Comparing Costing Systems: Pristine Limited's Profitability Analysis

This report analyzes the costing systems of Pristine Limited, a manufacturing company facing declining profit margins. It identifies the problems with the traditional costing method, which allocates overhead costs based on volume, leading to inaccurate product costing and reduced profitability, especially for plastic safes. The report presents indicators of an outdated costing system and calculates activity cost rates for an activity-based costing (ABC) system. It then compares the income statements and profit margins under both costing systems, demonstrating how ABC provides a more accurate view of product profitability. The report includes a detailed presentation to the Managing Director outlining the benefits, costs, and issues of adopting ABC, along with recommendations to improve customer profitability. The conclusion emphasizes the superior accuracy and reliability of ABC compared to traditional methods and highlights the importance of data-driven decision-making for Pristine Limited's financial health.

MANAGERIAL
ACCOUNTING

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
1. Two problems of Pristine Limited’s traditional costing system..............................................1
2. Four indicators that current costing system is outdated and flawed........................................2
3. Calculation of activity cost rates to be used in activity based costing system........................2
4. Calculation using activity based costing of income statement of product group process ans
support costs to product group.....................................................................................................3
5. Difference in product cost and net profit margins between the two costing systems..............4
6. Presenting report on the benefits, costs and issues of adopting the activity costing system.. .4
7. Suggesting methods to improve profitability of Pristine Limited’s customer.........................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
Costing system is a framework used by firms to estimate the cost of products for
profitability analysis and expenditure control. It’s essential to estimate the cost of production for
profitable operations. Pristine Limited is a manufacturing company whichis currently facing
issues regarding fall in profit margin on its metal safes products. The present report will critically
discuss the requirement of adopting activity based cost system . Present report will provide
deeper insight about problem of traditional costing which Pristine Limited is facing. Further, the
indicators about outdated current costing system will also be presented along with its limitations.
A brief reporting document is prepared to managing director which reports about importance of
implicating activity based costing in Pristine Limited. Suggestion for company to increase
profitability so as to enhance the customer's profitability is included in present report.
1. Two problems of Pristine Limited’s traditional costing system.
Traditional method is allocation of manufacturing overhead costs to the production of
products. This method assigns factory's indirect costs to items manufactured on the basis of
volume such as number of unit produced, direct labour hour, production machine hours. Pristine
Limited manufactures metal and plastic safe, despite of increasing in high volume sales in plastic
safes Pristine Limited is facing falling in overall profitability with the decrease in sales pf plastic
safes (Weygandt, Kimmel and Kieso, 2015). The problem identified in Pristine Limited’s
traditional costing methods are:
Pristine limited allocates cost on overhead volume based like labour and machine hour’s
only. Allocating costs on overhead volume on labour and machine hour will result in under or
over costing as resources consumed by product and costs allocated may not match (Traditional
Costing Vs. Activity-Based Costing, 2018). This leads the company to deceasing in overall
profitability as despite of getting cheaper resources overall production is complicated.
The cost of performing all diverse activities will be contained in one costing and divided
by number of production machine hours. Which leads to over using of machines hour that
increases the expenditure of Pristine Limited and decrease in profitability of company.
1

2. Four indicators that current costing system is outdated and flawed.
Given case situation presents some indicators due to which traditional costing system is
considered as outdated and flawed such as follows:
 Cited case shows that under traditional costing method application of overhead burden
rates are arbitrary. Such aspect influences net income of Pristine Limited and thereby
overall growth.
 Further, now company is not allocating overhead expenses on the basis of actual
consumption. This in turn considered as inappropriate under modern era because it places
direct impact on profitability.
 In addition to this, traditional costing method does not provide assistance in avoiding
wastage because it considers overhead cost generally.
 Traditional costing method also does not consider unexpected expenditure level. Due to
this, sometimes actual overhead expenses of the firm are highly over projected.
Activity based costing method present more logical manner of assigning manufacturing
overhead costs to products over traditional costing(Dale and Plunkett, 2017). Activity based
costing are centred to an activity or production process, that are based on resources consumed by
those activities.. Activity based costing is beneficial than traditional costing as it helps manager
in allocating overhead and understand profitability of products and customers effectually.
3. Calculation of activity cost rates to be used in activity based costing system.
Computation of cost per unit on the basis of relevant driver
Activities Cost driver
Metal
safes
Plastic
safes
Total
activity
Rat
e
Insulation
process 180700
Insulation
process hours 7000 6000 13000 13.9
per
process
Assembly
process 69600
Assembly
process hours 2800 1200 4000 17.4
per
process
Quality control 80080
Number of
inspections 40 100 140 572
per
inspecti
on
Materials
management 47800
Number of
requisitions 300 700 1000 47.8
per
requisit
ion
2

Selling and
administration 23870
Number of
sales orders 30 47 77 310
per
order
Total process
and support
costs 402050
Table 1: Cost assessment as per related drivers
4. Calculation using activity based costing of income statement of product group process and
support costs to product group.
Cost assessment:
Particulars Metal safes Plastic safes Total
Insulation process 97300 83400 180700
Assembly process 48720 20880 69600
Quality control 22880 57200 80080
Materials management 14340 33460 47800
Selling and administration 9300 14570 23870
Total 192540 209510 402050
Table 2: Cost calculation
Income statement as per activity based costing system:
Particulars Metal safes Plastic safes Total
Sales revenues 296900 246800 543700
Direct material 21500 20680 42180
Process and support
cost 192540 209510 402050
Total costs 214040 230190 444230
Net Income 82860 16610 99470
Profit margin (% ) 27.9% 6.7% 34.64%
Table 3: Profitability statement as per ABC
Profitability statement according to traditional costing method:
Particulars Metal safes Plastic safes Total
Sales revenues 296900 246800 543700
Direct material 21500 20680 42180
Process and support cost 231770 170280 402050
Total costs 253270 190960 444230
Net Income 43630 55840 99470
3

Profit margin (% ) 14.7% 22.6% 37.3%
Table 4 : Income statement as per traditional method
5. Difference in product cost and net profit margins between the two costing systems.
By observing the calculations, it can be interpreted that activity based costing system will
increase the profitability of Pristine limited. The net income from metal safe sales will increase
NI as per activity costing to 82860 than 43630. Activity based costing method used in identify
the productive business operations. With the help of above calculations, it can be said that by
using activity based costing system metal safes are more profitable for company than plastic
safes (traditional costing definition. 2018). It increases the profitability margin from 14.7% to
27.9%. Pristine Limited should focus more on metal than plastic safe
6. Presenting report on the benefits, costs and issues of adopting the activity costing system.
To,
The Managing Director,
Pristine Limited
Australia.
Date: 08/09/2018
Sir,
This is to report higher authority of Pristine Limited about the implementation of improved
costing procedures using activity based model replacing traditional approach of cost accounting
system. It is a modern approach of costing, which is appropriate to be used in manufacturing
firm (Maskell, Baggaley and Grasso, 2016). It is a way of allocating indirect, overhead costs to
department that could generate these expenses in the production process. There are many
benefits to apply activity costing in Pristine Limited.
 Activity based costing helps in bringing appropriate and reliable product cost evaluation
by focusing on cause and effect relationship in the cost sustainability.
 It assists managers of Pristine Limited to control many fixed overhead costs by
emphasizing more control over some activities.
 Activity based costing system improves the manager's decision making as more
4

reliable product cost data can be used. Assist in identifying and avoiding redundant practices
Cost: Application of activity based costing is a significant tool to apply, but is can cost a
burden on Pristine limited 's profitability, as implementation of it requires high skilled
employees, proper training should be given to the employees that will be an extra expenditure
to company.
Application of activity based costing has some limitations also which needs to
considered.
 Managers should have a deep understanding of the organisational process and products.
 Activity based costing will require use of information technology.
 Since there is a lot of steps and groundwork required to come out with a costing based
on this system.
 Some difficulties to implement activity based costing system in Palestine limited is that
it’s a major project which requires considerable resources (Delucchi and Jacobson
2011). After implementation this system requires maintenance which could be costly
for company. Data of numerous activity measures must be collected, checked and
entered into the system.
 Activity based costing data can easily be misinterpreted and must be used in care when
used in making decisions. Costs assigned to products, customers and other cost objects
are only potentially applicable.
Thank you
7. Suggesting methods to improve profitability of Pristine Limited’s customer.
Customer's profitability can be improved when the Pristine Limited’s profitability will
increase. Maximizing profitability is essential for company's sustainability. Following are some
suggestions which are essential for Pristine limited’s profitability
 Using activity based costing is an effective way to find the real cost of specific business
activities (Tseng and et.al., 2018). It helps to estimates the expenses for a particular
business functions. It improves the efficiency to eliminate the unnecessary task and
activities which doesn't add value to the company or customer.
5

 The company should review its material which they offer to customers. Setting a correct
pricing strategy is essential to increase the sales volume. Keeps on checking new ways to
increase value to clients and customers.
 Adopting new budgetary control techniques will help in comparing actual performances
with budgeted one. After comparing the two the variances, and correct measures can be
taken to control the budgets, which helps in reducing cost of business.
CONCLUSION
By summing up the above report, it can be concluded that activity based costing system is
more accurate and reliable than traditional system. Besides this, it can be inferred that problems
associated with traditional costing system directly impacts net income of Pristine Limited’s.
Further, activity and traditional costing system are also been articulated. A report to managing
director on application of activity costing system is included in report. Suggestion to increase
profitability of Pristine Limited is discussed in report.
6

REFERENCES
Books and Journals
Dale, B. G. and Plunkett, J. J., 2017. Quality costing. Routledge.
Delucchi, M. A. and Jacobson, M. Z., 2011. Providing all global energy with wind, water, and
solar power, Part II: Reliability, system and transmission costs, and policies. Energy
policy. 39(3). pp.1170-1190.
Maskell, B. H., Baggaley, B. and Grasso, L., 2016. Practical lean accounting: a proven system
for measuring and managing the lean enterprise. Productivity Press.
Tseng, P and et.al., 2018. Administrative costs associated with physician billing and insurance-
related activities at an academic health care system. JAMA.319(7). pp.691-697.
Weygandt, J. J., Kimmel, P. D. and Kieso, D. E., 2015. Financial & managerial accounting.
John Wiley & Sons.
Online
Traditional Costing Vs. Activity-Based Costing. 2018. [Online]. Available Through:
<https://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-
33724.html>
Traditional costing definition. 2018. [Online]. Available Through:
<https://www.accountingcoach.com/terms/T/traditional-costing>
7

8