Management Accounting - Case Study Example

Introduction Activity based costing is essential to managers and business entities since they provides with accurate information on the appropriate method of service and product costing. In essence, this information helps in making and informed ad sound decision on policies and approaches to profitability. Moreover, this approach helps in increasing the understanding on the cost drivers and overhead. Units selling price Advanced circuit units 3000 32 Boosted Circuitry 1000 40 Customized Circuitry 500 620 Requirements in hours & units Advanced Boosters Customized Direct material cost 0 7 100 Direct labor 2 1 0 Machine hours 1 2 0 Solution Advanced circuit, Booster cost, and Customized cost Income statement for Feb. 2014 Details AC B CC Totals Revenue (3000*320) 960,000 (1000*400) 400,000 (500*620) 310,000 1,670,000 Less: Marginal cost Manufacturing cost Direct material cost (3000*0) 0 (3000*7) 21,000 (3000*100) 300,000 (321,000) Direct labor (3000*2*80) (3000*80*1) (3000*0*80) Add: overheads Labor overheads (3000) (2/3*3000) 2000 (1/3*3000) 10000 0 (3000) Machine overheads (60000) (1/3*60000) 20000 (2/3*60000) 40000 0 60000 Variable overheads (180000) (3000/4500*180000) (1000/4500*180000) 0 (180000) Total cost: (22000) (62000) (300000) (384000) Add: mark up (20% ) (4400) (12400) (60000) (76800) Total production cost (26400) (74400) (360000) (460800) Net profit/income 933600 325600 50000 1209200 For AC and BC, we are heating the target but in CC, we are incurring a loss Part B Workings AOAR (activity overhead absorption rate) =total overheads/cost driven Labor related overheads Production scheduling =94500/370 255 per order Inspection =174000/8000 21.75 per inspection Packaging and shopping =166500/4500 37 per boards Machine related overheads Machine setup AOAR =176400/17000 10.38 per setup Machine insertion AOAR =300350/1320000 0.23 per insertion Machine soldering AOAR =83250/207500 0.4 per part Variable overheads General supplies =40000/7000 5.7 per machine Procurement =75000/207500 0.36 per part Hazardous waste disposal =65000/60000 1.08 per grain waste Solution Details Advance circuiting Boosted circuiting Customized circuiting Totals Labor overheads Production scheduling (255*0.1) 25.5 (0.02*255) 5.1 (0.1*255) 25.5 56.1 Inspection (1*21.75) 21.75 (2*21.75) 43.5 (4*21.75) 87 152 Packaging and shopping (25/220*37) 4.2 (70/220*37) 1 (125/220*37) 21 37.2 Machine overheads Machine setup (2*10.38) 20.76 (5*10.38) 59.1 (12*10.38) 124.56 197.22 Machine insertion (20*0.23) 27.6 (480*0.23) 110.4 (960*0.23) 228.8 358.8 Machine soldering (25*0.4) 25.04 (70*0.4) 28 (125*0.4) 50 103.04 Variable overheads General supplies (1*5.7) 5.7 (20*5.7) 114 (4*5.7) 22.8 142.5 Procurement (25*0.3) 9 (70*0.36) 25.2 (125*0.36) 45 79.2 Hazardous waste disposal (10*1.08) (15*1.08) 16.2 (30*1.08) 32.4 59.4 Total production cost ABC 150.35 406.3 629.06 1185.71 Notably, activity based costing is an accounting term that refers to the monitoring and costing activities that entails tracing the resources, utilization, and costing the outputs. Essentially, the resources are assigned to the activities to the cost objects. Later, the cost drivers are attached to the activity costs of the output. In other words, activity based costing is the current alternative to absorbing costing; this is essential in helping managers to understand customer and product net profitability. This is essential in providing the business with better information that enhances value based. Imperatively, activity based costing is essential for managers in making sound and informed decision on resource allocation. Activity based costing focus is on the activities that increases the cost of a product, as well as, cost drivers. Notably, the traditional absorption costing focused o the volume related driver, unlike activity based costing that focuses on cost drivers. In simple terms, absorption costing focuses on volume drivers such as labor hours while activity based relies on number of orders received. This is essential in tracing the product since the variable overhead is considered fixed cost traditionally. The figure captures what activity based costing entails Advantages of activity based costing Notably, activity based costing makes the non-value adding activities to be clear and visible. This helps managers to eliminate and reduce activities that increase the cost of business operation thereby increasing profitability. Effectively challenging the operational cost is essential in helping managers to allocate overheads effectively. In addition, activity based costing is in improving customer and product profitability analysis. Moreover, this technique helps in supporting the performance management tools such as scorecards and continuous improvement. When implementing activity based costing, one needs to consider organization culture and management style that is top down. This is essential in involving all the stakeholders in the organization and inducing a corporate learning, as well as, instigating innovative ideas. In essence, top management needs to be committed in developing new strategies and approaches in management of the entity. Inappropriate costing information and approach hinders company’s competitive and comparative advantage. Essentially, the role of activity based costing is to allocate overheads in manufacturing based on current labor and tracing direct labor cost to products and customer. Implementation of this technique will enable the company to spur development in the information technology. Computerization of the accounting and implementation of the enterprise resource planning will enable the company realize profitability. Standardization of the processes and working practices are essential in enhancing growth in an organization. Managers get sufficient information