Comparative Analysis of Costing Methods

This assignment requires a comparative analysis of various costing methods used in internal reporting. Students are expected to research and discuss the differences between normal costing, full costing, variable costing, activity-based costing, and absorption costing. The assignment also involves identifying the advantages and disadvantages of each method. A detailed comparison of these methods will provide insights into their effectiveness in different business scenarios.

Student Name/ ID Number Bui Khanh Linh/ F12-081
Unit Number and Title Unit 14: Advanced Management Accounting
Academic Year Semester 1, 2020-2021
Unit Tutor Dr. Ngoc Nguyen
Assignment Number and Title AMA2: Accounting Advisory Report (2 of 2)
Issue Date 28th September 2020
Submission Date To be announced by office
IV Name Ms. Nguyen Thi Thanh Mai (IV) and Dr. Doti Chee (Lead IV)
Date 4th September 2020
Submission Format:
The submission is in the form of an individual written report. This should be written in a concise, formal
business style using single spacing and font size 12. You are required to make use of headings,
paragraphs and subsections as appropriate, and all work must be supported with research and referenced
using the Harvard referencing system. Please also provide a bibliography using the Harvard referencing
system. The recommended word limit is 3,000–3,500 words, although you will not be penalised for
exceeding the total word limit.
Unit Learning Outcomes:
LO2 Evaluate the use of management accounting techniques to support organisational performance.
LO3 Analyse actual and standard costs to control and correct variances.

Table of Contents
Scenario 1:......................................................................................................................................3
Absorption costing.......................................................................................................................3
Activity-based costing..................................................................................................................3
Scenario 2:......................................................................................................................................6
Payback Period method...............................................................................................................6
Discounted payback period..........................................................................................................7
Net Present Value (NPV).............................................................................................................8
Internal Rate of Return (IRR).......................................................................................................9
Scenario 3:....................................................................................................................................10
Scenario 4:....................................................................................................................................12
Material Variance......................................................................................................................12
Labor Variance..........................................................................................................................13
References.....................................................................................................................................15
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Scenario 1:
Absorption costing
According to Izaaks (n.d), absorption costing refers to a process of tracking the variable
production expenses as well as the fixed one for each unit of product. This means that all the
indirect overhead of production will bi added together then be allocated into each of unit of
product based on labor hour or machine hour. Normally, the production cost of absorption
costing including direct material, direct labor, variable manufacturing overhead and fixed
manufacturing overhead.
Budgeted Activities overhead = 2.5 x 20,000 + 16,000 x 3 + 22,000 x 2 = 142,000

Production cost per unit
Activity-based costing
The activity-based costing method is the costing method assigning the overhead as well as
indirect costs that involve in the production cost of products and services based on different
activities and along with that is cost drivers (Soekardan, 2016)
Cost driver
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Overhead Absorption Rate
Manufacture overhead
Total overhead per unit
Production cost per unit
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From the calculation above, it can be seen that the total production cost for each unit of product
calculate by the absorption costing method is different from that of activity-based costing.
Looking into the details, the direct material cost as well as the direct labor cost in both methods
is similar to each other while the manufacturing overhead is not. In other words, the
manufacturing overhead calculates base on the absorption costing method is different from the
other.
It can be clearly seen that machine hour is the only allocating base in terms of absorption costing
method in which product X, product Y and product Z cost 2.5, 3 and 2 labor hours respectively.
Clearly, product Y waste the most time. This leads to Y is the product that bear the most
overhead compare with other products.
However, activity-based costing method allocates production cost based on the complexity of the
products which means that the more complicated the product is the more overhead it will bear. In
this case, the production cost is calculated based on different cost and activity such as machine
set up cost, material ordering cost and many others. According to the above calculation, product
Z has the greatest number of orders, machine hour as well as number of batches. To be more
specific, for example, the number of batches of product Z is 55 batches while product X and
product Y are 40 and 20 respectively. Similar with the number of labor hour and the number of
orders purchased. Product Z is also waste the most hour and orders when compare with others.
As a result, it can be said that product Z bear the most overhead.
Basing on the calculation, it can recognize that if Rang Dong allocate the product cost by general
cost using the traditional method which are absorption costing method, the manufacture
overhead of product X, product Y and product Z are $24.25, $29.1 and $19.4 respectively while
they are suppose to be $24.64, $19.25 and $26.21 using the modern method which is ABC one.
Clearly, the production cost of product Y is determined highest while product Z is the lowest.
