You have also been asked to give management a recommendation on whether the comp
ID: 2460311 • Letter: Y
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You have also been asked to give management a recommendation on whether the company should switch from process costing to activity-based costing (ABC) This is an exploratory discussion, but management would like to know more about the difference between the two costing systems and if a different costing system might work better for the company IlI. Main Costing Systems Activity-Based Costing vs. Process Costing a) Identify the cost allocation system that would benefit this company most. Justify your response. b) Does this cost allocation system meet management planning and control goals? Explain. c) What are the ethical implications that should be considered with this cost allocation system? d) Describe the ethical implications of direct costs versus indirect costs. What considerations should be made when selecting one of these two?Explanation / Answer
Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system. A company with only one electric meter might allocate the electricity bill to several departments in the company.
Process costing is a term used in cost accounting to describe one method for collecting and assigning manufacturing costs to the units produced. Processing cost is used when nearly identical units are mass produced.
Limitations of Process Costing:
1. Process costing is based on historical cost. The available cost information may not be useful for future managerial decision-making.
2. Unfinished units (work in process) at the end of the period are expressed in equivalent production units. This introduces subjective element in scientific cost determination.
3. The whole concept of process costing system is based on average costs. Average costs do not always reflect the true costs. If there is an error in cost determination in one process, it will affect the cost estimation in subsequent processes as well as the cost of work in process and finished products.
4. When two or more products are produced in the same process, the joint costs are prorated to the various products using some weight age say in terms of points. Giving weight age in terms of points is a subjective decision, which will give rise to approximate costs and cannot be taken as fully reliable. Absence of scientific base makes the process costing inadequate for managerial purposes.
5. Process costing system presumes that production activity of a factory is divided according to processes. A process is an organizational entity or section of a firm, in which specific and repetitive work is done. Thus a process becomes a practical unit for purpose of supervision of production and often it is an unsatisfactory unit for cost accounting purposes.
Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing.
Comparing to the process costing , activity costing analysis are used for various managerial purposes, including planning, controlling, and decision making. The best and most beneficial use of activity analysis is to combine the cost and other information provided by ABC with managerial functions; this is then referred to as activity-based management (ABM). This Portfolio explores many such managerial practices.
Activity-Based provide useful information to help management improve organizational performance. Determining the cost of resources used for carrying out activities and assigning that cost to the products and other cost centers falls within the area of cost accounting.
Activity based costing 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 has grown in importance in recent decades because
(1) manufacturing overhead costs have increased significantly,
(2) the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours,
(3) the diversity of products and the diversity in customers' demands have grown, and
(4) some products are produced in large batches, while others are produced in small batches.
Due to the following Advantages of Activity Based Costing meets the management and controlling goals
1. Improves Over All Processes
During the process of implementing an activity based costing method in a business, all of the processes that are used are looked at in depth. After a short period of time, a bigger picture begins to emerge of which processes are working well and which are not.
2. Waste Is Identified
Overhead costs often include quite a few wasteful products. All of these can be identified very simply with an ABC method of cost analysis, and then removed from the business all together, or at least managed more effectively.
3. Pricing Is Better Organized
With ABC businesses are able to fully identify all the costs that are associated with producing a single unit of their product. Because of this new understanding, they are able to develop pricing strategies and marketing much more efficiently.
4. Can Be Applied To The Entire Business
It may seem that activity based costing is only effective and efficient for the production costs that are involved in a business, but all overhead costs can be reduced using this method. Everything from management, CEO’s, and entry level employees.
As ABC provides the business, the accounting and other related information, in the best interest to the business, to support its internal decision making. It consists of several processes to include cost-volume-profit analysis, product costing. ABC is constructed and managed within the internal systems of the business. Management accounting is the internal part of a business that the business’s base is formed. It supports the business’s goals and uses its systems to provide the desired results to its stakeholders and customers.
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