Ways to Improve VVC’s Method for Applying Overhead
Discuss About The Abc Model Of Traditional Method Of Costing.
In the case of any business entity especially in the case of a manufacturing concern the way the overhead costs are being allocated to the departments and the resultant products forms a very important and crucial part. The reason for this is that without the proper allocation of the same it will not be possible for the entity to ensure that the costing of the products is being ascertained objectively. For the purpose of ascertaining the same an effort is being made to recognise a costing method that will objectively and reliably estimate the cost that has been incurred by the entity in respect of the overhead of the various activities that have been performed. Special attention has been given on the comparison between the ABC model of costing and the traditional method of costing.
Product costing is accounting process to determine all the business expenses relating to the production of the companies. These costs may include raw material purchase, worker wage, production transportation cost and the retail stocking fee. The companies also use product costing for finding ways to rationalize the production cost to maximize their profits.
In regards to improve the distribution of costs for applying overhead in the cutting and finishing departments, company administration should develop an activity-based costing system. Company should follow:
- Create activity-cost pools for each specific activity that is supposed to be performing in future.
- It is very essential to make a selection of appropriate cost driver for each activity to analyse the relationship of the cost driver or activity with overhead costs occurred.
- Develop a separate pool and rate to allocate overhead for this department.
- Clearly identify the fixed & overhead costs and then establish overhead rates for both costs.
- Allocate overhead costs for Moulding department on the base of machine hours or robot hours.
In the Cutting and Finishing Departments of Valdosta Vinyl Company there are problems of controlling costs. In this aspect the company can utilise the method of outsourcing. This process of business functions as well as activities helps the company to concentrate well on the core function in one hand and control cost on the other. The most important benefit of outsourcing is associated with the cost effectiveness (Schniederjans, Schniederjans and Schniederjans 2015). This method allows the company to get the works done at a very low cost in a more effective way. By using the workers outsourced from the developing countries, Valdosta Vinyl Company can get their works done at much cheaper rate. The company does not need to spend extra in the development of infrastructure. As the work is outsourced, the partners take care of all including the necessary changes in the infrastructure according to the type a nature of the work. One of the important benefits of outsourcing is that the company does not face problems directly with natural calamities, technological crisis as well as market fluctuations. This is because them outsource partners can keep working on their assignments. Beside all these, the method of outsourcing from the different countries, the company will get benefit of round the clock operations (Stark 2015). This leads to get faster results when the company depends in the outsourcing partners. This enables a quick and faster development of the ideas into the concepts. This helps in a faster delivery of products, and concepts into competitive markets.
Recommendations to Improve VVC’s Method for Applying Overhead
In reducing cost in the Cutting and Finishing Departments, the company can sell the left over materials instead of sending them to recycle (Vezzoli et al. 2016). Valdosta Vinyl Company must track as well as measures the operational proficiency of their business to adjust along with optimise the use of the available resources. By setting performance parameter, the company will be able to reflect the efficiency goals. The company can choose raw materials which are more cost-effective so that they can allow it to increase their profit by dropping the product creation cost.
By analysing the current usage of the physical space the company can reduce cost in the cutting and finishing departments (Schniederjans, Schniederjans and Schniederjans 2015). Overflowing storage, supplies, piles of leftovers and incompetent placement of the furniture and the equipment are some common space wasters which can increase utility by reducing cost.
Assessing the current practice of employee knowledge and skills will help the company to manage cost. It can give responsibilities to their employees who are the most skilled and efficient in those areas. It is often essential for the one person as responsible for variety of tasks, but exchanging tasks with other individual worker with low wage can do those tasks with efficiency.
To accommodate automation in the Moulding Department, the company can reduce the workforce or replace them which machines. This department of Valdosta Vinyl Company do not need very skilled workers and the tasks are very much recitative (Stark 2015). These tasks can be easily done by light weight and mobile robots which can rescue the manual labour and make the company leaner, more consistent, more profitable and highly competitive.
This will decrease the company’s cost as through automation, the company will be able to close the training program which they used to build an efficient workforce. Therefore, it needs to have a proper technology planning which first of all will focus on the core areas like operations (Groover 2016). Secondly, the company can explore the automation process that they will introduce in the moulding department. This will help it to further automate the other departments and cut cost of the company. Thirdly, through automation the company will be able to handle the widespread layoffs which lead the company to a high negotiation cost with the labour unions that detracts it from cost optimization. Finally, the company will be able to avoid the causes a microclimate of confrontation as well as mistrust between the top executives and the operative resources.
To Accommodate Automation in the Moulding Department
A cost accounting system is a framework that is used by different organisations to evaluate the cost of products to maintain inventory valuation, cost-effectiveness analysis and budget control. In any firm, an effective product costing system can help to estimate the closing value of the inventory, work in progress (WIP) and finished goods inventory in order to prepare accurate financial statement (Magerial accounting: cost systems).
- The job order costing
- The process costing
Job order costing: It is a cost accounting system that accumulates manufacturing cost of products for every single job. This system is appropriate for the organisations that deal with production of unique products and special orders (Magerial accounting: cost systems).
