Due to this heavy and stiff competition, a highly reliable and accurate method is required for the cost management. It helps in find out that area which is only a wastage for profit and disturb the amount of profit. On each overhead activity, the total cost of that overhead activity is collected at the organizational level. There are two main methods of costing, absorption and activity based costing. There has been a reduction in the amount of direct labor usage and a substantial rise in total overhead costs. However, there are disadvantages to this method; high volumes of specific data must be accurately collected, which could prove to be extremely time consuming. The Activity Based Management helps in determining the contribution of each person and also support Balanced Scorecard.
You are required to: To identify and discuss four factors that support the assertions that the relationship between a product and the overheads it causes can no longer be expressed in simple terms as single burden rate. With activity-based costing, we dig into the manufacturing process to determine number and type of activities required. Conversely, the traditional costing system incorrectly indicates that the small retail channel generates the highest profit margin 16% , followed by the mass merchandise 9% and wholesale 7% channels, respectively. Plant information systems, manufacturing capabilities, and plant performance. Allocation is the process of assigning overheads that are directly linked to the activity cost centre whereas apportionment is used where the overheads cannot be directly linked to the activity cost centre and have to be shared between several of them.
If the target cost is higher than the expected cost, the company has the several options to reduce target cost. Estimate an amount for the cost-driver for the appropriate period hours per quarter, etc. Companies usually use traditional costing for external reports, because it is simpler and easier for outsiders to understand. Activity based costing provides real accounting solutions to the organizations. Furthermore, some indirect costs can be difficult to assign to an individual unit or product produced. I have come to this conclusion as a result of the following research undertaken below. Brought to you by Activity Based Costing Activity based costing considers the costs associated with various activities.
The traditional costing method is best used for manufacturers that only make a few different products. If any company is using the wrong inappropriate techniques of costing then it can adversely affect their pricing strategy and they can lose their competitive edge and can create danger over the sustainability factor Rahman, Omar and Abidin, 2003. It will incur costs in the form of material, labor and other overheads and produce a number of units. This is the theoretical capacity. Traditional costing system is very much effective where the product line is not complex and company is dealing in one type of product Capettini, Chow and McNamee, 1998. To do it, it could require five full-time employees, each working 2,000 hours, plus another three supporters, also working 2,000 hours each.
This is called the overhead cost pool of that activity. Accountants who use absorption costing must allocate the overhead costs to each product being produced. Activity based costing uses multiple cost drivers to allocate costs. With activity-based allocation of overhead costs, it is easier to identify areas where expenses are being wasted on unprofitable products. Accepting historical costs as a given and reflecting these costs in standards does not support continuous improvement. Each financial situation is different, the advice provided is intended to be general.
Journal of Financial Reporting and Accounting. Other than this it is helpful for the organizations that use production cost as fixed cost. Managers can accurately determine the effectiveness and efficiency of activities based upon the collective and individual activities together in the activity cost pool. This is true for the present organizations as in them goods are manufactured by integrating technology with manpower. Traditional Costing and Activity-Based Costing System : 2 Two-Stage Allocation: It can be observed that both the costing systems follow a two stage allocation procedure. Also, unit cost of each activity driver is worked out by dividing the total overhead cost pool of that activity by the total units of the cost driver used at the organizational level.
In this simplified illustration, the organization has recognized four different activity cost pools i. However, for this same reason, it is a bit more complicated and time-consuming. The cost of products and other information are determines from the input data as per the particular costing system defined methodology. Therefore it depends on the company as to which method they would implement. It combines an actual cost with a factor to calculate how to allocate indirect costs, called a cost driver.
The traditional method takes one pool of a company's total overhead costs to allocate universally to all products. Analyzing costs can help companies make strategic, financially sound decisions. It also allocates the usage of common business resources to each product, again by the use of cost drivers such as labour hours. The three main cost drivers would be transaction, duration and intensity drivers. Activity base costing give a special report to management for taking decision about selling, designing and transferring of product and its costs.
Both forms of costing have various benefits as well as disadvantages. The overhead rate gets applied on the basis of a cost driver, such as number of labor hours required to make a product. Two roommates in an apartment will typically split the costs of rent, utilities and groceries, and they have a couple of options for doing so. Evidently, there are many inherent inaccuracies in this approach Atkinson and et. Is it good or bad? Activity base costing and traditional costing both used for measuring the cost of production of all products used in the companies or manufacture in the company. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues.