Accounting: Costing Methods and Profitability Analysis

This assignment delves into the application of Activity-Based Costing (ABC) to analyze product costing and profitability. It begins by highlighting relevant indirect costs for both traditional and advanced models. The solution then demonstrates the computation of product costing using the ABC system, determining unit costs for various cost drivers. A profit and loss statement is constructed to illustrate the impact of different costing methods on pricing and profitability, explaining why a foreign buyer might be interested in a specific product model. The assignment also discusses the discrepancies between overhead costs used for cost computation and those actually incurred, providing measures to manage these variations. It further explores the benefits and limitations of the ABC system, including its accuracy in cost allocation and its complexity. The analysis uses references from established accounting texts to support its findings.

ACCOUNTING
STUDENT ID:
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Question 1
The relevant indirect costs related to manufacturing are highlighted below.
Basic Model (Traditional Costing)
Advance Model (Traditional Costing)
Question 2
The product costing is to be computed using ABC system for which the unit cost for each of
the cost drivers need to be determined which is carried out below.

Basic Model (ABC Costing)
Advance Model (ABC Costing)
Question 3
It is known that a company charges a mark-up of 20% on the unit cost price for determination
of the selling price.

Therefore, the unit sale price for the advance system would be 1.2*890.93 or $1,069.12
Taking into consideration the above pricing and the traditional costing of the product, the
profit and loss statement for December 2017 is illustrated as follows (Emmauel and Otley,
2015).
Taking into consideration the above pricing and the ABC costing of the product, the profit
and loss statement for December 2017 is illustrated as follows (Drury, 2016).
The above P&L statement is indicative of the precise reason for the interest of foreign buyer
in procuring only the advance model. There is under-application of the indirect or overhead
costs to the advanced model which leads to lower costing and hence lower price than the
actual level. Also, at the given price, the company in reality is incurring losses, thus the
foreign buyer is finding this price very lucrative (Heisinger, 2014).

Question 4
The overheads which are actually used rarely match with the overhead used for cost
computation. One of the reasons for the same is the use of traditional costing methods that
deploy direct cost as the basis for indirect cost allocation. With regards to usage of activity
based costing also, it is imperative that every activity can be broken into further sub-activities
but owing to high complexity and cost factors the sub-activities are identified to a particular
level only which leads to potential mismatch between the two overheads (Drury, 2016).
In order to manage the above variation in overhead costs, he following three measures are
pivotal (Kinney and Rainborn, 2012).
 Firms having more than one product should use activity based costing especially
when the products are heterogeneous.
 The company should keep a track of the pricing offered by competition and any
failure on the company’s part to meet the competitor’s price or vice versa should have
a valid explanation. The inability to account for such observations implies that costing
is not accurate.
 In case of multiple products, if a particular product is doing very well while a lower or
higher range product is failing in terms of generating sales even though there are no
product issues. In such cases also, costing can be an issue and needs to be rectified.
Question 5
The use of ABC system offers various benefits that are outlined below (Heisinger, 2014).
 The overhead costs are accurately allocated across different product categories which
lead to accurate costing.
 Owing to accurate costing, the product pricing become competitive and instances of
overpricing or underpricing are avoided.
 Adherence to ABC system and accurate costing leads to improvement in decision
making by the management since major production decisions are related to cost only.
However, there are certain limitations with regards to use of ABC system as highlighted
below (Emmauel and Otley, 2015).

 This system is high in terms of complexity as compared to traditional costing system.
As a result, upfront costs are high with regards to breaking costs into individual
activities and determining the cost drivers.
 Even after implementation the decision making may not improve as decision makers
find it difficult to inculcate ABC related inputs into their decision making. As a result,
incremental training needs to be provided for these decision makers using information
generated through ABC system.
 Owing to the high resource requirement in terms of implementation of ABC system,
small companies might be discouraged to use the same and may continue with
traditional costing.

References
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York:
Cengage Learning
Emmauel, R.C. and Otley, T.D. (2015) Accounting for Management Control. 8th ed. London:
Cengage Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.
Kinney, R. M. and Rainborn , A. C. (2012) Cost Accounting: Foundations and Evolutions.
9th ed. New York: Cengage Learning.