Management Accounting: Comparing Costing Systems for Sewing Easy Ltd

This report analyzes the costing systems of Sewing Easy Ltd, a sewing machine manufacturer, comparing traditional and activity-based costing (ABC) methods. The company, operating for two years, aims to sell its advance model to an overseas buyer. The report highlights the concerns of the management regarding the sole interest in the advance model. It evaluates the firm's current traditional costing system, detailing unit costs for both basic and advance models. The report then presents an ABC system analysis, showcasing overhead allocation and unit costs. A profit and loss statement is provided for both costing methods, revealing discrepancies in net profit. The report emphasizes the importance of accurate cost estimation for financial statements and tax obligations. It explains the buyer's interest in the advance model due to hidden profits from the traditional method. Furthermore, it discusses the benefits and limitations of the ABC system and outlines methods for handling over or under-applied overheads, concluding with a list of relevant references.

Management Accounting
Institution
Name
Date

Introduction
Sewing Easy Ltd is accompany that have operated for 2 years producing sewing machines.
The firm currently produces two models; basic and advance. In the year 2017 the firm made
a profit and the management is contented that the firm is performing effectively. On their
quest to enter a new business phase they are planning to sell to an oversee buyer. The
buyer is however only interested in buying the advance model.
The manager is concerned, and this task have been conducted to address the concerns. The
traditional and Activity Based costing system will be reviewed in a bid to assist gauge the
reason for the sole interest in the advance model.
1. Current traditional costing system
Basic model
Units produced 1600
Direct material $ 325
Direct labour $ 150
Overhead costs
Inspection $ 20000
Assembly $ 90000
Product scheduling $ 105000
Machine set-up $ 35000
Total overhead cost $250000
Overhead allocated to the basic model using machine hours.
¿ 4600
8000∗250000=$ 143750
overhead cost per unit= 143750
1600 =$ 89.84
Total cost per unit
Direct material $ 325
Direct labour $150
Overhead $ 89.84
Cost per unit $564.84

Advance model
Units produced 1500
Direct material cost per unit $ 560
Direct labour per unit $260
Total overhead $250000
Overhead allocated 3400
8000∗250000=$ 106250
Cost per unit¿ 106250
1500 =$ 70.83
Total cost per unit
Direct material $560
Direct labour $260
Overhead $70.83
Cost per unit $890.83
2. Activity based costing system
Basic model
Distribution of the overhead cost
Task Driver Allocation
Inspection Inspection 200
950∗20000=$ 4210.53
Assembly Machine hours 4600
8000∗90000=$ 51750
Product scheduling Runs 50
550∗105000=$ 9545.45
Machine set-up Set-up 100
350∗35000=10000
Total $ 75505.98
Cost per unit ¿ 75505,98
1600 =$ 47.19
Total cost per unit
Direct labour $ 325

Direct labour $ 150
Overhead $47.19
Cost per unit $ 522.19
Advance model
Distribution of the overhead cost (Kaplan & Bruns, 1987).
Task Driver Allocation
Inspection Inspection 750
950∗20000=$ 15789.47
Assembly Machine hours 3400
8000∗90000=$ 38250
Product scheduling Runs 500
550∗105000=$ 95454.55
Machine set-up Set-up 250
350∗35000=25000
Total $ 174494.02
Cost per unit ¿ 174494.02
1500 =$ 116.33
Total cost per unit
Direct material $ 560
Direct labour $ 260
Overhead $ 116.33
Cost per unit $ 936.33
3. The company sells the advance model at a 20% profit.
a. Traditional costing
Profit and loss statement
For the period ended December 2017
Gross profit $267249
Expenses
Selling and administration $ 140600

Interest $ 25200
Office rent $ 35900
Total $ 201700
Net profit $65549
b. Activity Based Costing
Profit and loss statement
For the period ended December 2017
Gross profit $280899
Expenses
Selling and administration $ 140600
Interest $25200
Office rent $35900
Total $201700
Net profit $ 79199
In the preparation of the income statement as well as profit and loss statement
the accountants rely on the difference between the product production cost and
selling price. In a situation where the product cost was inaccurately estimated
the profit or loss amount will be wrong. Considering the nature of significant that
the income profit and loss statements play in an organization its very vital that
the values of cost are estimated as accurately as possible.
Furthermore, business enterprises are taxed based on the profit or loss earned, if
this was inaccurately valued then, the firm may end up paying more tax or less
tax than expected. Such cases may give rise to legal obligations where the firm
maybe accused of fraudulent activities aimed at tax evasion. Also, the firm may
end up losing a lot of capital paying excessive tax based on registering un existing
profits (Sapp, et al., 1990).
In the case above, the oversee buyer is interested in the advance model due to
the hidden profit resulting from the use of traditional accounting method. By
using the activity-based costing the oversee buyer have identified a profit gap of (

$ 79199−$ 65549 ¿ $ 13650. For this purpose, the buyer can benefit from the
product without the firm realising the costing error.
This is one situation which brings out hazards of a poor costing system to the
firm. Competitors with accurate costing system can derive accurate profits and
hence grow the firm’s capital or takes measures that may improve productivity.
This way forms with poor costing system end up being driven out of the market
in the long run (Nicholson & Rohrbach, 1919).
4. The difference between the actual overhead and applied overhead do arise due to
some of the highlighted reasons;
The overhead costs do not occur uniformly in the curse of the business operations
for instance the heating cost may be higher in winter than in the summer. But
allocation of the cost may be done uniformly hence leading to a difference value of
the two.
There are overhead costs like building depreciation which are normally fixed. Due to
the variation in the production rate the overhead cost applied may vary while the
actual value remains fix, this lead to a variation of the two in the end (Blocher, et al.,
2016).
Finally, the applied overhead costs are normally predetermined. For instance,
electric bills. For this reason, the actual value may vary since the predetermined
value was just an estimate.
Three ways of treating under or over applied overheads
 The amount may be carried forward to the next period’s accounts.
 The amount may be written off to the costing, profit and loss accounts.
 A supplementary rate may be computed and applied to the production.
5. Benefits of ABC
ABC gives a wider explanation of cost drivers; the managers are therefore able to
identify costly but non-profitable activities and hence eliminate them from the
production process.
Also. The use if ABC leads to more accurate cost estimate which is a significant factor
when estimating the business performance

The ABC costing system can be easily understood by the managers. Once the data
collection system is put in place, its implementation becomes easier (L. & Picone,
2012).
Limitations of ABC
The application of the ABC system is contingent on the cost of the required data. This
may lead to slowing down the processes in the delivery of services and
administration activities. The staff time utilised per task is used to define a dominant
portion of cost, this way the reported production application may not be a
favourable scenario (Horngren, 2003).

References
Blocher, Stout, Juras & Cokins, 2016. Cost Management - A Strategic Emphasis. 7th ed.
s.l.:McGraw-Hill .
Horngren, D. a. F., 2003. Cost Accounting - A Managerial Emphasis. 11th ed. s.l.:Prentice
Hall.
Kaplan, R. S. & Bruns, W., 1987. Accounting and Management: A Field Study Perspective, s.l.:
Harvard Business School Press.
L., D. A. M. & Picone, P. M. &. M. A., 2012. Bringing Strategy Back into Financial Systems of
Performance Measurement: Integrating EVA and PBC. Business System Review, 1(1), pp. 85-
102..
Nicholson, J. & Rohrbach, J. D., 1919. Cost accounting. New York: Ronald Press.
Sapp, R., Crawford, D. & and Rebishcke, S., 1990. Journal of Bank Cost and Management
Accounting, 3(2).