Activity Based Costing Theory - Case Study Analysis
Introduction
Activity-based Cost theory can be described as an instrument that is utilized in the management of cost. The adoption of the tool has in the recently gained much popularity as it is grounded on a simplified thought in that in any organization the operating expenses which are the overheads are mainly measured through several activities which are required to efficiently perform business and manufacturing procedures (Goektuerk, 2005). Based on its design the tool does not only offer relatively reliable cost information but in addition, all the information relating to the costs origin is indicated. The manufacturing expenses are usually assigned to respective products in a manner that is reasonable as compared to the traditional strategy which mainly incorporates costs allocation of the ground of hours. The theory gives an essential distinction amid resource spending as well as utilization (Goektuerk, 2005). ABC main prime task is breaking out all the indirect operations into useful pools which are then allocated to operative procedures in the approach that the mode in which costs are incurred. The system is therefore anticipated to recognize that firm’s resources are mostly consumed by products and processes in the differing portion for all the activities.
Problem Analysis and Recommendations
ABC system is an approach is where costs assignments are applied for services and merchandises. The approach was mainly created so that all the roles that are linked with traditional costs methods can be handled. The primary benefit of utilizing the approach is that it is a plan and control tool (Hansen & Mowen, 2017). Most of the outdated methods did not hold the capability to work with the costs involved in Information services and products in addition to their failure of supplying the required data as well as recommendations for all the operative sections of a firm. However, for ABC which is a theory based system firms are permitted to make merchandises as well as services in a decent and precise approach. The prime ABC features are that it mainly facilitates the cutting down of increased costs of operations per the unit of cost. However, the sole drawback is that it holds a description of operations and procedure which requires decent allocation which is at times challenging.
The company, in this case, utilizes traditional approaches which lead to the creation of total costs rather than indicating cost on every unit. With the use of ABC the company can benefit by enhancing the strategic decision making by managers in this firm (Hansen & Mowen, 2017). Fresh decisions and information regarding costs can be identified which was not previously being identified so that appropriate costing decision can be made. In this context, managers can gain a better understanding of the parts with most cost and actions can be broken in reference to maintenance and labor (Hansen & Mowen, 2017). One of the prime pooling cost can be regarded as the non-production volume. Further Cylinder Fabrication Corporation generates two differing merchandises one being an average merchandise with increased volume while the other is a customized merchandise that holds lower volume.
If Cylinder Company decides of utilizing machines hours particularly for the calculation of overheads rather than utilizing labor hours this means that the generated output is bound to be highly accurate. This is because machines hours are quite easier to establish as compared to labor hours. Given that the machines work on automatic systems from these machines reliable data regarding the total hours of these machines can be established that was utilized by each product. In addition machines efficiency are almost similar which differs much from that of labor given that the efficiency of humans is never equal (Hansen, Mowen, & Guan, 2009). In reference to laboring hours, the distinction amid expenses for the average products and the customized one can be categorized as high. However, in regard to machine hours, this is a bit lower. It is apparent that customized products require more hours for the working machines as compared to standardized goods. This means that the gap should be lower. It can, therefore, be stated that absorbed expenses in reference to machine hours offer more accurate results as compared to the absorbed expenses relating to labor hours. Through the use of ABC system, it would, therefore, be easier for managers to establish the sales costs more precisely and thus opt for appropriate products pricing and profit maximization approaches (Hansen, Mowen, & Guan, 2009).
Outdated costs methods normally apply resources on the given products in two differing ways. Direct costs such as direct labor and materials are attributed indirect manner to these products while all other resources are assigned randomly characteristically to the products via direct labor time mechanism or machine hours (Hansen, Mowen, & Guan, 2009). Marketing, management as well as sales expenses are excluded in the products expenses. However, for ABC, it does not focus on altering the mode in which direct labor and materials are accredited to all the products that the firm manufactures with an exemption that in all cases direct labor will lose its customized location as the replacement application approach for the operating costs resources. An additional cost that is accounted to be a cost pool that is to be allocated to procedures and products in a useful strategy which does not differ from any given resource is direct labor.
ABC advanced method that differs from all outdated allocation strategies as it makes precise allowances for all the costs sources. Via the utilization of this strategy, this implies that the company will be able to make a more accurate estimation of costs of services as well as the associated products and the involved channels of distribution (Weygandt, Kieso, & Kimmel, 2010. This will create a more justified understanding of how expenses affect the organization and how they should be reduced. Through this, all the members who are restricting change are bound to embrace it given that the benefits will not just be acquired by the corporation but also by staffs. In that when efficiency has been achieved this means that employees will need to employ fewer efforts in their duties. The corporation will improve its production, performance gain a desirable reputation as well as get the opportunity of maximizing income via reduced operative costs.