Process costing system: This cost accounting system accumulates manufacturing costs individually for each process. Firms can use this system for such products that involves in the production process and costs occurred in each department (Magerial accounting: cost systems)
In a cost accounting system, cost allocation for products is considered based on either traditional costing system or activity-based costing system (Magerial accounting: cost systems).
The traditional method in cost accounting system states about allocation of manufacturing overhead costs to the goods manufactured. By using this method management can assigns the factory’s indirect costs to the products produced or manufactured on the base of volume such as the number of units manufactured or by using appropriate cost driver such as machine hours and the direct labour hours (Averkamp).
Traditional approach to allocate overhead costs is an easier method of determining the price of the product, as it depends on assigning average overhead rates. This method is not always accurate because it determines which overhead costs really affect precise products (Hayden). The main issue with traditional approach is that the factory overhead sometimes is much greater than the basis of allocation, so that can affect the change in the sum of overhead applied. Activity-based costing was established to avoid this issue of traditional costing by using a more thorough analysis of the connection between applied overhead costs and cost drivers (Bragg, 2018).
Under using the traditional method of allocating factory overhead, all of the factory overhead costs are allocated on the basis of just one factor such as direct labour hours or machine hours. In other words, using the traditional method, there is only one driver of the factory overhead.
In real life there are many drivers oh the factory overhead: unique inspections, special handling, special storage and so on.(Accounting Coach). The more diversity in products and/or in customer demands, the bigger the problem of allocating all the costs of these various activities via only one activity such as the production machine’s hours.
Various Product Costing Systems
According to Accounting Coach web-site: “under the traditional method, the costs of performing all of the diverse activities will be contained in one cost pool and will be divided by the number of production machine hours. This results is one average rate that is applied to all products regardless of the number of activities and the complexity of those activities. Since the cost of many of the diverse activities do not correlate at all with the number of production machine hours, the resulting allocations are misleading.”
Activity-based costing is intended to overcome the weakness of the traditional method by having various pools of costs and then allocating each pool’s costs based on its root cause.
Activity based costing is a managerial accounting method that traces overhead costs to activities and then assigns them to objects. In other words, it’s a way to allocate indirect, overhead costs to products or departments that generate these costs in the production process.
Activity-based costing identifies all of the specific overhead operations related to the manufacture of each product. Not all products require the support of all overhead costs, so it is not reasonable to apply the same overhead costs to all products.
Accountants created the ABC method to solve the problems of inaccuracy that result from the traditional costing approach. Managers needed more accurate costing methods to determine which profits were actually profitable and which were not. (Chron, 2018).
Setting up an ABC system can be expensive and time-consuming. As business activities are analyzed, they must be broken down into each activity’s individual components. The entire process can use up valuable resources as data are collected, measured and entered into the new system. Businesses may also need the assistance of a consultant who specializes in the setup of an ABC system and can provide training on its use. Using software can add an additional expense to the implementation but it can be used to automate many of the manual aspects involved in using ABC. (Chron, 2018).
Moreover, using the Activity Based Costing the managers can face the problem of misrepresentation of Data. Reports produced by an ABC system contain information, such as product margins, that vary from the information reported for a traditional cost method. It’s also possible that some activity-based costs may be irrelevant in certain decision-making scenarios; for example, ABC does not conform to accounting standards and should not be used for external reporting. Since traditional cost figures tend to be the norm, interpreting ABC data along with regular accounting information can be confusing and lead to bad decision-making.
Conclusion
After conducting the various analysis and the comparison between the various methods of costing an understanding has been developed in respect of the viability of the use of the various methods of costing in the operation fo the entity. For the purpose of ensuring that accurate and scientific approach is being taken for the reporting of the cost of the entity, the ABC model of costing has to be approached. The reason for the same is that the costing method involves making the activities that are undertaken by the entity as the basis for allocation of the costs that are incurred by the entity. Thought the cost that is involved in the process of implementation and the integration of the same in the operations of the entity is high the value that is going to be created by its adoption by way of availability of the right and adequate costing information with the management will be immense. This will help the entity to monitor the cost that has been incurred by it and the corresponding revenue that is being generated by it.
References
Averkamp, H. (n.d.). Retrieved from AccountingCoach, LLC (US): https://www.accountingcoach.com/blog/taditional-method-cost-accounting
Bragg, S. (2018, May 19). Traditional costing. Retrieved from Accounting Tools: https://www.accountingtools.com/articles/what-is-traditional-costing.html
Hayden, A. (n.d.). Retrieved from https://quickbooks.intuit.com/r/pricing-strategy/activity-based-vs-traditional-costing/
Magerial accounting: cost systems. (n.d.). Retrieved from Accounting Explained: https://accountingexplained.com/managerial/cost-systems/
Groover, M.P., 2016. Automation, production systems, and computer-integrated manufacturing. Pearson Education India.
Schniederjans, M.J., Schniederjans, A.M. and Schniederjans, D.G., 2015. Outsourcing and insourcing in an international context. Routledge.
Stark, J., 2015. Product lifecycle management. In Product Lifecycle Management (Volume 1) (pp. 1-29). Springer, Cham.
Vezzoli, C., Kohtala, C., Srinivasan, A., Xin, L., Fusakul, M., Sateesh, D. and Diehl, J.C., 2017. Product-service system design for sustainability. Routledge.
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