Managerial Accounting: Traditional Costing vs Activity Based Costing

This document discusses the differences between traditional costing and activity based costing in managerial accounting. It provides case studies comparing the two methods and explains how they allocate costs and impact profitability. The document also includes a regression analysis to determine fixed and variable costs.

MGMT E-1600 - Managerial Accounting
Case Assignment

Table of Contents
Question 1........................................................................................................................................3
Question 2........................................................................................................................................3
Question 3........................................................................................................................................4
Question 4........................................................................................................................................6
Question 5........................................................................................................................................6
Question 6........................................................................................................................................8
References......................................................................................................................................10

QUESTION 1
Table 1: Statement Showing Gross Margin using Traditional Costing Method in 2018
Particulars Traditional Products Modern Products
Sales Units 12500 12500
Direct Labor Hours 2500 1250
Sales Price / Unit $400.00 $550.00
Total Sales $ 5,000,000.00 $6,875,000.00
Change in Inventory $ - $ -
$ 5,000,000.00 $6,875,000.00
Direct Material $2,500,000.00 $4,375,000.00
Direct Labor $462,962.50 $ 234,182.50
Manufacturing Overhead $1,450,000.00 $ 725,000.00
Total Direct Cost $ 4,412,962.50 $5,334,182.50
Gross Profit $587,037.50 $1,540,817.50
QUESTION 2
Table 2 Statement Showing Gross Margin using Activity Based Costing Method in 2018
Particulars Traditional
Products Modern Products
Sales Units 12500 12500
Direct Labor Hours 2500 1250
Sales Price / Unit $400.00 $550.00
Total Sales $ 5,000,000.00 $6,875,000.00
Change in Inventory
$
- $ -
$ 5,000,000.00 $6,875,000.00
Direct Material $2,500,000.00 $4,375,000.00
Direct Labor $462,962.50 $ 234,182.50
Manufacturing Overhead (Working Note 1) $685,212.23 $ 1,489,787.77
Total Direct Cost $3,648,174.73 $6,098,970.27

Gross Profit $ 1,351,825.27 $ 776,029.73
Activity
Break
Down In
Percent
age Overhead in $
Traditional
Products
Modern
Products
Machining 50%
$
1,087,500.00
$
362,500.00
$
725,000.00
Assembly 25%
$
543,750.00
$
283,695.65
$
260,054.35
Material Handling
Parts 7%
$
152,250.00
$
8,903.51
$
143,346.49
Inspection Hours 18%
$
391,500.00
$
30,113.07
$
361,386.93
$
2,175,000.00
$
685,212.23
$
1,489,787.77
QUESTION 3
Traditional Costing
Traditional costing is a technique of assigning factory overhead to products which totally
depends on quantity consumed by production activities. In this technique cost that are allocated
are based either on the amount of machine hour or direct labor hours used. These methods face
several difficulties where factory overhead might be greater than the allocation base, therefore a
little change on the amount of resources consumed can cause a great alteration in the amount of
overhead which is functional. Such issues are significant in the sectors of highly automated
manufacturing surroundings, where expenses of factories are huge and direct labor is close to
unreal (Maas, Schaltegger, & Crutzen, 2016).
Activity Based Costing

Activity based costing is a technique of managerial accounting which helps to trace the overhead
costs to behavior and further assigns them to objects. It is a method in which overhead and
indirect costs are allotted to the products or departments by considering how such costs are
generated in the manufacturing process (Chenhall, & Moers, 2015). Activity based costing
majorly focus on recognizing production procedures and actions which facilitates the working.
All the individual actions are combined within the same procedure into a cost pool which
directly relates to single activity cost driver. Further cost pools are evaluated and predetermined
overhead rates are allotted which will ultimately be allocated towards products and individuals
working (Hoozée, & Hansen, 2017). ABC is a precise method of allocating indirect costs. This
technique helps to identify the connection within costs, overhead activities, and produced
products, and throughout such association, it allocates indirect expenses to products less
subjectively than traditional method. These techniques fail to allocate some types of costs, for
example indirect costs like staff wages and salaries, management cost etc and because of which
this technique set up its positions in the manufacturing division (Mahal, & Hossain, 2015).
Table 3 COGS and GM for the year 2018 under traditional costing and activity based costing
Traditional Costing Activity Based Costing
Particulars Traditional
Products
Modern
Products
Traditional
Products
Modern
Products
COGS $4,412,962.5 $5,334,182.50 $3,648,174.73 $6,098,970.27
Gross
Margin $587,037.50 $1,540,817.50 $1,351,825.27 $776,029.73
On the basis of above data, it has been seen that, by applying the traditional costing method, the
profit of the traditional product is less than as compare with the profit computed from the activity
based costing. On the other hand, the profit from modern product under the traditional costing is

