Lecturer xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Kent garage and spare parts A renowned motor vehicle repairer and genuine motor vehicle spare parts, we specifically specialize in Standard component - exhaust Custom component – valve Question 1 Costing systems are information systems put in place by an organization’s accounting department to minimize waste during production by effective monitoring of the costs incurred in the production process, (Al-Omiri & Drury, 2007). The information processed through the costing systems facilitates decision making for the management. Costing techniques on the other hand are the different available for the management to control cost. Several costing systems and techniques can be used to establish the cost of the company's products taking in to account all possible business functions within the company. Such systems and techniques are activity based costing, job costing marginal costing, parts costing, the process costing and absorption costing, (Yahya-Zadeh 2011). Activity based costing This costing technique evaluates the true costs of a product or a service. This technique assigns manufacturing or production overheads to the products. By this, it is more logical and gives true and accurate information thereby helping the management in making decisions. ABC focuses more on activities and hence assumes that overhead costs are caused or incurred by various activities. It also assumes that many products utilize these costs homogenously. This system recognizes the connection and relation of activates, coats and products, it is more useful and important than the traditional method of allocating costs by machine hours, (Askarany et al, 2010). Though this costing technique is expensive to implement the long term benefits outweigh the costs of implementation. Companies especially manufacturing, process and production companies should use this technique. This is because, unlike the other techniques, it improves efficiency and helps identify activities that do not add value to the products. It highlights activities and functions that are not performing well, the management uses this as a decision making tool. The other costing techniques were not used because they are difficult to identify activities that cause or influence costs, they does not use cost drivers appropriately like ABC and they are not advisable to use for big manufacturing concerns. This made ABC the best option to use in this company. Process costing This is a costing system where the organization is involved in mass production of their products in a series of processes. In this system it is the process involved in costed, unlike with job costing where it is the job order that is costed or in contract costing where costs are charged to the specific contract, (Al-Omiri & Drury, 2007). In process costing the total production cost incurred in the production process are accumulated and then ascertained to their specific level of production. Use of this system in a company is effective because it is easy to allocate the expenses s to the specific process. It also enhances good management because the information on the cost of each process is available. When a company adopts this costing system it becomes easy for the management to give tenders and their quotations. The output of one process in the costing system is often carried forward to the next system as an input, (Yahya-Zadeh 2011). This facilitate in lowering the cost of production incurred in an organization. Question 2 Determination of unit costs of labeling Operation capacity = 80 units per hour Operational costs = £9500 per week Material costs = £17 per hour Number of working hours per day = 8 hours a) Five working days per week Number of hours = 8 hours x 5 days = 40 hours Total capacity per week = 80 units x 40 hours = 3200 units Material costs = £17 x 40 hours = £680 Total costs = operational costs + material costs = £9500 + £680 = £10180 Unit cost = total costs/ total capacity (units) = £10180/3200 units = £3.18/ unit b) Seven working days per week Number of hours = 8 hours x 7 days = 56 hours Total capacity per week = 80 units x 56 hours = 4480 units Material costs = £17 x 56 hours = £952 Total costs = operational costs + material costs = £9500 + £952 = £10452 Unit cost = total costs/ total capacity (units = £10452/4480 units = £2.33/ unit There is a difference on the unit cost that exists between the two methods. When using the operational costs for the five-day week, the cost per unit is more at £3.18/ unit. This is bigger than the second one where a week has seven days, £2.33/ unit. The operational costs are constant for the two methods. From the results it indicates that the more the working days the lower the unit costs. This is because the operational costs are constant. In this regard, the company should adopt a seven days working week to reduce the costs per unit of the components. The seven days working week is more efficient than the five day working week. This is a good strategy that the company management should apply to minimize the production costs. However, the management must be considerate of the labour costs if it decides to increase the working days