Costing Methods
Discuss about the Managerial Accounting Methods Of Costing.
The costing of the product has the significant effect on the decision making power of the company. It is because only on the costing of the product, the profit margin has been marked and thus the selling price is determined. If the costing of the product is not determined correct then the selling price will be futile for the business. Due to this very fact, the report has been prepared with regard to the discussion of the costing methods.
At first the cost per unit of two models – basic model and advance model of the company Sewing Easy Limited has been calculated using the traditional method of costing then the cost per unit has been calculated on the basis of the new method activity based costing method. The calculation has been provided in the separate excel workbook. After having the calculated cost per unit of each model, the significance as to the product costing which shall be correct and accurate has been discussed. Then the ways has been listed and describes as to how to deal with the applied overheads which can be under or over. Lastly and the most important the benefits and the limitations of the activity based costing has been discussed in detail. The report has then ended up with the appropriate conclusion and recommendation. The data for preparing the report has been obtained from the reliable sources and the same has been listed in the references section.
In the given case study, two methods of costing have been detailed. One is the traditional method of costing and other one is activity based costing method. The traditional method of costing lays down that all the indirect costs which are not directly related to the products of the company will be allocated on the basis of the rate which is predetermined on the basis of either machine hours or the labor hours.
On the other hand activity based costing is the method under which the costs are allocated on the basis of the activities which are defined for the manufacturing of the product. It helps the company in allocating the costs of the product in accordance with the activities which is undertaken by the company. The main aim of this method of costing is the identification and specification of the cost drivers which help the company in estimation of the cost (CIMA, 2016)
Importance Of Accurate Product Costing
In the given case, the company has adopted both the methods and has identified the cost per unit of both the models – simple and advance.
Although both of the methods have provided the cost per unit but the activity based costing has provided the more accurate figure than the traditional method of costing.
Product costing has the significant role in the managerial accounting. Product costing not only gives an idea to the management of the company regarding the sale price of the company but also gives how much cost is being consumes by each level of the product. Whether the same is at the level of the procurement or at the level of the work in progress or at the level of the finished goods, the costing of the product can be analysed.
The product costing acts as the medium for controlling the cost of the product in any manner. It is because by having the product cost the management of the company can have the idea of whether the cost so incurred is within the budget of the company or out of the budget and whether the said cost can be controlled or not. Through the product costing only, the budgets are prepared for the next financial year. If the product costing is not available then the material budget will also not get prepared.
Now if the product costing is available but is not accurate then it will harm the functioning of the company in many ways. One of the basic harm will be that the sale price of the product will be futile as it will not be in accordance with the benchmark as set by the industry and the company will not be able to run for the long time in future. Secondly, in case the company requires the working capital limit from the bank then the inaccurate product costing will lead to bad image in front of the bank which in turn will fail to sanction the working capital limit. Thirdly, with the inaccurate product costing, the profit figure of the company will also not be up to the mark as product cost is not actual or real in relation to the expense already incurred and paid by the company.
Thus in this sense the product costing shall be accurate and correct and then only it will serve the purpose of the management of the company.
There are three ways to deal with the applied overheads:
- First way is to transfer the entire amount of the under or over applied overheads to the cost of goods sold
- Second way is to transfer the entire amount of the under or over applied overheads to the Work in Process
- Third way is to transfer the entire amount of the under or over applied overheads to the Finished Goods.
Activity based costing is the method of costing in which the costs are allocated on the basis of the activities associated with the product. For the purpose of the activity based costing, the cost drivers are identified which drives the costs in actual and also identifies the cost pool in relation to the cost. The activity based costing has the benefits as well as it is suffering from the limitations. The benefits and the limitations have been mentioned below:
The Benefits of the Activity Based Costing are mentioned below–
- It is very easy in the case of ABC system to have the costs of the company divided into the fixed potion as well as the variable portion. It is due to the very fact that the method is using the long run variable cost which in itself have made very clear that the division has been made from the beginning itself. As in the given case, the number of machine hours with respect to the Assembly activity is long run variable cost.
- The management of the company will find it very useful to have the cost of the product at the end of each activity in the very easy manner unlike to the traditional method where the costing can be known only at the time when the manufacturing will be done. It means under the later method the information will be known only at the time when the whole process gets completed. Thus, the former method will be more useful for the management of the company as they can apply the management techniques for the reduction or the control of costs (Pohlen, 2014).
- This method of costing has provided the figure of the cost of the product in the most accurate and effective manner. The accuracy and the reliability in the costing of the product are associated with the identification of the cause and effect relationship of the cost which is being incurred. The system has entails that it is the activities through which the resultant factor is cost rather than the product also the activities are consumed by the products only. In the environment where the support function constitutes a large share of the overheads and the costs thereof the product, it’s the ABC system only which provides the more accurate results.
- The ABC system is the system which improves the decision making power of the management of the company in a very higher degree. It is because of the fact it helps the company in fixing the selling price of the product and further the product cost will be made as more accurate.
- The ABC system is mainly regarded as the cost controlling technique whereby it helps in identifying the activities which does not add any type or form of value to the product rather it is being treated as the extra cost of the product.
In this manner, the ABC system is beneficial to the organization. Apart from its benefits, the ABC system also has the demerits or the limitations which shall also be considered by the management of the company before its installation. The limitations have been described as below:
- The ABC system has one major disadvantage. The disadvantage is that the system provides the company with the multiple cost drivers. Availability of more than one cost driver for the activity will lead to the availability of the different costs for that activity which in turn lead to the different product costs at the same time. Thus, the selection of the cost driver requires the more attention from the management as the wrong selection of the cost drivers will lead to inaccurate product costs and thereby making the decisions of the management as futile (Haddai, 2015).
- The system’s second disadvantage is that the cost of installation and the implementation of system are expensive. Along with the expensive in nature, it is the more time consuming system.
- Another demerit of the system is that the implementation of the system is very complex in nature. It is because of the fact that it involves the selection of the various cost pools and cost drivers (Rasiah, 2011).
- Last major demerit is that the management of the company finds it’s very difficult to identify the activities as the costs have the nature which may belongs to several number of activities at the time. Managers are required to exercise due professional skill and care.
Thus, in this manner, ABC system has the benefits and the limitations.
Conclusion And Recommendation
Each and every company shall employ correct method of costing so that the management of the company can have the useful and correct decision with regard to the profit of the company and the cost controllable techniques that the company wants to employ. In the report two methods have been discussed in detail. One is traditional costing and the other one is activity based costing. Both of the methods have their own merits and demerits but in the report only the activity based costing has been detailed with its merits and demerits. To conclude the report, the methods of costing shall be applied with professional and due care.
It is recommended to have the activity based costing installed in the company as it provides the cost of the product in the real and fair terms.
References
CIMA, (2016), “Activity Based Costing”, available from https://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf available on 09-05-2018.
Haddai M, (2015), “Comparative Study of Traditional and Activity-Based Costing in Forging Companies of Iran Tractor.” available from https://www.ijmsbr.com/Volume%204%20Issue%203%20Paper%201.pdf and accessed on 09-05-2018.
Pohlen, T.L, (2014), “Implementing activity-based costing (ABC) in logistics”. Journal of Business Logistics, Vol.15(2), p.1.
Rasiah D, (2011), “Why Activity Based Costing is still tagging behind the traditional costing in Malaysia?” Journal of Applied Finance and Banking, Vol.12, p 22-51.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
