ADVANCED MANAGEMENT ACCOUNTING
The advanced accounting management helps an organisation in forecasting the future, also help to forecast the flow of cash. The positive and negative aspects of traditional and Activity-based costing (ABC) has formed the main subject matter of the project. The accounting in advanced management helps the organisation in understanding the variances in the business performances. It also helps to analyse the return rate and in taking, the decisions related to buy or make products.
1 .0 Introduction
Accounting in management is a method, which helps in preparing management accounts and reports that supply timely and accurate statistical and financial data to the managers. Advanced management accounting helps the manager in making long term and short-term decisions related to business. This management helps in measuring, identifying, communicating and interpreting the information or data, which enables a business entity to achieve its goal.
2.0 Literature review
General principles to allocate indirect cost to objects of cost
The general principles to allocate the indirect cost to objects of cost are:
This principle based on traditional approach, proportional allocation of indirect cost assigns indirect cost percentage to all or various divisions within the business. This principle helps in determining the percentage every month for all the indirect cost. Sometimes, this is also reviewed or assigned annually. According to Locke et al. (2016), an amount charged in each division within the business depends on indirect cost type.
Cost allocation based on activity:
This principle based on activity-based costing, involves allocating the cost that is more time talking but on the other hand, it shows more accuracy to allocate indirect cost. This principle, firstly need the manager to record and identify each activity of the business division or department within the business. This activity is then considered as the indirect cost. At the last of the period of reporting like the end of the month, the records are analyzed and reviewed, the rate of indirect cost is calculated and proper allocation of indirect cost is done.
Calculating the rate of cost:
The rate of indirect cost is calculated based on both traditional and ABC approaches by dividing the cost that is indirect by the cost object. The examples of such cost objects include square footage or sales revenue. The rate of indirect cost for proper allocation is calculated by using calculations related to overhead cost by cost that is direct which each division of the business incurs.
Cost and benefit of the system of traditional cost
The cost of the system of the traditional cost is allocating the overhead of the factory to the goods based on resources of production-consumed volume. Under this system, overhead is generally applied upon the hours consumed on direct labor amount or hour of machine used.
The benefits of the system of traditional cost are:
The system of the traditional cost is easily applied. The managers feel easy in tracing all the cost, which is direct and is related to the goods, including the cost of direct materials and labor. In this system of traditional cost, the hours of the direct labor are an easy way for apportioning the cost of overhead.
The system of traditional cost can provide a proper idea of the manufacturing cost of the product or goods. The other benefits of the system of the traditional costing include recognizing the fixed cost importance in the process of production. This system of the traditional costing also provides benefit soaking up the costing up when the production of the goods remains unchanged but the revenue, which is gross, fluctuates or changes. Inland Revenue accepts this system of traditional costing. This system of traditional costing is used in preparing financial histories.
Principles of ABC to assist cost of overhead and benefit of approach of ABC
According to Chiarini et al. (2015), the costing based on activity is used in assisting the cost of overhead to cost of the goods or product. The first step in allocating the overhead cost requires identifying the activities, which are costly for completing the product. This costing system is a process, which consumes the resources of overhead. The aim of this system of costing understands all activities needed for making the product of an organisation. This is done by meeting and interviewing personnel within the organisation. The companies or organisations that use the costing based on activity like IBM and Hewlett Packard may assist in identifying the activities needed in making the company product.
The second step in allocating the overhead cost needs assigning the cost of overhead to identified activities in the first step: This step needs that the cost of overhead related to every activity is assigned to all the activity. The third step in allocating the overhead cost is identifying the driver of cost for every activity. This needs the collection of information or data and interviewing the essential personnel in different areas of the company like production, purchasing and accounting. The fourth step is calculating the rate of overhead, which is predetermined for every activity of the business. This calculation is done by dividing the estimated cost of overhead by the level of estimated activity of driver of cost. The fifth step or the last step is allocating the cost of overhead to the products which is done by multiplying the rate of overhead that is predetermined for every activity by activity of cost driver level used by goods or product.