when using activity based costing in making decisions that are value based. Therefore, it is assist in product prioritization and pricing decisions hence activity based costing should be implemented to enable placement and management of processes in realizing profitability. However, not all costs are relevant in making decisions since not all cost will disappear with discontinuation of the product. For instance, the business entity will continue to incur occupancy cost even when the product is discontinued. In essence, the managers need to understand that resource implications are essential in managing and running activity based costing. The business entity needs to have necessary resources in implementing activity based costing. Moreover, the costs of managing the business should not outweigh the benefits accrued. In other words, activity based costing is essential in accurately costing customers, distribution channels, and products, or services. The entity will also establish the non-value adding activities, as well as, waste hence make a decisive decisions. Conversely, understanding people better is essential in facilitating benchmarking and production of customized products. Cost determination using activity based costing is reliable and accurate since it focuses on the effect and cause linkage in the goods producing context. This is because cost in the business is allocated based on appropriate cost drivers. Accurate allocation of overheads is essential in occupying considerable portion in the total cost components. Notably, activity based costing helps in identifying customers’ losers and winners hence enabling management to influence the bottom line. This is essential in eliminating management of clients in terms of changing the customers’ terms. In sum, activity based costing system helps in allocation of indirect cost basing on the cost drivers making the business process to perform well. Proper allocation of resources is essential in businesses hence activity based costing helps in allocating resources on profitable and efficient activities. In essence, activity based costing helps in improving business processes hence continuous improvement. Limitations of activity based costing Establishing and maintaining the activity based system is time consuming and expensive since business processes and activities needs to be analyzed. In essence, breaking down the activities I each component is cumbersome, expensive, and time consuming. Data collection and gathering will use the valuable resources as they are entered into the system. In addition, implementation of activity based costing requires knowledgeable and expert in the field, which can be expensive to procure. In essence, a consultant in establishing the activity-based system is needed. They will be used in setting up the system and training the staff on using the system. Furthermore, using software in the implementation of activity-based system is expensive. However, this is essential in automating manual aspects of activity based costing. In addition, activity-based system produces reports that contain much information that varies from the information as reported it conventional costing approaches. The traditional costing techniques does not produce information such as product margins. This means that activity based costing can be irrelevant in making decision in a business entity; for instance, when the activity based costing dos not kowtow to accounting principles. This is because conventional costing figures tend to be norm hence interpreting the activity based costing can be confusing when used along with regular accounting information. This means that the management can make a wrong decision. However, when used appropriately activity based costing system can help management in simplifying integration with regular accounting information. Moreover, reconciling activity based costing and the general ledger to kowtow to generally accepted accounting principles is difficult to accountants. As a result, this causes distrust between management and stakeholders hence disrupting business activities. The traditional costing approaches assume full use of resources and do not address capacity issues. Therefore, deploying analysis is inherently difficult and unmanageable. Furthermore, activity based costing is overly detailed thus require maintenance of resources making implementation of the model difficult. Activity based approaches emphasize on change hence faces resistance from the workers as it contradicts corporate culture; mostly, organization change is difficult. Another disadvantage of activity based costing is that it can be misinterpreted. This calls for the management to examine the analysis in making rational and informed decision. This is because cost attached to customers, products, and other objects can be rendered irrelevant. Hence, managers need to identify relevant cost before making decision. Notably, reports that activity based systems fail to conform to the generally accepted accounting principles. As a result, the management will be forced to use two accounting cost systems; one for external and one for internal use. This is an addition responsibility to staff in the accounting department. In addition, implementation of activity based costing system in an organization requires enough resources both financial and human. The system is costly to maintain owing to data checking, collection, and entry into the system. Emphasizing on control and details can be difficult to understand hence making the business entity lose focus on the strategic objectives in cost saving. For example, activity based costing can categorize a supply channel as non-remunerative and non-value adding. However, this distribution channel can be helpful in other strategic objectives other than achieving profitability. Read More