Activity-Based Costing and Immaterial Balance Analysis

The assignment involves analyzing a business scenario where the CEO is pushing to keep an underperforming product due to personal gain. The accountant must use various cost analyses, including activity-based costing, to provide evidence for phasing out the low-profitable product and convince the CEO to make a decision based on data-driven insights.

Case Study Acc200

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK...............................................................................................................................................1
1. Importance of accurate product costing and problems associated with using traditional
costing system.............................................................................................................................1
2. Cost driver rates for various activities in ABC system...........................................................2
3. Calculation of cost of each model using ABC........................................................................3
4. Profitability analyses...............................................................................................................3
5. Suggestions and Recommendations........................................................................................4
6. Ways to dispose the amount of over/under overhead costs....................................................5
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
In this project report, traditional costing and modern costing methods are analysed in
order to provide solutions for the case. According to the given case scenario, Sue Smith is asking
for suggestions and recommendations. The primary aim of this report is to provide a
understanding about importance of activity based costing in this case scenario. Beztec Limited is
producing two types of printers and seek for advice that which model should be phased out.
Issues using traditional costing is discussed in this report along with cost drivers under activity
based costing. In order to analyse this case and develop recommendations various analyses is
performed such as profitability and costing (Ahamadzadeh, Etemadi and Pifeh, 2011). Hence, it
will cover accurate product costing and its importance, cost driver rates, predetermined
overhead, activity based costing framework etc.
MAIN BODY
1. Importance of accurate product costing and problems associated with using traditional costing
system
Product costing:
It is a methodology of managerial accounting which serve organisation to determine cost
involved in every good produced by them. This costing method is considered as significant as it
does not classify according to its nature but according to the related activity. Accurate costing
framework assist an organisation in staying more competitive and helps making smart choices in
relation to business organisation. It is more efficient and effective techniques which can help a
firm in meeting the set outcome in more standard forms meeting the present requirements. In this
case, Beztec Limited is producing two types of printers that is Lexon and Protox. This method is
used to ascertain costs and profit generated from these two models. Not only overall cost but it
also helps to calculate various kinds of cost such as direct material, labour, operating, selling cost
etc. Beztec is currently using traditional costing methods due to which they are facing few issues
as this technique has various drawbacks which are mentioned below:
Inaccurate costs – Traditional costing classifies overall costs into fixed and variable
expenses which is quite unrealistic as all the costs cannot be categorised into only two classes,
due to which it gives inaccurate results (Miller-Nobles, Mattison and Matsumura, 2016).
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Non reliable decisions – This costing method is not considered as a reliable source for
decision making as some fixed costs are variable in long run and there are few other flaws such
as complexity in cost determination, high time and cost involvement etc.
No accounting for unexpected expenses – This costing does not account any
unexpected expenses by which a product can cost way more than its projected price.
Product costing plays an important role while ascertaining cost of any product, this cost
involves ABC technique which is a modern method of calculating cost in which all expenses are
classified according to the activity conducted to produce a certain product. Significance of this
method is that every organisation despite of its size and scope can use this technique as it
involves low cost. This technique accounts expenses of all the operations including designing,
manufacturing, packaging and many more. Another important aspect of this technique is that it is
even appropriate for mass production organisations (Öker, 2013).
2. Cost driver rates for various activities in ABC system
Activity cost driver is a factor which contributes to the expense of a business activity. In
the process of activity based costing, few examples of these cost drivers are labour, material,
operations and many more. A cost driver rate is the charge on which every activity of the
organisation is charged. Cost drivers such as direct labour hours and number of set ups are use in
this case.
Activity Activity cost
Cost
driver
quantity
(Lexon)
Cost
driver
quantit
y
(Protox
)
Activity
cost driver
rate
(Lexon)
Activity
cost
driver
rate
(Protox)
Soldering (number of solder
points) 1165725 1333125 433125
0.87443037
97
2.69142
85714
Shipments (number of
shipments) 1064250 18225 4275
58.3950617
284
248.947
3684211
Quality control (number of 1534500 63225 23963 24.2704626 64.0362
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inspections) 335 225097
Purchase orders (number of
orders) 1176120 90113 123727
13.0516129
748
9.50576
67284
Machine power (machine-
hours) 71280 198000 18000 0.36 3.96
Machine set-ups (number of
set-ups) 928125 18000 15750 51.5625
58.9285
714286
According to the above performed ABC analyses of Beztec Limited, cost driver rate is
ascertained using its formulae which is:
Activity cost driver rate = activity cost/ cost driver quantity
Cost driver rate of Protox is comparatively better than of Lexon. Taking an example of
soldering activity, rate of Lexon is 0.87 and rate of Protox is 2.6914285714.