of the week to more than seven. Importantly, the company would be more efficient when working at seven working days a week. Question 3 2.1 cost of each product   Component 1 cost Component 2 cost Production volume 1500   500   Direct Material’s cost £30/unit £ 30 £45/unit £ 45 Activity based production analysis:         Set-up cost 1@£20,000 £ 20,000 1@£20,000 £ 20,000 Manufacturing costs 600@£5/unit £ 3,000 600@£15/unit £ 9,000 Assembly cost 600@£4/unit £ 2,400 600@£6/unit £ 3,600 Packaging 350@£15/unit £ 5,250 150@£15/unit £ 2,250 Despatch/delivery 350@£25/unit £ 8,750 150@£25/unit £ 3,750 total costs   £ 39,430   £ 38,645 Activity-based product cost for each component 1 = £39,430/1500 = £26.28 Activity-based product cost for each component 2 = £38,645/500 = £77.29 2.2 suitability of this type of costing Activity based costing is suitable for an engineering business we established; first, this costing method is more accurate than the other costing methods. It is more reliable as it focuses on the effects and causes of activities and costs on the production of components. Management can therefore rely on this method in their production process, (Kennedy & Affleck-Graves 2001). Second, it allocates the overheads on the costs drivers, for this, it identifies the costs for which cost drivers incurred them; the management can be able to trace which cost driver is incurring huge costs for review. Overheads for a significant part of the total costs, fair allocation of the same helps in tracing them accordingly. This is in addition to provision of information to management and therefore makes informed decisions. This costing system improves the process in this company. Its allocation of the costs to their drivers indicates which parts are performing well as well as which ones needs to be improved. The processes or activities that do not add value are identified and done away with hence improving efficiency. It facilitates performance management in this company. Lastly, this costing system provide strategic directions for the business, it as well develops operational methods and policies, which improves efficiency considerably. 2.3 impact on business performance   Component 2 cost Production volume 2000   Direct Material’s cost £45/unit £ 45 Activity based production analysis:     Set-up cost 1@£20,000 £ 20,000 Manufacturing costs 600@£15/unit £ 9,000 Assembly cost 600@£6/unit £ 3,600 Packaging 150@£15/unit £ 2,250 Despatch/delivery 150@£25/unit £ 3,750 total costs   £ 38,645 Activity-based product cost for each component 2 = £38,645/2000 = £19.32 There is a great decrease in the cost of each product when the company products are changed from component 1 to component 2 at a production volume of the same units, that is, 2000 units. The total costs of producing each unit of component 1 and 2 are £103.57. When changed, the total costs of producing each unit of the combined components are £19.32. The difference is £84.25, which is the impact on the business performance. This is a very huge difference, it indicates improvement in efficiency on operations and used of use of materials. Advantages There is many savings on the costs of producing the units. In addition, it gives better pricing margins as the cost of production is lower. The company can be able charge lower prices, and thus have higher profit margins. Another advantage of this activity to the company is that it lowers the overall costs of production incurred due to reduced labour costs, (Kaplan & Anderson 2007). There is increased efficiency because of the savings in production costs. Disadvantages Lower production costs may make the customers to question the quality of the products hence may be reluctant to purchase the company products. The composition of the costs of this activity is unclear; this brings in confusion to the production process. The decision to drop the production of one component will make them loose their customers who were buying that component. In the same way, increasing production of the other component does not guarantee increase of sales for the product. The activity does not eliminate the wastage of materials, (Drury 2007). There will loss of employment opportunity for the workers, this deprives them economic benefits. References Al-Omiri, M., & Drury, C, 2007, A survey of factors influencing the choice of product costing systems in UK organizations, Management Accounting Research, 18(4), 399-424. Askarany, D., Yazdifar, H., & Askary, S. (2010). Supply chain management, activity-based costing and organisational factors. International Journal of Production Economics, 127(2), 238-248. Drury, C, 2007, Management and cost accounting, CengageBrain. com. Kaplan, R. S., & Anderson, S. R. (2007). Time-driven activity-based costing: a simpler and more powerful path to higher profits. Harvard business press. Kennedy, T, & Affleck-Graves, J, 2001, The impact of activity-based costing techniques on firm performance, Journal of management accounting research, 13(1), 19-45. Yahya-Zadeh, M, 2011, Product-mix decisions under activity-based costing with resource constraints and non-proportional activity costs, Journal of Applied Business Research (JABR), 14(4), 39-46. Read More