Activity-based Costing System For Safe Manufacturing Company

Traditional volume-based costing systems

Introduction

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The company manufactures family safes, made out of metal and plastic, but most of the production comes under metal lockers. The lockers are fireproofs and comes in various shapes and size for family uses. The company’s products are verified under Australian/New Zealand Industry standard AS/NZS 3809. The company manufacture 50 different types of products in which 35 are metal safes and the rest 15 are plastic safes. The sales of the metal safes were in hype from last quarter but though the increment in sells, the profit from the metal safes was decreased by more than 20%. On the other hand, the plastic devolved safes sell at a much lower price but its sales have increased by more than 15%, apparently high margins. The increment of the sales of metal safes and lower the profit ratio for the metal production unit has put pressure on the management team to analyze the following problem. After a meeting was held it was found that the company’s cost management system was very dated one and cannot handle big data calculation. A new cost management system is needed which was found to be Activity-based costing system. It had new ways to tackle problems and the complicated costs of the system will be efficiently handled by this system.

Traditional volume-based costing systems

A costing system is a basic element of any business; it is a set of rules or system which a business adapts to run itself effectively. A costing system is made to look after the costs and expenses of a business firm by managing and setting strategies for different revenue, expenses, profits etc. A costing system does not only include set of rules but also every part of a business starting from employees, departments, the facilities provided, research agendas. The information acquired from this costing system can be used for maximizing profit effectively, to decide where to eliminate costs for a downturn of any business. The most important work of a reliable costing system is to create strategies for the future operation. Moving on to Traditional costing system which is also known as volume based costing system is the allocation of the factory overhead, which is the cost valued during manufacturing process of an item omitting the costs of the direct labor and the direct material costs ; to the products based on the volume of products consumed (Ax & Greve, 2017). Here the factory overhead is applied on the basis of labor hours or the machine hours. The factory overhead includes the salaries of the laborers, salaries of the managerial post’s people, the factory rent and so on. Traditional costing system was initially used but a major drawback has been noticed  as the factory overhead may change and the allocation can become higher , following with a change in the volume of resources will trigger the amount of overhead applied. The factory environment where there are much more number of machines and thus the overhead will be null and void. This method actually reallocated the indirect costs to the items manufactured depending on the volume. The Australian based Safe manufacturing company CMI safe co. In uses a typical traditional costing system and this is the reason of the un identification of costs and thus it leads to minimum profit although the number of sales is higher. It is found that the net margin of the company’s metal safes had fallen 20% below the target that it was not supposed to fall. Metal safes are high volume products and the sales fell down instead the plastic safes are less volume product in comparison to metal safe but the sales increased. After a research on the costs, net profit and other criteria it is discovered that traditional costing system can be the cause of this disruption on business (Bromwich & Scapens, 2016).

Activity-Based Costing System

Activity-Based Costing System

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 It is a modern and more efficient way of costing where the indirect costs are used and allocated to products and departments where they generate costs to products. This type of costing helps us to recognize the relationship between the various costs, the factory overheads, the manufactured products and after analyzing the relationship between them, allocating the indirect costs to products less arbitrarily and in a better way than the traditional costing system (Cooper, Ezzamel & Qu, 2017). For a successful running and execution of an activity based costing system, first the business firm has to identify costs and create cost pools which will include both primary and secondary cost pools. A data collection system is used to gather information about the activity drivers which will further help in allocating cost pools. The best thing about this activity based costing system is the identification of products that are unprofitable. Often this goes missed in traditional costing system but the activity based costing system catches it and puts it aside. The efficiency of the products also increases as a result. The products are also priced appropriately and there is a hassle free product pricing (Cooper, 2017). This costing system finds out the irrelevant costs which if not noticed bundles up and becomes prominent for elimination. Activity based costing is actually precise and increases the understanding of factory overheads and makes the costly and unnecessary activities highlighted. It can thus be said that if the company changes its costing system from traditional to activity based costing system the breach can be easily discovered making the profits and costs visible for the company by eliminating all the unnecessary costs which thus creates difficulties for this high class company which wishes to advance with the modern technology (Dale & Plunkett, 2017).

Calculating the rate per activity driver to be used in the desired activity-based costing system and producing a revised income statement by product group tracing process and support costs to product groups using activity-based costing methodology

Cost Driver

Estimated costs ($)

Metal Safes

Plastic safes

Total activities

Insulation process hours

 $       156,000.00

7000

6000

13000

Assembly hours

 $          48,000.00

2800

1200

4000

Total process hours

 $       102,000.00

9800

7200

17000

Number of inspections

 $          11,480.00

40

100

140

Number of requisitions

 $          12,000.00

300

700

1000

Number of sales orders

 $            2,002.00

30

47

77

Income statement

Particulars

Metal Safes

Plastic safes

Total

Amount

Amount

Amount

Amount

Sales Revenue

 $ 296,900.00

 $ 246,800.00

 $ 543,700.00

Direct Materials

 $   21,500.00

 $   20,680.00

 $   42,180.00

Process and Support Cost

 $ 187,968.75

 $ 143,513.25

 $ 331,482.00

Total Costs

 $ 209,468.75

 $ 164,193.25

 $ 373,662.00

Net Income

 $   87,431.25

 $   82,606.75

 $ 170,038.00

Profit margin

29%

33%

31%

Above are the calculations which show prominent result which are generated through Activity  based costing as it can been seen that the cost incurred through the costing method is relatively lower than previous calculation cost made by the company which is a positive sign for the company’s profitability.

