Cost Management And Construction Companies

Analysis of the Case of Wurst Company

Discuss about the Cost Management and Construction Companies.

The allocation of overhead costs to the products produced by the company is a crucial decision. The overhead cost comprises a significant portion of total production cost and thus, it is necessary that allocation of this cost is made on some rationale basis. The conventional costing system provides for allocation of the overhead costs on the volume based cost driver such as labor hours, machine hours, and production units (Kim, 2017). The volume based cost drivers may result in cost distortion in the situations when the overhead costs are not directly related to the volume of production. In order to handle this problem of cost distortion, the activity based costing system has been designed. The activity based costing system provides for apportionment of the overhead costs on the basis of activity based cost drivers (Weil and Maher, 2005). In this context, the report presented here provides analysis of the case of Wurst Company, which is a manufacturing unit engaged in the production of a range of items.

Earlier the company was manufacturing only three products but gradually it grown and now it produces a range of small products along with three main products. The company had been allocating the overhead costs to the products based on the conventional volume based cost drivers. However, now it is considering change in the overhead cost allocation by adopting activity based costing in place of volume based cost drivers. This report highlights the deficiency in the existing system of the cost allocation along with the suitability of the activity based costing system.  

As mentioned above the company produces three main products along with a range of small products. Presently, the company allocates overhead costs based on the number of units produced. However, the allocation of overhead costs on the basis of number of units produced might not present the true picture; therefore, the company is considering replacing the traditional system with the activity based costing system. In the activity based costing system, the costs are first allocated to the activities based on the resource cost drivers and then the cost allocated to the activities is further allocated to the cost object (products or services). The allocation of the cost to the cost object is made based on the activity cost driver (Weygandt, Kimmel, and Kieso, 2015).

It could be observed that there are in total 8 activity cost centers. The overhead costs such as wages, building cost, depreciation, consumables, energy, and others have been assigned to these activity cost centers. There are various resource cost drivers being identified for this purpose such as number of employees, floor space, machine hours, number of orders, and electricity use in kilowatt.

Assigning costs to the activity centers

Further, the cost of a particular activity center needs to be investigated in detail. In this regards, the cost of inspection has been investigated in detail by allocating the cost to different activities within this activity center as detailed below:

It is important to remember that to allocate the costs to the products, the activity cost drivers rate is essential. The activity driver rate is computed by dividing the cost an activity by the volume of resource consumed by that activity. In case of Wurst Company, the calculations of driver rate have been shown below:

It could be observed that there are two activities such as corporate management and new product development the costs of which have been allocated directly to the products. Apart from these two activities, the cost of other activities has been allocated based on the driver rate as arrived in the statement shown above.

Currently, the company follows volume based cost drivers to allocate the overhead cost to the products. The product cost distortion occurs when the non-volume based overhead costs are allocated based on the volume based cost drivers or the products are diverse. In the case of Wurst Company, the product portfolio of the company has been diversified over the number of years. Now the company is no more running with production of three products rather it produces a range of products. However, it could be observed that overhead costs of the company are majorly volume based only. The overhead costs such as wages, consumables and energy can be considered to be volume based. But despite this fact, the cost distortion is possible because product diversity applies (Weygandt, Kimmel, and Kieso, 2015).

If the cost distortion occurs, the cost allocation will be arbitrary and therefore, the total cost of the products will be wrongly analyzed. An analysis of total cost of two products under the conventional system and activity based costing system is shown below:

It could be observed that the current costing system of the company overstates the cost of both the products by $4,317,693.2409 and $3,029,890.1867. The main products are also bearing the overhead costs of other products and this is reason that cost of these products is so high. The cost analysis using the conventional costing system would be vague and it is probable that it might result in sub optimal decisions. Looking at the high cost of Mettwurst and Csabai, the company may wrongly take decision to eliminate these products from the product line. However, if we analyze the cost by applying activity based costing; the product cost does not seem to be so costly. An analysis into the profitability of the two products under conventional system and activity based costing system is presented below:

Cost of each activity: Inspecting cost center

It could be observed that both the products show high losses if the conventional system of costing is followed. This is because the conational system is resulting in allocation of high overhead costs to these products. However, the position is different when the costs are assigned applying activity based costing system. It could be observed that Mettwurst turns into a profitable product under activity based costing system. However, Csabai is incurring losses under the activity based costing too, but the losses are lower as compared to conventional system of costing.      

The implementation of activity based costing is recommended to the company because it will result in rationale cost allocation to the product and help the management in decision optimal decisions in regard to product additions and eliminations. However, the implementation of activity based costing is not easy; it involves high costs and change in the accounting and reporting system at a large scale (Reckers, 2006). The monitoring and record maintenance in the activity based costing is becomes time consuming and requires high costs to be incurred. Further, the employees may resist to the changes caused by the activity based costing system, which may pose serious challenge in front of the top management while considering implementation of the activity based costing (Reckers, 2006).

Further, the activity based costing may not be so beneficial in the situations where the products are homogenous and the overhead costs are driven by the volume based cost drivers. In this situation there will not be any fear of cost distortion and therefore the conventional costing will do (Reckers, 2006).        

Conclusion

The discussion in this report has been carried out on the analysis of overhead costs and comparing the overhead allocation under the conventional system and activity based system in the context of Wurst Company. From the discussion, it could be observed that the activity based costing has various advantages over the conventional costing system. The activity based costing system provides more detailed and rationale basis for allocation of the overhead costs to the products. Therefore, it is recommended that the Wurst Company should implement the activity based costing system.

References

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

Reckers, M.J. 2006. Advances in Accounting, Volume 22. Elsevier.

Weil, R.L. and Maher, M.W. 2005. Handbook of Cost Management. John Wiley & Sons.

Weygandt, J.J., Kimmel, P.D., and Kieso, D.E. 2015. Financial & Managerial Accounting. John Wiley & Sons.

Order an Essay Now & Get These Features For Free:

Turnitin Report

Formatting

Title Page

Citation

Outline

Place an Order