3. Calculation of cost of each model using ABC
Beztec Limited is producing two printers and in order to determine the most profitable
one, the costs are calculated below using total activity cost and total quantity.
Unit cost cost of Lexon cost of Protox
total activity cost/ total quantity
1165725/1766250=0.66 879862.5 285862.5
1064250/22500=47.3 862042.5 202207.5
1534500/87188=17.599 1112753.6186 421746.3813
1176120/213840=5.5 495621.5 680498.5
71280/216000=0.33 65340 5940
928125/33750=27.5 495000 433125
total cost 3910620.1186 2029379.8813
A limited company named Beztec produces two type of printer: the Lexon older version
(2014) and other introduced in 2016 the Protox .
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During complete analysis for both printer, company should phased out the production of
Protox printer for a period of time as the actual profit generation rate of Protox (30%) is much
lower than that of Lexon(36.667%) approx. However, the cost of production for Protox is
2029379.8813 which is less than the production cost of Lexon(RS 3910620.1186) because
number of unit produced are much higher of Lexon than those of Protox. So company should
focus to produce more unit of Lexon printer and earn more amount of profit and recover the cost
of production.
4. Profitability analyses
In order to determine the profitability of both the printers, ABC system is used by which
it is ascertained that gross profit for Lexon is 8712000 and for Protox is 2257200.
Gross profit percentage Gross profit / revenue *100
Gross profit percentage for Lexon 8712000/2376000*100 36.67%
Gross profit percentage forProtox 2257200/7524000*100 30.00%
According to the above performed profitability analyses, it has been observed that Lexon
is earning more profit than Protox that is 36.67% and 30.00%. Smith should try to convince Kay
that they should phase out their newly launched printer model that is Protox as it is less
profitable than Lexon.
5. Suggestions and Recommendations
In this case scenario, Sue Smith is an accountant of Beztec Limited who advised CEO of
this company to phase out their new printer model i.e. Protex as it is resulting in decline stage
and losses. Steven Kay, CEO of this company pressurise Smith to come up with an alternative as
this new product printer cannot be phased out because it help in earning bonus to Kay. With the
help of ABC method, Smith has ensured that the newly launched printer is not beneficial for the
organisation and it must be phased out unless there is any other solution (Proctor, 2012). In order
to convince Kay, there are various Code of ethics which are conveyed and they are discussed
below:
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APES 110 Code of Ethics for Professional Accountants are few standards which are
issued by regulatory board. These codes were introduced by APESB which is a individual body
established in 2006 in Australia. These codes were made with an objective to bring similarity in
the accounting books of all the organisation. These standards are quite different from basic
accounting standards as these deals with ethical issues. For example, accountant is said to present
true and fair position and performance of an organisation despite of pressure from superiors.
These codes and standards are applied to all the members. Members of this association are said
to be individuals who are working as an accountant in any organisation (Plank, 2018). Few of
these codes are:
Integrity – According to this code of ethics, an accountant is said to produce reliable and
accurate financial statements. Accountants should be honest and straightforward with their
superior and external audit bodies. This code should be followed in all the organisational
operations. In this case, Smith should not be get pressurised from Kay's orders and follow what
is right.
Objectivity – Under this code of ethics, accountant shall not allow bias or do not interest
any individual due to any reason such as influence or greed. According to this case scenario,
Smith should convey code of ethics to Kay which are needed to be followed by her
(Suthummanon, 2011).
Professional competence – Every accountant should has a reliable knowledge and skills
up to required level so that they can be provide appropriate effective services to their clients.
These skills include diligence and technical knowledge.
Confidentiality – This is considered as the most significant ethical code as it states that
all organisational data should not be disclosed to any other party in order to protect the sensitive
information. Smith has a responsibility to secure the data of Beztec Limited, and do not disclose
it unless there is a legal requirement for that.
Professional behaviour – This code of ethics states that Kay should comply all the laws
and legislations regarding preparation of accounting statements so that she can credit to her
profession (Terpstra, 2014).
