The cost accounting system is used to determine the product cost and profit. The two main cost accounting systems are traditional cost system and activity based costing system. There are many differences in both of these cost systems. Traditional costing system allocate overhead cost either through labour hour rate or machine hour rate while under activity based costing system overhead costs are allocated on the basis of consumption of different activities by each product. So it can be said that traditional costing allots cost without providing the base of allocation and activity based costing frames a base before proceeding with the allocation.
The purpose of this report is show the application of activity based costing and to provide the analysis of difference between the traditional costing approach and activity based costing. Beztec is currently using traditional costing method and management accountant wants to apply the activity based costing to ascertain the actual profit provided by the two products manufactured by Beztec. There will be discussion on professional code of ethics on the part of management accountant for the purpose of giving advice to the management on profitability position of each printer model.
The determination of accurate cost of products is very important as it has a direct impact on the profit reported by a company. The method of accurate product costing adopts the use of standard cost methodology for calculating the cost of component items. The accurate cost of a product depends on determining the cost of a unit of production by studying every resource that is sued in its production. The final cost of product is calculated by incorporating the cost from all streams. The determination of accurate cost of products is very essential for taking well-informed decisions regarding the future growth and development of an organization. The accurate determination of product cost is dependent on adequately estimating the calculation of cost of goods sold. This involves calculating the manufacturing cost that involves calculation of cost of direct labor, indirect labor and overhead. This is followed by calculating the cost involved in designing of products and then recording the cost of each product line or item (Drury, 2008).
The calculation of accurate cost enables a business to achieve higher growth as it helps in determining the prices of sale at a competitive margin. The establishment of base cost helps in determining the mark-up cost to be added for calculate the right sale spruce for a product. The accurate calculation of product cost helps in making a right forecast of the next accounting period by gaining actual figures of expenses and revenues. As such, it can be said that the method of accurate product costing is becoming extremely essential for business companies to determine actual profit.
Rate of cost driver for each activities identified in activity based costing system
The method is preferred by the business companies nowadays in comparison to the technique of traditional costing system that is associated with many problems as depicted in the given case study of Beztec. The traditional costing system is associated with the major drawback of not proving to be useful in determining the actual cost involved in manufacturing of a product item. This is because it involves developing a cost pool that contains the cost of performing all the diverse activities that are divided by the number of machine hours consumed in production. The average rate calculated is applied to all the products irrespective of the number of activities and their complexity. Beztec as such is emphasizing to adopt the use of activity based costing for determining the accurate cost of the products. The method of activity based costing helps in overcoming the weakness of traditional method of costing by developing various cost pool and allocating each pool cost based on activities involved in its production (Bradtke, 2007).
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Rate of each activity cost driver identified by the management accountant |
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|
Activities |
Activity Cost |
Total Units |
Rate per unit |
|
Soldering (number of solder points) |
$ 1,165,725.00 |
1766250 |
$ 0.66 |
|
Shipments (number of shipments) |
$ 1,064,250.00 |
22500 |
$ 47.30 |
|
Quality control (number of inspections) |
$ 1,534,500.00 |
87188 |
$ 17.60 |
|
Purchase orders (number of orders) |
$ 1,176,120.00 |
213840 |
$ 5.50 |
|
Machine power (machine-hours) |
$ 71,280.00 |
216000 |
$ 0.33 |
|
Machine set-ups (number of set-ups) |
$ 928,125.00 |
33750 |
$ 27.50 |
(Kaplan and Atkinson, 2015)
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Particulars |
Lexon |
Protox |
|
Total units |
24000 |
6000 |
|
Sale Price |
$ 990.00 |
$ 1,254.00 |
|
Direct Material cost per unit |
$ 228.80 |
$ 642.40 |
|
Direct Production Labour cost per unit |
$ 19.80 |
$ 46.20 |
|
Machine cost per unit |
$ 158.40 |
$ 79.20 |
|
Production overhead cost |
To be divided as per solution 2 |
|
|
Selling and administrative expense |
$ 291.50 |
$ 268.95 |
|
Cost of each model under activity based costing |
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|
Particulars |
Lexon |
Protox |
|
Direct Cost |
||
|
Direct materials |
$ 5,491,200.00 |
$ 3,854,400.00 |
|
Direct Production Labour |
$ 475,200.00 |
$ 277,200.00 |
|
Machine |
$ 3,801,600.00 |
$ 475,200.00 |
|
Total Direct Cost |
$ 9,768,000.00 |
$ 4,606,800.00 |
|
Indirect Cost |
||
|
Production Overhead Cost |
||
|
Soldering (number of solder points) |
$ 879,862.50 |
$ 285,862.50 |
|
Shipments (number of shipments) |
$ 862,042.50 |
$ 202,207.50 |
|
Quality control (number of inspections) |
$ 1,112,753.62 |
$ 421,746.38 |
|
Purchase orders (number of orders) |
$ 495,621.50 |
$ 680,498.50 |
|
Machine power (machine-hours) |
$ 65,340.00 |
$ 5,940.00 |
|
Machine set-ups (number of set-ups) |
$ 495,000.00 |
$ 433,125.00 |
|
Selling and administrative cost |
$ 6,996,000.00 |
$ 1,613,700.00 |
|
Total Indirect Cost |
$ 10,906,620.12 |
$ 3,643,079.88 |
|
Total Cost |
$ 20,674,620.12 |
$ 8,249,879.88 |
|
Cost per unit of each model |
$ 861.44 |
$ 1,374.98 |
(Horngren, 2009)
Gross profit is equal to total sales revenue less cost of goods sold and gross profit percentage is equal to gross profit divided by total sales multiple by hundred.
