Management Accounting

This document discusses the various methods of costing for allocation and absorption of overhead costs to various products and cost units. It also explores the advantages of using the Activity Costing System for more efficient and effective allocation of overhead costs. The document provides a case study analysis and recommendations for managing activities and increasing production and sales to improve profitability.

Running head: MANAGEMENT ACCOUNTING
Management Accounting
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Answer to question 1:.................................................................................................................2
Answer to question 2:.................................................................................................................4
References:.................................................................................................................................5

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Answer to question 1:
Workings:

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Notes:
In the above tables various computations and calculations have been made to present
an income statement under the activity based costing method. The first table in the workings
shows the computations of cost driver rates for various activities and in the next four tables of
workings, the overhead allocation to four individual products have been shown based on use
of various activities by the individual products. As per the given instruction the indirect

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labour has been allocated based on three cost drivers and the computer system expenses have
been allocated based on two cost drivers. The total use of cost driver for fringe benefits has
been computed as the sum of total indirect labour and direct labour. As the fringe benefit is
an overhead it has been shown separately with the overhead otherwise it could have been
included with the direct and indirect labour costs also.

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Answer to question 2:
There are various methods of costing for allocation and absorption of overhead costs
to various products and cost units. The traditional method of overhead allocation, considers
only a single base or activity for the allocation and absorption of overhead costs, hence it is
considered to be less effective and logical as the costs depends on numerous activities
(Klychova et al. 2015). To eliminate the disadvantages of traditional method and to allocate
the overhead costs more efficiently and effectively, the Activity Costing System can be
applied where overheads are allocated based on various activities which causes an increase in
the overhead costs (Balakrishnan, Labro and Soderstrom 2014).
It can be observed from the case study that, under the traditional system of overhead
allocation system, where the overhead costs were allocated as 300% of the direct labour
costs, all the products were having an operating profits. But it did not distribute the overhead
costs to all the four products rationally. Usage of various activities for the products varies and
the overhead costs must be distributed based on such usage of activities. Applying the
Activity Based Costing Method and allocating the overhead to the four products, it can be
observed that there is a loss for Red pen and Purple Pen. It can be observed that, both the two
products making a loss are having a high machine setup time despite having a small amount
of production and sales (Kaplan and Atkinson 2015).
Based on the analysis, it can be recommended for the company to manage its
activities efficiently and to increase the production and sales of Red pen and Purple Pen.
They need to reduce the number of machine setups and use of other activities for the two
pens and they need to increase the production and sales for the two pens to have a better and
a profitable situation.

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References:
Balakrishnan, R., Labro, E. and Soderstrom, N.S., 2014. Cost structure and sticky
costs. Journal of management accounting research, 26(2), pp.91-116.
Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.
Klychova, G.S., Zakirova, A.R., Zakirov, Z.R. and Valieva, G.R., 2015. Management aspects
of production cost accounting in horse breeding. Asian Social Science, 11(11), p.308.