Management Accounting

This document discusses the overhead cost allocation methods in management accounting, specifically the traditional costing method and activity-based costing (ABC) method. It explains the differences between these two methods in terms of accuracy and complexity. The document also analyzes the departmental rates and plant wide rate for overhead allocation and recommends the use of departmental rates for better cost calculation. Additionally, it highlights the drawbacks of Rex's plant wide overhead allocation method and suggests using a more accurate method. Finally, it discusses the benefits of ABC method in improving overhead allocation and identifies its advantages over traditional costing approach.

Running head: MANAGEMENT ACCOUNTING
Management accounting
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The overhead coast to production can be allocated by the two different methods. One
is traditional Costing and another is activity based costing (ABC) method. Both the methods
are used to estimate overhead costs related to production and then these costs are assigned to
products based on a cost driver rate (Mahal & Hossain, 2015). Both these methods are
different from each other in the term of accuracy and complexity. The traditional method is
simple and less accurate that assigns overhead cost to products based on an arbitrary average
rate, while ABC method is more accurate as well as complex that assigns the cost to products
in accordance with the products usage of the activities.
Answer to Question (i)
Answer to Question (ii)
The departmental rates are $56.52 for the Machining Department and $11.67 for the
Assembly Department while the Plant wide rate computed by the manager is $47.14.
Analysing both the rates, it can be stated that the department rates are clearer and easily
understandable. Further, the plant wide rate only calculated one rate considering only one
base for the entire departments of the factory. On the contrary, the departmental rates are
calculated separately for each department which help to understand the working cost
departmental wise easily but from the plant wide rate is become difficult to calculate the cost

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for the department wise (Kim et. al,2016). The plant wide cost also assumes the departmental
cost because it only consider the based cost for every department which may vary from the
actual cost that will have an impact on the pricing of product. However, the departmental
costing provides the exact cost of the each department. Therefore, it can be said that
departmental costing method is rational and scientific.
As per the analysis, the Rex’s plant wide overhead allocation method is not
appropriate because Rex simply divided the overhead cost by labour hour and calculates the
overheads by the plant wide cost. The plant wide cost is calculated by using only one base
cost. As plant cost is only based on a single cost or in the average cost therefore, the actual
cost of each product cannot be correctly calculated (Haroun, 2015).This method is further not
appropriate as this is the historical based costing system which is less accurate but easy to
calculate. This is also a main reason behind losing the sale of product R907 to his competitor
who was able to sell a similar product at a lower price because by following this method, Rex
is not able to calculate the actual cost of the product and it comes high by cost. The actual
overhead allocation should be made by dividing the overhead cost by machine hours
consumed in Machining Department and by dividing the overhead cost by the direct labour
hours consumed for the Assembly Department for the each product separately. This method
will help Rex to understand the cost of each product more accurately and more clearly
(Esmalifalak, Albin & Behzadpoor, 2015). If Rex follows the above stated method to allocate
the overhead, he will able to ascertain the actual overhead of the each product that is $
1334.57 for the Product X123 and $ 521.25 for the Product R907. It will also help Rex to sell
Product R907 in a lower price to compete with his competitors who provides the similar
product in the lower price. Further, this method is more rational and scientific.
Based on the above discussion, it can be recommended that Rex should use $ 1344.57
cost per unit for the Product X123 and $ 521.25 as the cost per unit for the product R907.

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Answer to Question (iii)
ABC method will surely improve the way of allocating the overhead in this firm. The
ABC method calculates the overhead cost separately for each department that helps to
calculate the cost more accurately (Groover, 2016). ABC determines the relationship between
overhead activities, cost and manufactured products. It further recognizes costs of overhead
activities and after that assigns the identified costs to products. In this method, an activity can
also be considered as any transaction or event that is a cost driver. This cost driver or the
activity driver is used to refer as the allocation base (Maskell, Baggaley & Grasso, 2016).
Activity Based Coasting is more accurate as compared to the traditional method of
coasting. It is more suitable for the companies with high overhead cost that manufacture
products than the historical based coasting method. It is also beneficial for the companies that
manufacture large number of different product because it computes the cost of each product
more accurately as compared to traditional approach. This method also assists the firm to
identify areas where expenses are being wasted on unprofitable product (Osadchy &
Akhmetshin, 2015).
The above mentioned differences between ABC and traditional costing approach can
be stated in different ways. ABC can identify the costly activities, which is required to
complete the products, which is not possible through the traditional costing approach.
Secondly, it helps to assign costs to the identified costly activities that require completing the
product. It also identifies the cost driver for each activity. The cost driver is the action that
causes the costs associated with the activity. It also calculates a predetermined overhead rate
for each activity. Further, it allocates overhead costs separately for the each product.

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The paper concludes that the ABC method is more accurate and scientific as
compared to traditional costing. The traditional costing approach calculates the overhead by
considering the only one rate for the all department, which may differ from the actual cost of
the product. While ABCcalculates, the overhead cost separately for the each product, which
is more accurate and clear. The method used by the Rex to overhead allocation is not
appropriate as it is based on the plant wide cost and the plant wide cost only considers one
base to calculate the overhead cost. While, departmental base allocation is more clear and
accurate. Therefore, Rex must consider departmental wise rate while allocating the
overheads.

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References
Baumers, M., Dickens, P., Tuck, C., & Hague, R. (2016). The cost of additive manufacturing:
machine productivity, economies of scale and technology-push. Technological
forecasting and social change, 102, 193-201.
Esmalifalak, H., Albin, M. S., &Behzadpoor, M. (2015). A comparative study on the activity
based costing systems: Traditional, fuzzy and Monte Carlo approaches. Health Policy
and Technology, 4(1), 58-67.
Groover, M. P. (2016). Automation, production systems, and computer-integrated
manufacturing. Pearson Education India.
Haroun, A. E. (2015). Maintenance cost estimation: application of activity-based costing as a
fair estimate method. Journal of Quality in Maintenance Engineering, 21(3), 258-270.
Kim, Y. W., Han, S. H., Yi, J. S., & Chang, S. (2016). Supply chain cost model for
prefabricated building material based on time-driven activity-based costing. Canadian
Journal of Civil Engineering, 43(4), 287-293.
Mahal, I., & Hossain, A. (2015). Activity-Based Costing (ABC)–An Effective Tool for Better
Management. Research Journal of Finance and Accounting, 6(4), 66-74.
Maskell, B. H., Baggaley, B., & Grasso, L. (2016). Practical lean accounting: a proven
system for measuring and managing the lean enterprise. Productivity Press.
Osadchy, E. A., &Akhmetshin, E. M. (2015). Accounting and control of indirect costs of
organization as a condition of optimizing its financial and economic
activities. International Business Management, 9(7), 1705-1709.

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