6. Ways to dispose the amount of over/under overhead costs
Overhead rate: It is said to be total indirect costs for a particular reporting period
divided by proper allocation measure. It can be comprised of either using actual cost or budgeted
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one. All the indirect costs of fixed expenditure of a business is included such as management and
marketing costs. It is categorising into two parts. Some of them are discussed underneath:
 Over applied overhead: It is said to be additional amount of overhead applied during
manufacturing over actual overhead incurred during that particular point of time. On the
other hand, it is the amount that is over estimated from the actual rate for a production
period (Whitecotton, 2011).
 Under applied overhead: It is a kind of situation under which overhead applied to work
in progress goods is less than the actual WIP. This is reported on balance sheet as in the
form of prepaid expenses. During the closing period of time, under applied overhead is
being balanced through creating a debit to COGS (Cost of goods sold).
It is necessary to make analyses of over and under applied overhead account that should
end during the period of time. There are various ways to dispose the amount of over and under
applied overhead costs. Some of them are mentioned underneath:
Allocation among WIP (Work in progress), finished goods and COGS: Under this
particular approach, the amount of over and under applied overhead is disposed of through
allocating it within WIP accounts on the basis of overhead applied in every of the account during
that period of time. This approach is more reliable from other methods. The only limitation of
this is that is more time taken activity.
Transfer the whole amount of over or under-applied to cost of goods sold: According
to this method, the company need to transfer all their net amount of over and under applied to
COGS. In this particular situation below mentioned entries must be passed.
In case overhead is under-applied:
Cost of goods sold a/c…………………Dr
To manufacturing overhead A/c………...Cr.
In over-applied:
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Manufacturing overhead A/c……………Dr
To cost of goods sold a/c…………………Cr
This particular method is not so effective for the companies as compare to first method.
Most of the companies can uses this because of economic cost and easy operations. To reduce
per units cost of production, the company has to reduce the unit cost while manufacturing a
product. This will lead to dispose of over and under applied overhead rate within an organisation.
Immaterial balance: In case in the production overhead, costs which are taken into
account are considered as immaterial and is adjusted to COGS. If the outcomes of overhead are
over applied, then it is transferred as credit balance to cost of goods sold. The choice of method
is being associated with the materiality of the records. All the amount that is being analysed in
large amount can made impacts on decisions that are considered to be material (Immaterial
balance, 2015). Immaterial balance can be avoided by using modern techniques of costing such
as Activity based costing.
CONCLUSION
From the above project report, it has been observed that Kay, the CEO of Beztec Limited
is forcing the accountant that is Sue Smith to figure out some way so that they do no have to
phase out their new printer Protox as it helps to gain bonus. After performing various analyses
such as activity based costing and profitability analyses it can be recommended that Smith
should follow the code of ethics and convince their CEO to phase out low profitable printer and
provide evidences of various analyses.
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REFERENCES
Books and Journals
Ahamadzadeh, T., Etemadi, H. and Pifeh, A., 2011. Exploration of factors influencing on choice
the activity-based costing system in Iranian organizations. International Journal of
Business Administration. 2(1). p.61.
Miller-Nobles, T. L., Mattison, B. and Matsumura, E.M., 2016. Horngren's Financial &
Managerial Accounting: The Managerial Chapters. Pearson.
Öker, F. and Özyapici, H., 2013. A new costing model in hospital management: time-driven
activity-based costing system. The health care manager. 32(1). pp.23-36.
Plank, P., 2018. Introduction. In Price and Product-Mix Decisions Under Different Cost Systems
(pp. 1-5). Springer Gabler, Wiesbaden.
Proctor, R., 2012. Managerial Accounting: Decision Makling and Performance Management.
FT Press.
Suthummanon, S., Ratanamanee, W., Boonyanuwat, N. and Saritprit, P., 2011. Applying
Activity-Based Costing (ABC) to a parawood furniture factory. The Engineering
Economist. 56(1). pp.80-93.
Terpstra, M. and Verbeeten, F.H., 2014. Customer satisfaction: Cost driver or value driver?
Empirical evidence from the financial services industry. European Management
Journal. 32(3). pp.499-508.
Whitecotton, S., Libby, R. and Phillips, F., 2011. Managerial accounting. McGraw-Hill Irwin.
Online
Immaterial balance. 2015. [Online]. Available through:
<https://www.bayt.com/en/specialties/q/204288/what-if-there-s-a-small-immaterial-
difference-in-a-trial-balance/>
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