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AYB225 - Management Accounting

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Added on  2021-06-14

AYB225 - Management Accounting

   Added on 2021-06-14

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AYB225 ASSIGNMENT PART C (2 full pages maximum, 1.5 spaced, excluding References)Allocation of indirect cost is a typical allocation as the costs cannot be directly allocated toproducts and services produced/provided by the company. Hence, an allocation method orbasis is required. For such allocation of indirect overheads, two methods are provided bythe cost accounting. These methods are traditional costing method and activity basedcosting method. (Martin, 2018)Under traditional method, the costs are allocated using either direct labour hours ormachine hours, or in other words using a single cost driver. Whereas under activity basedcosting, the costs are allocated on the basis of production resources consumed by thevarious activities involved in the production. Hence, activity based costing allocates theresources in a practical and meaningful way which is far more realistic than traditionalcosting.However, we do not agree with the view of Kerry that the activity based costing is useful formanufacturing companies only and has no benefit for service industries. Since, thechallenges faced by both the industries are common, i.e. appropriate allocation of overheadcost and since, both the industries have indirect overheads which needs to be allocated tothe products produced or services consumed, hence, activity based costing can be appliedby both the industries. Further, the purpose of activity based costing is to allocate indirectoverheads to the products or services. It not only allocates the overheads, but also helps infixing the correct price of the product. And appropriate pricing of the products or services isthe most important factor for any business. Moreover, ABC is an important analysing toolfor the management as it helps in analysing the profitability and the costs of the company. Itis a simple method to adopt and provides the insight of the costs allocated to the products.It breaks down the costs in to the activity level costing, and then finds out the relevant costdrivers of the activities. Then the costs are allocated on the basis of these cost driversconsumed by the products or services. Further, application of ABC will not just help inappropriate allocation of overheads instead it also helps in taking informed decisions by themanagement. As well managed service firms with the good understanding of theirprofitability, markets and customers, can become more profitable and successful. ("Role ofABC in Service Industry", 2018) (2018)However, ABC has some limitations as well. ABC is useful if it is implemented in thecompany having more than one products and services, as if the company has only onePage 1
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AYB225 ASSIGNMENT PART C (2 full pages maximum, 1.5 spaced, excluding References)product or service, then the question for allocation of costs does not arises, as the entirecosts belong to that single product or service.Moving to our firm costing scenario, if the costs are allocated using the traditional method,i.e. the current method, the total overheads of $410,000 are allocated as $162,491 in Tax,$53,100 to bookkeeping services and $194,409 to Advisory services. Whereas, when weallocate the costs of $410,000 using activity based costing, then the allocation comes at$133,555 to Tax, $44,651 to bookkeeping services and $231,794 to Advisory services.Hence, we can see that the overheads are over allocated by $28,936 to Tax division andsimilarly, the overheads are over allocated by $8,449 to bookkeeping services and theoverheads are under allocated by $37,385 to advisory services.Due to this inappropriate allocation of costs, the loss from bookkeeping services divisionhas been increased. If the costs are properly allocated, then it may mislead themanagement to take correct decisions. As due to incorrect allocation, an profitable divisionmay seem to be loss making and loss making division may seem to be profit making.As in service industry, the main cost is the cost of professional labour employed forproviding the services and further, the cost of each assignment or service differs from otheras the services are personalized and vary upon needs of the customers, hence appropriatecosting of the service provided is yet another important challenge in the service firm, inwhich ABC proves to be very helpful.Hence, considering the above stated positive impacts of ABC, it is proved that the ABC canbe used by the service industries also and it is highly recommended for the firm to useactivity based costing system.Page 2
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