|
Profitability analysis of each model through using ABC |
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|
Particulars |
Lexon |
Protox |
|
Revenues |
$ 23,760,000.00 |
$ 7,524,000.00 |
|
Direct Cost |
||
|
Direct materials |
$ 5,491,200.00 |
$ 3,854,400.00 |
|
Direct Production Labour |
$ 475,200.00 |
$ 277,200.00 |
|
Machine |
$ 3,801,600.00 |
$ 475,200.00 |
|
Total Direct Cost |
$ 9,768,000.00 |
$ 4,606,800.00 |
|
Less: Production Overhead Cost |
$ 3,910,620.12 |
$ 2,029,379.88 |
|
Total cost of goods sold |
$ 13,678,620.12 |
$ 6,636,179.88 |
|
Gross Profit |
$ 10,081,379.88 |
$ 887,820.12 |
|
Total Units |
24000 |
6000 |
|
Gross profit per unit |
$ 420.06 |
$ 147.97 |
|
Sales price per unit |
$ 990.00 |
$ 1,254.00 |
|
Gross profit percentage |
42.43% |
11.80% |
(Kaplan and Atkinson, 2015)
The case study analysis depicts that there is an ethical issue present in the context of suggestions given by Kay to smith. Smith, the management accountant of Beztec Ltd, has shown his analysis to Steven Kay, the CEO of the company. As per the analysis, the major issue present before the management is to show the results to headquarters. This is because initially the Lexon printer model was not profitable as per the use of traditional costing method. The management then decided to introduce a new printer model of Protox but its results are also not profitable developed based on activity based costing suggested by Smith. In this context, Kay has advised Smith to later the cost produced by ABC system as Protox line is the new model of Beztec and thus as per him the company cannot phase out the new product line of Protox. Therefore, Kay after analyzing that their costing is posing a major issue has asked Smith to later the costs produced by the ABC system (Accounting Professional & Ethical Standards Board, 2013).
However, as per the APES 110 code of ethics this suggestion of Kay to Smith can be regarded as unethical as it would result in manipulating the financial results for the sake of profit maximization for Kay as his bonus is based on division revenues. Smith has re-checked the costing results again and again through the use of different activity drivers but has identified the result to be accurate. Thus, as per the code of ethics Smith is advised not to alter the costs as advised by Kay as it is unethical and would negatively impact the interest of the stakeholders. APES 110 stated that CPAs must not allow biasness, conflict of interest or undue influence of others on their judgments provided during development of financial results. Kay is asking Smith to violate the principle of objectivity during giving their opinions about the financial position of the company to its stakeholders. Smith by altering the cost in the ABC system would result in providing false results to the headquarters that could lead them to take wrong decision regarding the future growth and development of the Protox product line. This could eventually result in causing more loss to the company in future context. This is because the product is not providing to be profitable at present and thus incurring more capital investment on it will result in incurring more financial loss to the company on it in future context. Therefore, as per APES 110 code of ethics Smith should not follow advice of Kay but rather must make him understand the future outcomes of this decision. Smith should suggest him other ways of reducing the cost and making the product profitable and making this strategy in presence of board of directors by presenting true costing results in front of the headquarters (CCH Australia Limited, 2009).
The over or under applied overhead occurs because of difference between actual manufacturing overhead and manufacturing overhead applied to work in progress using the predetermined overhead rate. Basically predetermined overhead rate is calculated on the basis of budgeted labour hours or budgeted machine hours but the actual labour hours or machine varies at the end of production period. This give rise to either over applied overhead or under applied overhead (Ward, 2012).
The three ways used to dispose the amount of over/under applied overhead cost are as follows:
- Through allocating the over applied or under applied overhead cost to WIP, finished goods and cost of goods sold
- Through transferring the complete cost of over or under applied overhead cost to cost of goods sold account in income statement
- Through maintaining separate account for over or under applied overhead cost and transfer it afterwards (Weston and Brigham, 2015)
Conclusion
Activity based costing is better approach to calculate the cost of products as it allocate the overhead costs in more meaningful manner as compare to traditional cost approach. Through applying activity based costing method it has been found Protox model is providing operating loss to Beztec while under traditional costing method Protox is giving highest profit. The main reason for the difference in cost of both products is method applied to calculate the overhead cost. In traditional costing approach predetermined approach overhead allocation base is used while in activity based costing overhead cost are divided on the basis of actual activity consumption by each product.
Reference
Accounting Professional & Ethical Standards Board. 2013. Compiled APES 110 Code of Ethics for Professional Accountants. [Online]. Available at: https://www.publicaccountants.org.au/media/711182/APES-110.pdf [Accessed on: 10 September 2018].
Bradtke, D. 2007. Activity-Based-Costing. GRIN Verlag.
CCH Australia Limited. 2009. Australian Master Accountants Guide. CCH Australia Limited.
Drury, C. 2008. Management and Cost Accounting. Cengage Learning EMEA.
Horngren, C.T., 2009. Cost accounting: A managerial emphasis, 13/e. Pearson Education.
Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.
Ward, K., 2012. Strategic management accounting. Routledge.
Weston, J.F. and Brigham, E.F., 2015. Managerial finance. Hinsdale, IL: Dryden Press.
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