From 1970 to up to 1998 company producing the products using standard accounting system. In 1998, the founder’s daughter Davina Brinkwater joining the company after completing the graduation from the university in accounts and finance. After the joining she analyse the company current accounting system and recommend to revise the accounting system as there was a demand for more accurate product cost information to support the firm’s strategy of offering keen price in a highly competitive market where a few firms dominated.
Problem After joining the company she analyse the company accounting system which is using “Traditional Accounting System”. With The support of his powerful and influential father, Davain succeeded to implement the New System, Which is “Abstract-Based Costing ABC”. But she faces the problem by the members of the firm that she is trying to change the organization. Some members of the firm are happy who to accept the challenge and understand how new system working. After the retirement of his father, she is conscious that she must prove herself.
The Real Problems Davina is aware that disruption due to the implementation of the new system can be upsetting. And that happening, when the accountant saying her that the profits are down below of the budget. He is very critical about the current costing system saying that it is out of line with the updated manufacturing systems as well as way behind current theoretical ideas on product costing. According to the accountant, they are still absorbing overheads on labour hours and that they have an artificially high overhead absorption rate of £150 per labour hour. He claims that they are pricing themselves out of the market on their established product line. He suggests that product costs would be more meaningful if absorbed on the basis of machine hours.
On the other hand, Davina decides that she herself investigate the problem over the past five years. And she got the following results.
Overhead cost had risen to £599300 per month ,which is 46% increase
direct labour hours have risen from £168200 to £170000
Direct labour hours are 4000 compared with machine hours of 6500
Davina asks the manufacturing manager about the rise in overhead cost, he gives the explanations as below.
23 Different versions of a single product
Cost of a product is high
materials handling is an increasing headache
overtime is going through the roof
lack of skilled peoples
Davin then decides to talk with the marketing manager, who says
We are facing fierce competition for our high volume lines, just can’t match the low price in market
However we have successfully increase our sales
We are meeting our overall sales target
OBSERVATION After the study of the firm’s history and launching a new activity base system over traditional method, In my point of view that every manager / employee just blaming and blaming. They did not realise the exact problem even they have increase in the sales and achieving the sales target. And also there is more demand of the special product in the market.
I considered that the firm is using both method simultainusly. Especially firm is focused on Standard product production rather than the Special product production. Using standard method they are rendering the more service over labour cost and result the overhead increase. They did not utilized and increase the machine labour. And which is more demanding product in the market.
“Realisation that overheads do not just occur, but are caused by activities, such as holding products in store, that ‘drive’ the cost is at the heart of Activity-based costing (ABC). The traditional approach is that direct labour hours are a cost driver, which probably used to be true. It is now recognised to be no longer the case.
Traditionally, we tend to think of overheads as rendering a service of cost units, the cost of which must be charged to those units.
ABC sees overheads as being caused by cost units, and that those cost units must be charged with the costs that they cause.” (Accounting and finance by Peter Atrill and Eddie Mclaney)
ABC is the one and only solution for the problem and implanting the new activity cost based system is the big challenge. After implementing the new accounting system we will able to calculate the actual cost of the both products Standard and Specialised product.
Budgeted overhead cost per month Machines 279500
Set-up and engineering support 200200
Materials handling 119600
Total overheads 599300
Direct labour 170000
Total manufacturing cost excluding direct materials 769300 Solution: Here we will simply calculate the machine hours which tells the overheads recovery base by the ABC method.
Formula: (Machine Hour / Total Hours) * Total Over heads
Standard Product: (3500 / 6500) * 599300 = 322700
Specialised Product: (3500 / 6500) * 599300 = 276600
After calculating machine hour with ABC system we have actual cost of both products. Where we can easily indentify that standard product is using more hours than the specialised product. Because there are already 23 different versions of standard products in the market, and there demand is also less so we cannot increase the price of standard product due to the market competition.
Although on the other hand the scope for the specialised product is available in the market and its demand is also high. Specialised product driving the cost more than the standard product. Only the company needs skilled labour, increase the no of setups and store orders than the standard product.
Standard product is absorbing the cost of Specialised product.
Standard Product is not giving more profit, so we need to improve our new specialised product which has the market and giving more profit. Specialised product giving gaining the profit targets.