This would affect the pricing policy of the company which might leads to the losses of the
company as product Z is priced less while product Y is priced higher. Consequently, Rang Dong
company is recommended to apply the ABC method to allocating the production cost as it
calculate the cost for each unit of product more accurate.
On the one hand, applying absorption costing brings about some of the advantages as follow.
Firstly, this method shows the more realistic of the value of the product. To specify, in this
method, the fixed overhead is considered as the value of the products. This means that the value
of the manufactured products includes the fixed overheads that involve in the manufacturing
process (Gersil and Kayal, 2016). Secondly, the absorption costing is more suitable for small
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business. Indeed, calculating based on this method is easier as small companies do not have
much types of products (Nan, 2019). Hence, this help business estimating the selling prices as
well as profit. Lastly, according to Waller (1971), absorption costing can help firms to control
the cost. To specify, as this method includes all kinds of cost then allocate them into each unit of
products. Therefore, this would easier for companies to see and find out the most profitable price
for each produced unit.
However, this method also has some disadvantages. In detail, according to Collis and Hussey
(1999), this costing method calculates the production cost using the fixed cost regardless of the
quantity or the nature of the products. This can lead to the wrong calculation of manufacturing
overhead. Moreover, as the absorption costing method does not differentiate between variable as
well as fixed cost then it may difficult for companies to predict and forecast the more reasonable
and possible budget (Kaplan Financial Limited, 2019).
On the other hand, the activity-based costing can also be beneficial to business. First, the
activity-based costing method provides the more accurate production cost for each types of
products as this method allocates the manufacturing overhead more accurately based on different
cost drivers equivalent to each activities of the producing process (Reyhanoglu, 2004). Second,
this costing method helps business to determine the profit margin for each product easier as well
as more precisely (Popesko, 2010). In other words, this method provides organizations with a
clearly picture about products that helps to create profitability. By this method, manager would
know which kind of product need to be focus on so as to have positive impact on their profit.
Last, activity-based costing can be applied in order to support business in decision making in
terms of selling price or detect whether it is needed to add or remove items from the list of
products (Kannaiah, 2015). This means that ABC gives better understanding as well as
justifications in terms of manufacturing overhead costing so that firms will know what to do to
minimize the production cost.
On the contrary, the activity-based costing also has some limitations. One of the most
considerable disadvantages of this method is that this method is that it is costly. Indeed, as it can
be seen from the above calculations, the activity-based costing is much more complicated than
the other one (Kannaiah, 2015). Therefore, it is easy to understand that the implementation of
this method requires more cost. For example, due to the complication of this method,
organizations might need support from experts so as to generate the cost based on different
activities as well as training about its usage. Besides that, this method cannot be applied to small
businesses that producing a few numbers of products (DBA Software Inc, 2017). To be more
specific, because ABC costing method calculate the production cost for each unit of products
based on different types of activities which is rarely incur in small companies. Hence, the
application of this method is inappropriate for some types of business.
From the above evaluation of two types costing method, it can be recognized that absorption
costing can be used appropriately by business with small scope as it includes few types of
products as well as simple producing activities. Meanwhile, the activities-based costing often
used in manufacturing industries or business that have complicated production line with many
activities and many types of products. Therefore, with the calculation and evaluation above,
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Rang Dong company should apply the ABC method in order to allocate the cost of each unit of
product more accurate which ensure the profitability of the company.
Scenario 2:
Payback Period method
The payback period method is used in order to calculate the possible amount of time till the
breakeven of a particular project.
 Project A would be the first chosen due to the shortest payback period.
 Project B would be ranked second place because its payback period longer than that of
project A
 Project C would be the last choice as its payback period is the longest among others
This method beneficial for business as it is simple to calculate (Stamalevi, 2015). Indeed, the
payback period method only calculate through years continuously which shows the amount of
time needed to get back the original investment. Moreover, because this method easy to calculate
the payback period so it is easier for investors to evaluate and decide which project to invest in
base on the shortest payback time as well as fast return. In addition, this method also shows the
effectiveness as well as improve the solvency capability of a company. This means that the
project being invested is less risky which is appropriate for business having limited resource.
However, this method completely ignore the profitability of the cash inflow after the payback
period (Mawih, 2015). For example, there are some projects that require longer payback time but
they would bring about much profit compare with projects with shorter payback time. Hence,
this leads to rejection of profitable projects. Another deficiency of method is that it does not care
about the changes of the value of money or currency through years (International Center for
Responsible Tourism Australia, 2002). To be more specific, normally, the value of the cashflow
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at the beginning of the project will be higher than that of the cashflow in later years. As a result,
from the evaluation above, it is easy to understand that this method is rarely apply to determine
which project is appropriate to invest in.
