Question

Soon after Nick had the budget discussion with Sue, he invited her over for a cup of coffee. While sipping the coffee he mentioned to Sue:

“It is not only the budgeting process that needs fixing, I am concerned about the process for cost control”. We follow the traditional method of variance analysis of direct material, direct labour and overhead.   However, I would question the initial standards that were set so long ago based on labour intensive manufacturing departments. Each time we introduce a new product the manufacturing division sets the standards for direct material price and usage, direct labour rate and efficiency and overheads. I believe direct labour variances are no longer relevant as we have fully automated systems for at least 75% of the production process. This has caused fluctuations in the overhead variances. Further, we produce a mix of standard products and made to order products for customers, this makes traditional cost control systems in place irrelevant. Take the example of flexible medical device packaging.   Our expertise and product line breadth will provide the customer with the most cost-effective packaging solution to protect and maintain the sterility of their device until the moment the package is opened. From packaging design through to validation, we offer a range of value-added services to supplement customers’ in-house resources and reduce the time to market. Equipped with the broadest technology base in the industry, we customise packaging solutions to individual requirements for package configuration, performance, processing, opening features, and sterilisation. Pouches and bags, form fill seal packaging, flow wrap films and fluids wrapping are some of the items we produce as sterilised packaging. As you can see there is a significant component of overheads in manufacturing and delivering these sterilised packaging.”   

Sue replied to Nick saying:

“It seems that you may have an out-dated cost control system in place, have you thought of introducing Activity Based Budgeting based on Activity Based Costing? This may suit your circumstances more than the existing conventional cost control system”.

Nick was interested in Sue’s suggestion. He wanted to know more about the Activity Based Budgeting and asked Sue to explain the nuts and bolts of the Activity Based Budget. Sue explained to Nick how the methodology would suit a situation where there are significant proportion of overhead costs and multiple cost drivers. She said to Nick:

“By implementing Activity Based Budgeting, you can compare standard costs with actual performance and extract variances for cost control.”

She gave an example of the Activity Based Budget to Nick.

Discussion forum questions

Q1 Give an example of how an Activity Based Budget can be prepared and how it can highlight variances that can be used for cost control purposes?

Q2 Search the AMCOR's website and find out whether AMCOR has a labour intensive manufacturing environment or an automated manufacturing environment. Explain how this manufacturing environment can influence AMCOR management accountants on deciding the type of input measures to be used when setting standards to control overhead variable costs.

Q3 Using your knowledge on variance interactions in Chapter 10 of the textbook, comment on the possible interactions between the four types of overhead variances that maybe used in AMCOR.

Q4 Using AMCOR case, critically comment on this statement: "while standard costing systems can offer a business many benefits, their continued relevance in the modern manufacturing environment can be questioned."

Answer 1

Q1

Activity based budgeting required 3 essential steps:-

• Identify activities and their respective cost drivers
• Forecast the number of units for the cost driver required for the concerned activity
• Compute the cost driver rate

Example: Sales office

Acitvity: Identified sales order processing and its cost $10 per order

Number of sales order required based on revenue budgets= 20000 orders

Total cost= 20,000*10 = $200,000

Q2

Amcor Limited is an Australian-based multinational packaging company. It produces flexible and rigid packaging, mainly for the food, beverage, health care, and tobacco industries.

In my personal opininion, Amcor being a flexible packaging company has an automated manufacturing environment. The process is completely dependent on machines producing different types of packaging.

In terms of understanding the difference, Amcor management accountants will need to understand how much time and activity is required from each machine and work out their cost. This will change from product to product. Had it been a labour intensive manufacturing environment, labor hours and their rates would have been the case. In terms of managing overhead cost, they will be keen to look at better machines with lower breakdown, maintenace cost as compared to skilled manpower to manage the production function.

Q3 No idea about variance interactions forming part of chapter 10 of the textbook

Q4 Standard costing systems can offer a busines many benefits, their continued relevance in the modern manufacturing can be questioned.

.The underlying assumption in standard costing is, one can exercise control by concentrating on the efficiency of the workforce. Direct labour efficiency standards are seen as a key to management control.In real life, manufacturing systems are highly automated, and therefore the productivity ratio & rates of production output and materials consumption, are controlled by the machinery rather than the workforce.