In addition instead of using the total costs, it will be utilizing the cost units. This approach will interact properly with all the programs that are mainly intended at creating improvements. This will create wastes visibility that will enable the creation of suitable strategies to deal with issues. This will permit the standardization of procedures while supporting high performance as well as increased achievements (Weygandt, Kieso, & Kimmel, 2010. More will be understood regarding costs thus permitting expenses to be broken in a manner that is easy to understand. This will result in the development of strategic decision making by the administrators since all the information regarding cost efficiency and production will be made clear. The use of resources and accuracy of data will also be created by generating precise data regarding expenses.
Advantages of Switching To Machine Hours
With the focus on machine hour’s levels, Cylinder Manufacturing Corporation can make an accusation of all the involved operative expenses on the grounds of the machines. In addition with the assistance of machines overhead under preoccupation, the corporation can be able to establish the idle machine timing and develop strategic approaches on how it can be lowered (Weygandt, Kieso, & Kimmel, 2010). The company is mainly faced with the issue of costs and the lack of efficiency which has resulted in increased costs in its production while the generation of profit is below the predictions. This, therefore, implies that development might not be acquired in this scenario since costs and efficiency must be reduced and improved respectively.
The most important operation is that of increasing the production efficiency of the machines being utilized since the corporation can effectively accommodate the opportunity since all the expenses mainly rely on it. This is more of a scientific approach of making calculations of the firm’s overhead expenses in a precise mode. In this context, the corporation can begin by calculating the general cost that is acquired in the production procedures after which it will become even easier in making calculations of the prices sales for all the products. If the corporation absorbed operative expenses on the ground of machine based hours this means that the company can acquire for essential and precise costs of production while being compared to labor hours (Weygandt, Kieso, & Kimmel, 2010.
When Cylinder’s company case is analyzed then the overheads that will be established on the ground of labor and machine hours are as follows;
The planned labor level is 149.825 £
The total operative expenses for the average products, therefore, becomes 149.825 £ * 2500 which is equal to £ 374,562.50
The total expenses for the customized products accounts to 149.825 £ * 1500 which is equal to £ 224,737.50
Operating Costs In Reference To Machines Hours
Total Hours for the machine is equal to 6500
The total distribution overheads = 599,300£
Therefore the accounted machine hour burden is £ 599,300 divided by 6500 = 92.2£
The total overhead load for all the average products accounts for 92.2 *3500 = 322,700£
Total operating expenses for the customized products will thus be 92.2 *3000 which will total to 276,600£.
ABC System Implementation Advice
ABC tends to be more complex to implement because it requires expert knowledge and more time. In addition, the system will require the use of more funds in running the system’s implementation activities and maintenance (Cokins & NetLibrary, 2001). In my opinion, Cylinder Company will require making more preparations given that the procedure involves a number and research should also be conducted. In addition to the setup period, the corporation can begin by temporary utilization of absorption and old marginal accounting approach. The focus of the firm’s management focus should also be modified and not just the general performance. This means that the operations involved in this performance should acquire efficiency given that success cannot be obtained by mainly focusing on a single area but the entire company should adopt. The manager’s perspective of the firm and regarding change should also be changed. This means that there focus should not be grounded on cost but their attitudes and activities supervision should also be modified in referent to cost operations.
ABC system has proven to be more simplified as well as progressive when compared to traditional expenses approaches (Cokins & NetLibrary, 2001). It is clear that Davin should, therefore, focus on implementing the system given that the system comprises of some of the important aspects that take consideration of efficiency, cost and sound decision which results in increased production and maximized profit. These are some of the issues which are overlooked by most of the outdated approaches which mainly focuses on ensuring that tasks are accomplished and products generated (Cokins & NetLibrary, 2001). In addition, the methods offer indication of costs in general but cost in each unit is not given while understanding cost sources is essential in dealing with high cost and efficiency issues. On this grounds, it is apparent that Davina is required to follow the approach of ABC and should additionally incorporate staffs who clearly understands the approach which will result in net income increase. ‘The greatest worry that is held by Davina is that despite meeting the revenues mark the net income mark continues to decrease. This has mainly been caused by the lack of appropriate machine and labor hour’s allotment. The machine hours should, in this case, be portioned in a manner that the specialized products are manufactured in higher numbers by the corporation so that the net income can be increased and improve the firm’s value. In general, if the corporation implements the system appropriate through incorporating al the needed features and modifications the benefits of the actual system use will be guaranteed.
References
Cokins, G., & NetLibrary, Inc. (2001). Activity-based cost management: An executive's guide. New York: Wiley.
Goektuerk, H. (2005). Activity-Based Costing (ABC) - advantages and disadvantages: How ABC can be applied to institutions of higher education.
Hansen, D. R., & Mowen, M. M. (2017). Cornerstones of cost management. Cengage Learning.
Hansen, D. R., Mowen, M. M., & Guan, L. (2009). Cost management: Accounting and control. Mason, Ohio: South-Western.
Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2010). Managerial accounting: Tools for business decision making. Hoboken, NJ: Wiley.