The benefits of Activity-based costing approach are:
More information that is accurate is of cost leading to make better decisions
The information of cost provided by the ABC approach is more accurate as compared to the information of cost supplied by the system of traditional costing. This assists the management of the organisation in making decisions, which are better in areas like pricing of the product, changes in product line, and decisions related to product mix.
Increases the knowledge of the activity of production, which leads in the improvement of process and cost reduction:
ABC approach needs identification of the activities included in the process of producing and assigning costs to the production activities. This approach gives better sight of the included activities and cost of every activity. The company's managers are focused on improving the business efficiency in most of the activities that are costly, hence, assisting in cost reduction.
3.0 Discussing whether businesses in Australia should cease completely the use of systems of traditional cost
According to Harrison et al. (2017), the businesses in Australia should totally cease the usage of the system of traditional costing based on several factors. The system of traditional costing provides inaccurate information regarding costing which leads to taking decisions by management, which are wrong. According to Dong et al. (2014), the decisions are taken incorrectly if the system of traditional costing is used for controlling or to fix the selling price or to send quotations. This system should be completely ceased because the indirect cost allocation does not display correctly the consumed resources by products. The other weakness of the system of traditional costing includes the rate of overhead recovery like the rate of labor hour, the rate of machine hour that is not used to make decisions because the decisions have been implied over 2 to 5 years. Besides, few costs that are fixed are variable or changeable in long run.
According to Yazdifar et al. (2005), the business in Australia should totally cease the usage of the system of traditional costing because the cost splitting under this system into the variable and fixed is unrealistic often. Moreover, the cost splitting provides inaccurate product cost if there is growth in the business. In the present business world, where modern technology is used, most of the work is related to labor is done by automation that is manual work mechanizing. Through this, the indirect cost may increase and the direct cost is reduced. According to Weygandt et al. (2015), this leads to change the product structure if automation of labor takes place in any of the company's product. Thus, due to all the weakness if the system of traditional costing as mentioned above, businesses in Australia should completely stop using this system.
4.0 Discussing appropriateness of approaches related to ABC for allocating cost for resolving problems of costing
According to Max et al. (2007), the adoption of the ABC approach can be done as mentioned in the following steps for resolving the issues related to overall costing:
Reviewing the financial information of the company:
The first step helps in identifying the direct cost, cost of overhead and cost of capital of the company (Tsai et al. 2008). This approach can be implemented by acquiring all the information related to finance from the balance sheet and the statement of income of the company.
Establishing the requirements and the objectives of the system of ABC:
In this step, the management of the company makes the decision-related to the system of costing for adopting or implementing the system of ABC, which will help in resolving costing issues.
According to Torok et al. (2003), the third step is the identification of the important activities of the business, the fourth step and the fifth step includes tracing overhead to activities and the object of costs respectively. The sixth step of adopting the ABC system includes calculating the cost of production of each object of cost. The last or the seventh step is using the ABC analysis for resolving the problems related to cost by making strategic decisions.
According to Liu et al. (2007), the costing issue can be resolved by adopting the approach of activity-based costing as this approach helps in providing the information of cost that is accurate. The information obtained from this approach leads to making better decisions within the organisation. This, in turn, helps to resolve the costing issues by enhancing the business performance. ABC approach helps to resolve costing issues by improving the efficiency of the production process of the business in an organisation.
5.0 Analysis and findings in the form of case study synopsis
Traditional costing involves the factory overhead or the allocation of the products, which is very dependent on the production volume consumption of the resources. With the usage of this method, the overhead is totally applied based on either of the number of total hours of the direct labor or maybe the usage of the machine hours (Altawati et al. 2018). As for example, the calculations of the traditional costing depict the overhead of the factory, which is charged to the factory products at a higher rate. Mainly, in the textile manufacturing company of the USA, the traditional systems of costing has been used.
This system of costing assists in the allocation of the manufacturing overhead by the division of all the indirect costs with the cost driver. A cost driver is the one who handles all the total amount of the incurred cost (Vieira et al. 2017). As for example, the total number of hours for running a machine depicts the electric consumption and depicts the cost of its maintenance too (fenix.tecnico.ulisboa.pt, 2018). However, these traditional costing systems are also much simpler to use, despite having a few drawbacks, which may result in under-costing or even over cost. