Question

Activity-based costing (ABC)

Marconi is a Portuguese telecommunications company that encountered problems with its ABC system. The company’s production managers felt that 23% of the costs included in the system were common costs that should not be allocated to products and that allocating these costs to products was not only inaccurate, but also irrelevant to their operational cost reduction efforts.

Concerns over the application of the ABC approach at Marconi have been raised by personnel, including some of the senior leadership team. It is the opinion of some that this method of cost allocation does not accurately reflect the cost of production and will lead to unnecessary improvements that will ultimately result in the elimination of jobs. As a respected member of the leadership team, the Chief Executive Officer (CEO) has tasked you with investigating the concerns expressed by some of the employee and management officials. You are expected to prepare a position paper either defending the use of the ABC method or recommending an alternative method of cost allocation.

1 defending the use of the ABC method or recommending an alternative method of cost allocation.

Answer 1

Answer. There are two method of allocation of indirect costs/overheads to different department/products of an organization.

1. ABC method (Activity based costing)
2. Traditional absorption costing method.

I suggest using ABC method of costing. For this action management of Marconi should identify cost driver for each activity/cost item. After that he should get date of uses these cost activities by each department during business process. And based on that activity, specific cost should be allocate to each department in ratio of activity uses by them. We can allocate all indirect cost on different department on accurately and correctly. In traditional absorption costing method, we allocate indirect cost on the basis of direct labor hours, machine hour or other traditional basis. This method not provide correct basis for allocation of indirect cost on various departments of an organization. Management of Marconi can determine correct cost data, sales price, and quantity production through this costing ABC method. This technique of allocation indirect cost is effective, improved, resulting and latest.