Analyzing and explaining the differences in product costs and net profit margins between the two alternative costing systems

Calculating the rate per activity driver

Now it can be seen in the income statement above that the results are different than that of the income statement which was made under traditional based costing system. It can be said that the products cost relating the safes rendered by the company has decreased constantly which means that previously the cost were overvalued (Weygandt, Kimmel & Kieso, 2015). The product costs after the calculation of income statement through activity based costing have decreased constantly. This is because the company has been using a traditional costing which was not able to efficiently identify the complexity of the activities which were performed by the company hence the cost were either power valued or undervalued affecting the calculation of overall cost which will incurred by the firm in there operational activities (White et al. 2016). It can be seen that as the products cost decreased in the calculation done through ABC costing the profit margin has increased considerably. This is positive sign for the company as now the profit margin shows near true and fair value of profit margin which is rendered by the company. It can be said through the calculation made above that the statement made by some of the managers regarding backdated traditional costing affecting the company’s accounting process was indeed correct. It can be said that traditional based costing interfered in the costing operations of the firm and created materiality within the costing process of the company. This directly affects the calculation of profitability within the company (Van der Stede, 2018). Hence, it can be said that the old traditional based costing system hampered cost calculation system of the company which resulted in over and under valuation of cost in respect to the operations and activities which the company conduct in the production of the products. It can be said that through the introduction of activity based costing the company will be able to identify the cost incurred by the firm in there operations. Thus it can be said that Activity based costing is evident costing system which the company should adapt in order to get proper valuation of cost in the operations of the firm. It can be seen in the calculations above that through the use of ABC costing the production cost decrease which increased the profit margin of the company and gave the real amount of profit which was incurred by the firm in there operational activities (Renz, 2016).

Analyzing and explaining the differences in product costs and net profit margins

Factors affecting the selection of an appropriate product costing system

Owing to the advancement of technology and globally connected business system it becomes necessary to make use of an effective product costing system and so does CMI requires. Without a proper product, costing system the business will soon get crippled. However, there are some factors that need to be analyzed before installing a product costing system. Initially the objects of the company should be analyzed, the mode of profit future plan and then only can a particular product costing system can be made effective after analyzing the goals. The nature of business also determines the type of costing a business can adopt (Plank, 2018). It is also necessary to find out whether the particular business firm can get adapted to the new costing system. A learning process of the employees which will rather be explaining and teaching them about new costing system may help. A discussion is to be made about the various costs whether direct or indirect, factory overheads, and so on with the employees and the other financial heads of the company (Otley, 2016). A proper communication is the key to success in this case. A harmonious office environment, unity among workers and goal oriented discussions and communication can help achieve the target. What becomes more necessary is the research about the company, by collecting previous records and the costs and creating a graph and evaluating everything very minutely including the business plans in future. The research shall include the history of the company along with the size of the organization and the cost structures along with the diversity of products and the wide range of products it manufactures. A regular cost monitoring is also one of the important factors which helps in determining that which product costing system can be applied. A proper monitoring of the global business condition is also required to determine that what type of costing system should a company acquire. They should again start a research operandi to find out what type of costing systems is being used by other companies. The advances in the modern machineries and workforce are also another factor for determining the type of costing. A level of training and expertise of the employees also becomes a major factor. The company must hire employees who are well versed with this modern costing system.

After reviewing the case study of the well reputed company it would be fine to declare that this company should adopt the activity based costing system (Mossialos, Wenzl, Osborn & Sarnak, 2016). It is found that there is an irregularity of the costs and the activity based costing system can only be the solution to this.  It shall be true to say that the activity based costing is truly classified as online analytic software. The profit maximization and cost effectiveness of CMI can be done if it successfully tries to adapt the activity based costing system (Malmi, 2016).

Recommendations for product strategy

Limitations of adopting Activity-Based Costing System

Now as discussed above there are various benefits of using ABC costing as the company modern costing system as it will increase the efficiency of the following in cost calculation of the firm operational activities (Langfield-Smith, Smith, Andon, Hilton & Thorne, 2017). Although there are some limitation in very costing method and ABC costing method is no different from other methods. Hence the limitations of Activity based costing are as follows:

  1. As ABC costing provides accurate results and proper outputs it can also be said that process of costing under the ABC costing guidelines are very complex and expensive. It can be said that costing system becomes complex as there care identification of different activities that the company performs which then is converted in units and so on. This makes the process complex and expensive. The company has to incur Hugh expense to recruit experts in order to conduct ABC costing system within the firm which will increase overall expense of the company’s operational activities (Kumar & Reinartz, 2018).
  2. It can be said that one of the biggest limitation and difficulties which arises in selection of ABC  costing as costing system within the firm is its process of selecting cost driver. It is very complex procedure that takes time to be conducted. In this case implementation of ABC  costing in continuously operating firm is difficult and challenging as it will lacks its essence of costing accurate results without identification of actual cost drivers which makes it hard for the company operate such costing system (Grande et al. 2015).
  3. It can be said that the process is very time consuming, as the process requires various stages of operation before producing accurate cost that is incurred in operations of the firm. It can be said that these stages ignite the most out of every operations that is conducted within the operations of the firm. It can be said that in this case the process of ABC costing becomes very time consuming which can be a limitation of the following costing system (Fullerton, Kennedy & Widener, 2014).

It can be said that the above stated limitations are minor limitations and can be heard by CMI if they want to choose a better costing system which enables them to know there real cost and profit margin incurred in a period of time.

Conclusion

The company’s loss due to the metal selling unit was figured that old school cost managing system was not working for the company; the company need a new cost management system to synchronize the new sell and cost of the product in the efficient manner and does not have any error in future. The solution is Activity-based costing system against old cost management system, the new cost management system is efficient and can tackle big data of inputs without providing any error, thus in order to bring back the company in profit the Activity-based costing system is needed.    

Reference list

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