Only the reason behind is this, that the company using less machine hours and still depending over the labour, which caused to increase the overheads and also the graph of the profit is going down.
Recommendation As I mentioned before that there is demand of specialised product in the market is high and this product is giving more profit. So there is the need to increase the price of the product.
According with the Market Manager firm is meeting the Overall sales target, and there is more demand available. There is the need to increase the Machine hours, so that production of the specialised product increase and also need to increase the product price. This will generate the more profit and help to overcome the overhead margin. We can increase the machine hours which can increase the production and to adjust labours we can run the manufacturing department in different shifts to use maximum numbers of labour and machine hours to our profitable product.
SECTION II: – Show how an activity based system would change the analysis of the costs between the standard and specialist products.
First we can analysis the problem and after that we will be working through these data. Firstly to see how traditional cost accounting methods might deal with them; secondly to look at the ABC method itself. Of these approaches we will be looking at, only ABC will be using all of the data in any great detail. This is consistent with the general nature of the traditional method.
Analysis The firm is using the old accounting system is which they have a single pool for the overheads through which they cannot calculate actual drive of the cost, where the “ABC system is a technique for more accurately relating the overheads to specific production or provision of a service. It is based on acceptance of the fact that overheads do not just occur but are caused by activities, such as holding products in store products in store, which drive the cost”.(Ref: Accounting An introduction by Eddie Mclaney and Peter Atrill. Forth Edition)
By calculating the cost between standard and specialised product with ABC system we can see difference.
Traditional Direct Labour Hours Formula:
(Labour Hour / Total Hours) * Total Over heads
(Machine Hour / Total Hours) * Total Over heads
Standard Product: (3500 / 6500) * 599300 = 322700
Specialised Product: (3500 / 6500) * 599300 = 276600
After calculating the cost of standard and specialised product we have machine hours and labour hours, where we can easily analysis that standard product is absorbing more labour hours as the results Machine hours are producing less products. As far manufacturing manager is also worried about the standard product, because he is keeping the cost low because there are 23 other versions of the product are in the market. Because of the low price and Standard product competition it is not giving profit to the firm.
Alternatively, specialised product has the market and running very smoothly in the market. According to the marketing manager is meeting the targets and the sale is increased and still there is demand for the specialised product. But manufacturing manager is worried about the cost of manufacturing it. He needs more skill labour, machine set-ups and the cost of material handling.
Cost Analysis: Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities.
Activity based costing recognizes that the special engineering, special testing, machine setups, and others are activities that cause costs-they cause the company to consume resources. Under ABC, the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities. In our example, Standard Product will be assigned some of the company’s costs of standard engineering, Standard testing, and machine setup. Other products that use any of these activities will also be assigned some of their costs. Specialised Product will not be assigned any cost of special engineering or special testing, and it will be assigned only a small amount of machine setup.
A report on the Implementation of Standard Costing
In current years, various tools such as activity-based costing, the balanced scorecard and target costing have been used in the business community. However, traditional management accounting systems continue to be widely applied. One example is standard costing, which has been used on a wide front during the last century.
The purpose of this paper is to examine the widely use of standard costing system. Despite it is less relevant than newer accounting methods, standard costing is far from obsolete. Because of its simplicity, flexibility and affordability, standard costing remains a favorite cost accounting method among accounting and finance professionals.
Introduction: In today’s time of rapid technologic change, tough global and domestic competition, total cost management is central to sustained corporate profitability and competitiveness. The management focus today is to minimize cost. The cost leadership strategy does not mean compromise on either quality or technology or product differentiation. Low costs are no advantage, if the customers are not willing to buy the product of low cost firm. Cost management has to be driven with customer as the focus.
The survival way for any company is how to manage its product/service cost, quality and performance. The customers are continuously demanding high quality and better performance products/services and at the same time, they want the prices to fall. The shareholders are also demanding a required rate of return on their investment with the company. Thus, cost has become a residual. The challenge is being able to manufacture or provide service with the stipulated cost framework. Thus, cost management has to be an ongoing continuous improvement program.
Standard Costing In recent years, various tools such as activity-based costing, the balanced scorecard and target costing have been used in the business community (Kaplan