Implementation Of Activity Based Costing In A Manufacturing Company

Analysis under Traditional Costing System

Discuss about the Implementation In A Manufacturing Company.

The overhead cost comprises significant part of the overall cost of production, particularly in the manufacturing firms. The overhead costs in most of cases can not be traced to any particular product or service and hence, the allocation of overhead cost becomes an important issue for the management. The allocation of overhead should be based on some consistent and rationale basis else it may show distorted picture of the product cost. In the traditional costing system, the allocation of overheads is done based on volume based cost drivers such as machine hours and or labor hours. However, the allocation in fashion is not considered to be appropriate (Kim, 2017). Thus, to overcome limitation of traditional costing system, the activity based costing system came into existence. In this context, this report deals with analysis of product cost based on traditional costing system and activity based costing system. Further, the report also describes the advantages of activity based costing and its application in the company.  

The analysis of cost allocation on production and service departments of the company under the traditional costing system has been presented in the table given below:

All the overheads have been allocated to the products based on the machine hours using single overhead recovery rate. Thus, the cost of production of simple luggage is $164.62 per unit and that of complex luggage is $376.28 per unit.

Under the activity based costing, the overheads of material procurement and general factory support have been allocated based on the activity cost drivers (Kim, 2017). Other remaining over heads have been allocated based on recovery rate being arrived at applying machine hours. The allocation of overheads has been presented here below:

The comparison of manufacturing cost of both the products under traditional costing system and activity based costing system has been presented in the table given below:

It could be observed that the manufacturing cost of simple luggage has increased from $164.62 per unit to $225.32 per unit. Further, the manufacturing cost of complex luggage has reduced from $376.28 to $323.27 per unit under the activity based costing as compared to traditional costing system.

Conclusion

The biggest advantage of activity based costing system is the allocation of overheads to the products and or services in an appropriate manner (Maingi, 2013). The allocation of the overheads in an appropriate manner leads to improvements in the decision making process which is essential for the overall development and achievement of the objectives for a firm. Thus, the activity based costing helps in achieving the goals and objectives of the firm. The management is provided correct information about the cost of products which is necessary to take decisions regarding enhancing and decreasing the capacity utilization. The overall productivity of an organization of purported to improve with the use of activity based costing (Zeuner, 2012).        

The traditional costing system sometimes does not provide accurate picture of the product cost and due to distorted view of product cost, the management keep running business on wrong decisions which ultimately results in firm incurring losses (Öker and Ad?güzel, 2016). The cost management of the firm improves with the implementation of activity based costing system. For instance, in the current case of Happy Traveller Ltd, the management was concerned about lower profit margin on Complex luggage type product. However, the analysis under activity based costing revealed that Complex luggage has lower cost of manufacture and hence it should not be low profit margin. The management was misguided by the improper allocation of overheads on the product (Zeuner, 2012).

The implementation of activity based costing requires extensive changes in the processes and structures of the company. Further, it is also a time consuming process. The implementation of activity based costing system in the company may interrupt the operations if it is not handled adequately (Bradtke, 2007). The activity based costing system works on the basis of identification of activities being performed in different departments and consumption of these activities. Thus, in order to implement the activity based costing, it is essential for Happy Traveller Ltd to identify the activities within the departments and link the consumption of these activities. Based on this linkage, the company needs to identify the cost drivers and then compute the cost driver rate to allocate the overhead cost to different (Bradtke, 2007).

References

Bradtke, D. 2007. Activity-Based-Costing. GRIN Verlag.

Öker, F. and Ad?güzel, H., 2016. Time?driven activity?based costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), pp.39-56

Kim, Y. 2017. Activity Based Costing for Construction Companies. John Wiley & Sons.

Maingi, J. 2013. Advantages & Disadvantages of activity based costing with reference to economic value addition. GRIN Verlag.

Zeuner, P. 2012. Activity-Based Costing. GRIN Verlag.

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