Discounted payback period
Discounted payback method provides number amount of time ton recover the capital that is
invested in the present year using the interest rate so as to value the time value of the money
through years.
From the calculation, it can be seen that project B should be the most consider to be invested in
due to the shortest payback period among others which is 5 years and 0.3 month. Following that
is project C with the payback time within approximately 5 years and 8.9 months. Project A
cannot payback within 5 years so this project is rejected.
One of the most considerable benefits when apply this method to determine the payback time of
projects is that it consider the value of money through years while payback period method does
not. Therefore, the method would point out the more exact payback time for businesses as well
as investors in order to consider which project to invest in. Another advantage that this method
brings about is that is provides opportunities to realize the actual risk that occur in each project.
Looking into the details, as the method involve the current interest rate of the cashflow through
years into calculating process. As a result, the output would be more accurate and reliable to
determine the most profitable project.
Nevertheless, there still some limitations of this method. Clearly, similar to the payback period
method, the discounted payback method only concern about the time that the capital is repaid
(Torre, Martinez and Lemmon, n.d). In other words, this method does not consider about how
profitable it will be after the break-even. Hence, there might be some profitable projects that are
missed. Moreover, the calculation of discounted payback is more complicated than the payback
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period. Because the present value will be used the discounted factor table to calculate, it is
possible to incur mistakes which leads to wrong cumulative present value and wrong conclusion.
Net Present Value (NPV)
Net Present Value (NPV) is used with the purpose of comparing between the cashflow or
benefits that can be received in the future and the cashflow or capital of investment currently.
Based on the results above, it can be concluded that project C is the best choice because of the
net present value which is 66,244 is the highest compare with other projects. Following that is
project B is the second most chosen with the NPV of 54,947. The last one is not accepted as the
net present value is negative value. This means that project C does not brings about any benefit if
it is invested.
Applying this method brings about some benefits as follow. On the one hand, this method
provides business a specific measurement of potential investments based on the current currency.
As business using the discounted cashflow, it would calculate which project would create most
profitability and wealth that should be invested in. On the other hand, because this method
consider the time value of the cashflow, the analysis of how profitability is a particular project
would be more accurate and specific. In details, this method calculates the present value using
discounted factor, which means that business would not miss any profitable project.
Nevertheless, the use of net present value also has several drawbacks. One of the most
considerable problem when using this method is that it is not applicable for projects that different
from each other in terms of size (Hui, 2015). For example, it is inequal if making comparison
between project B and C as they do not have the same amount of investment and also their time
creating producing positive cashflow. The net present value of larger project like project C is
obviously higher than that of smaller ones like project B. Another weakness of this method is
that it require assumption about future capital of business (Nabradi and Szollosi, n.d). To specify,
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the investment of the project would be below the standard level in case the capital cost is
assumed too low. On the contrary, if the capital cost is assumed too high then many ideal
investments would be missed.
Internal Rate of Return (IRR)
Internal Rate of Return is often used by managers in financial analysis so as to determine how
profitable a project is with the purpose of making investment decision.
According to the above calculation, it can be seen that project C rank the first place due to its
highest IRR which is 15.7% among other projects. Following that is project B with the second
highest internal rate of return of 14.2 percent. Project C rank the lowest place as the lowest rate
(9.3%).
Business can beneficial from the internal rate of return because of the following reasons.
According to Hazen (2002), one of the most significant reasons is that this method is easy to
compare the profitable ability between projects. Looking into the details, the internal rate of
return would reflect which project can bring most potential cashflow. Furthermore, as Kierulff
(2012) had mentioned in his study, the time value of money is considered in this method. This
means that it use the interest rate where the value of the future cashflow is equal to the current
capital investment. Hence, each cashflow is measured equally using the time value of money. In
contrast, there still occur some limitations during the application of internal rate of return such as
this method ignore the potential cost in the future affecting the profitability (Jiang, 2016). As a
result, the cashflow of the project that is measured might not be accurate which leads to wrong
evaluation of the whole scope of the project.
