In: Accounting
Choose a product that would lend itself well to activity-based costing and explain why. What are the activities that raise costs and can they be decreased? How?
Solution:-
ABC, as stated in the above comments is primarily seen as an overhead allocation system which is supposed to provide more accurate product cost. That is true but is the less interesting side of ABC. The first and most interesting information provided by an ABC system is information on the way the organization produce value for its partners of for the market. This is done trough the ananlysis of the production of the activities carried out in the organization. The production measure of the activities are also allocation bases but they are primarily production measure for internal or external customers. And there is much more to gain in analyzing the value produced than just looking for a better overhead allocation. The value perspective can be enhanced by grouping activities in processus which usually deliver a bunch of value attributes, an object easier to commpare to the value expected by the customer.
Let’s figure out how much you are spending on utilities to create a product. To do this, you estimate that your total utility bill is $20,000 for the year.
You determine that the cost driver impacting your utility bill is the number of direct labor hours worked. The number of direct labor hours worked totaled 1,000 hours for the year.
Divide your total utility bill by your cost driver (the number of hours worked) to get your cost driver rate. Your overhead application rate is $20 ($20,000 / 1,000 hours).
For this particular product, you used utilities for 3 hours. Multiply the hours by the cost driver rate of $20 to get $60.
The Chinese electricity company Xu Ji used ABC to capture direct costs and variable overheads, which were lacking in the state-owned enterprise’s (SOE) traditional costing systems. The ABC experience has successfully induced standardisation in their working practices and processes. Standardisation was not a common notion in Chinese culture or in place in many Chinese companies. ABC also acts as a catalyst to Xu Ji’s IT developments – first accounting and office computerisation, then ERP implementation.
Prior to the ABC introduction in 2001, Xu Ji operated a traditional Chinese state-enterprise accounting system. A large amount of manual bookkeeping work was involved. Accounting was driven predominantly by external financial reporting purposes, and inaccuracy of product costs became inevitable. At this time, Xu Ji underwent a series of flotations following China’s introduction of free market competition.
The inaccuracy of the traditional costing information seriously impeded Xu Ji’s ability to compete on pricing. The two main tasks for the ABC system were to: trace direct labour costs directly to product and client contracts; and allocate manufacturing overheads on the basis of up-to-date direct labour hours to contracts.