more than the profit computed under the activity based costing. There is significant difference in
both approaches, therefore the results are totally different. However, Activity based costing
generates an accurate picture of the resources and activities. It helps in facilitating best procedure
in terms of product and decision making. It allows better resource allocation for balancing the
operational necessities. This technique helps to avoid investment in operationally infeasible plan
by eliminating unproductive business activities. Moreover, cost allocation by traditional costing
method not present the correct picture of the cost and profit. Therefore, it can be said that
traditional product generate more profit as compare with the modern product.
QUESTION 4
Table 4 Statement Showing Gross Margin using Activity Based Costing Method in 2020
Particulars Traditional Products Modern Products
Sales Units 12750 12750
Sales Price / Unit $ 425.00 $ 575.00
Total Sales $ 5,418,750.00 $ 7,331,250.00
Change in Inventory $ (275,000.00) $ (200,000.00)
$ 5,143,750.00 $ 7,131,250.00
Direct Material $ 2,805,000.00 $ 4,908,750.00
Direct Labor $ 519,443.93 $ 262,752.77
Manufacturing Overhead (Working
Note 1) $ 768,808.12 $ 1,671,541.88
Total Direct Cost $ 4,093,252.05 $ 6,843,044.64
Gross Profit $ 1,050,497.95 $ 288,205.36
QUESTION 5
Summary output client 1

Table 5Regression Statistics
Multiple R 0.957303
R Square 0.916429
Adjusted R Square 0.908072
Standard Error 5615.029
Observations 12
Table 6
df SS MS F
Significance
F
Regression 1 3457381185 3457381185 109.65875 1.04011E-06
Residual 10 315285482 31528548.2
Total 11 3772666667
Coeffic
ients
Standard
Error t Stat
P-
value
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercep
t 13649
3265.403
922
4.1798
7353
0.0018
8809
6373.20
2074
20924.
7488
6373.20
21
20924.7
4877
X
Variabl
e 1
451.47
3
43.11319
979
10.471
8074
1.0401
E-06
355.410
9287
547.53
532
355.410
93
547.535
3196
Summary Output Client 2
Table 7Regression Statistics
Multiple R 0.892860694
R Square 0.797200219
Adjusted R Square 0.776920241
Standard Error 7490.523299
Observations 12
Table 8

df SS MS F
Significance
F
Regression 1 2205587274 2205587274 39.3097 9.26454E-05
Residual 10 561079392.9 56107939.3
Total 11 2766666667
Coeffici
ents
Standard
Error t Stat
P-
valu
e
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercep
t
5018.76
8196
5007.043
137
1.0023
4171
0.33
982
-
6137.61
9151
16175.1
5554
-
6137.61
9151
16175.1
5554
X
Variabl
e 1
361.078
4077
57.59059
351
6.2697
4625
9.3E
-05
232.758
5688
489.398
2466
232.758
5688
489.398
2466
QUESTION 6
Generally, the costs are bifurcated into two types, such as fixed cost, and variable cost. fixed cost
are the cost, which do not change with the level of output, either the company produced one unit
of the product or the hundred unit of the product, the cost remain the same (Brook, 2018). on the
other hand, variable cost are the cost, which changes with the level of output. The total cost the
fixed cost and variable cost, is regarded as a total cost of product. Regression analysis assists in
the computation of the fixed cost and variable cost (Hox, JMoerbeek, & Van de Schoot, 2017).
This method applies several numbers of mathematical equations to get the best possible outcome
to the data point.
The equation of the regression analysis is –
Y = f + vX
Here,

Y represents the total cost of the product,
v is the per unit variable costs of the product
X is the number of unit.
In the given problem, if we apply the equation of regression for client one, on the basis of 75
specification –
Then, regression equation will be –
Y = 13649+451.473X
For the performance of the data analysis and regression analysis, several inputs are required.
Input Y ranges requires cost of goods sold and the input X ranges required the number of
specifications. By applying the regression analysis, total cost of goods sold can be bifurcated into
the fixed cost and variable cost (Ives, 2015).
Along with this, R-Square measures the variance in the data. In other words, it can be said that it
measures the percentage of variance on the dependent variable, which is the total cost of
production, described by the independent variable (that is number of specification) The range of
R-square is lies between the 0 and 1 (Cremers, Mulder, & Klugkist, 2018). In the present study,
R-square for the client one is 0.92 and for the client two is 0.80. It explains that, for the client
one, 92% of the variance in total cost of production is explained by the level of unit produced.
Similarly, for the client two 80% of the variance in total cost of production is explained by the
level of unit produced. Therefore, it can be said that regression analysis is the useful technique
for determination of the fixed cost and variable cost.

REFERENCES
Brook, R. J. (2018). Applied regression analysis and experimental design. Routledge.
Chenhall, R. H., & Moers, F. (2015). The role of innovation in the evolution of management
accounting and its integration into management control. Accounting, organizations and
society, 47, 1-13.
Cremers, J., Mulder, K. T., & Klugkist, I. (2018). Circular interpretation of regression
coefficients. British journal of mathematical and statistical psychology, 71(1), 75-95.
Hoozée, S., & Hansen, S. C. (2017). A comparison of activity-based costing and time-driven
activity-based costing. Journal of Management Accounting Research, 30(1), 143-167.
Hox, J. J., Moerbeek, M., & Van de Schoot, R. (2017). Multilevel analysis: Techniques and
applications. Routledge.
Ives, A. R. (2015). For testing the significance of regression coefficients, go ahead and log‐
transform count data. Methods in Ecology and Evolution, 6(7), 828-835.
Maas, K., Schaltegger, S., & Crutzen, N. (2016). Integrating corporate sustainability assessment,
management accounting, control, and reporting. Journal of Cleaner Production, 136, 237-
248.
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.