Scenario 3:
As can be seen that the budget number of units sold is 640.000 units which is different from the
actual one which is 720.000 units. This means is inappropriate to have comparison between the
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two different in to quantity of product. Therefore, the budget total number of units sold have to
transfer into the flexible total quantity of units sold (the flexible quantity have to be equal to the
actual one) so as to have the same level to make comparison more accurate. Following that, the
budget cost would be transfer into the flexible cost using the formular as follow:
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Basing on the calculation above, it can be seen that the flexible material cost is $189.000 while
the actual cost is $144.000. Therefore, the variance is calculated is 45.000 (Favorable). This
means that Rang Dong had saved much of the material cost which minimize the production cost.
This favorable result might be the result of that the company had found a new supplier with the
more reasonable material price or the company had changed the used material to the new one
with lower price.
However, in terms of labor cost, it can be easily seen that the actual labor cost which is $288.000
is over the flexible one ($270.000). This means that the company had spent more on the labor
expense than expected. The possible cause for this waste is that the company want to improve
the quality of the production line by recruit more employees that are qualified or hiring experts to
train the current labor force. Thus, there are some solutions for the company in order to minimize
the labor cost such as training the workers for improving quality of the human resource or
applying high technology so as to reduce the labor force cost. It is considerable that the overhead
in both actual and flexible cost equal 0 so there is no overhead variance.
Looking into the sales, it can be seen that there is an adverse result which is a result of the actual
sales is less than expected. The possible cause for this is that the competitive market. To be more
specific, there are many competitors that are more prestigious with not only the higher quality
products but also reasonable pricing. For that reason, in order to increase the sales of the
company, Rang Dong should implement market research so as to catch up with the latest trend as
well as the customers’ demands. Moreover, the company should invest in and develop more the
R&D department with the purpose of creating products that meet the needs and demands of
customers.
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Scenario 4:
Material Variance
In terms of usage variance, on the one hand, it can be seen that the operational variance incur the
adverse value which is 5.280. This is the result of the actual quantity (54.560 meter) is more than
the revised standard quantity (52.800 meter). This means that the company had wasted more
amount of material than expected. On the other hand, based on the calculated results, because the
revised standard quantity (52.400 meter) is much more than the standard quantity (48.000 meter),
it leads to the adverse planning variance of 14.400. In other words, it can be said that Rang Dong
had not produced the dress based on the revised budget meter per output currently in the market.
It can be guessed that the reason of these waste is during the production process, there might be
incur some errors which leads to waste in material. Moreover, this might because of the new
dress model is more complicated than the previous one which means that it requires more
material to produce.
In terms of price variance, the calculation shows that Rang Dong had saved much cost per unit
during production. In detail, as can be seen in the calculation above, the actual price per meter
($2.85 per meter) is less than the budget one ($3 per meter). This might because the company
had found a new supplier with cheaper price or choosing different material that cost less than the
old material used. Therefore, this would save much production cost for the company which can
be consider as an effective production.
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However, after all the calculation, the company still receive an adverse result which is 11.496.
Basing on the analysis above, it can be said that the main problem here is the use of material
during the manufacturing process.
As a result, Rand Dong should have some adjustment in the use of material in manufacturing
such as the company can reuse the excess material after production or have a strict management
and supervising on the working process of the workers so as to make sure to minimize the
potential errors that can be incur. Consequently, this would not only maximize the production
efficiency of the company but also saving much cost that will ensure the profitability of Rang
Dong.
Labor Variance
It can be seen that the total variance of labor efficiency variance is 9.600 which is determined as
an adverse. Looking into the details the actual hour is more than the standard hour. In other
words, the company had wasted more time to produce than expected. This can be difference
between labor efficiency operational and labor efficiency planning. Clearly, because the
operational variance equal 0, the main cause of the adverse result is from the labor efficiency
planning variance. Specifically, it can be seen that the budgeted hour for a unit is 2 minutes less
than the revised budgeted hour per output which leads to the calculated revised standard hour is
much higher than standard hour. There are some possible reasons for this waste. One of the most
considerable cause is that the design of the new dress model may be more complicated than the
previous one which requires more time to produce. Hence, so as to minimize the production hour
for a unit, one of the most possible solution for Rang Dong is the company should train the
employees with producing new design so that they would get used to making the new model.
Consequently, this would improve the labor efficiency as well as saving time of production.
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It is reasonable that the company separate the labor efficiency into operational variance and
planning variance. Indeed, by dividing the labor efficiency into operational and planning, the
company can determine the root cause of why there is the occurrence of the adverse value. In
other words, Rand Dong company would know causes which would comes up with suitable
solutions to solve the problem. Moreover, separate the labor efficiency variance into operation
variance and planning variance would make it easier for the company to evaluate equally and
accurately the performance of each department.
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