Accounting and Finance PDF

Accounting and Finance
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Introduction
The present essay is developed for providing an understanding of the recently used
management accounting systems by the accountants for allocating of costs to the products. In
this context, it discusses the usefulness of activity based costing system over the traditionally
used methods to allocate the costs to the products.
Use of Management Accounting Systems
Calculating the Cost of an Individual Project by Activity-Based Costing (ABC) system
The increasing competition is causing the businesses to adopt the use of efficient
management accounting systems for gathering accurate information about the costs of the
processes, products and services. The traditional method of costing is largely criticized by the
management accountants due to their inappropriateness to assign overhead costs on the basis of
products (Wnuk-Pel, 2010).
As such, the management accountants are largely incorporating the use of Activity-Based
Costing (ABC) system for calculating the cost of an individual project, service or activities
within a department. The system is providing to be highly useful in identifying the important
activities within a department and allocating accurately their overhead costs. The different
activities required for manufacturing a product is considered as a cost driver such as
consumption of power, quality inspections or machine setups. It then assigns the cost involved in
carrying out these activities to the products that requires these activities for completion. As such,
it helps in assigning accurately overhead costs to the activities and therefore highly useful in
determining the price of product (Fadzil and Rababah, 2012).
The benefits of using ABC costing system in comparison to the conventional system of
costing can be discussed in relation to the two products that are manufactured by the same
company, that are, Product A and Product B. Product A requires many type of activities such as
engineering, testing and machine set ups for completion and is produced in low volume. On the
other hand, Product B does not require any special activities for its completion but it’s
manufactured in high volume. As such, the use of conventional system of accounting will result
in allocating the overall overhead to the products on the basis of machine hours consumed. This
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will result in allocation of only small overhead costs to the Product A as the machine hours
consumed is less but it requires different type of special activities for completion. On the other
hand, Product B will be allocated high amount of overhead although it has consumed very less
overhead activity. Therefore, the use of traditional method of costing will result in inaccurate
calculation of costs of products and this drawback can be effectively overcome with the use of
ABC method of costing. ABC system will result in allocation of costs as per the resources
consumed by each of the products for their overall completion. The costs of the activities will be
allocated to the products on the basis of consumption and thus will result in accurate allocation
of overhead costs to the products (Aryanezhad, Makui and Rashidi Komijan, 2009).
Following is a hypothetical example to explain the use of activity based costing:
Information Given
Products ==> Product 1 Product 2
Output in units: 9000 15500
Selling price per unit
£
90.00
£
110.00
Cost per unit:
Direct material
£
38.00
£
48.00
Direct labour
£
27.00
£
25.00
Total machine hours 1000 3000
Number of production
runs 48 70
Order Executed 60 70
Number of Shipments 70 80
Basis for activity based costing
Overhead
Annual
Budgeted
cost
Cost Driver
Machine department cost £ Machine hr
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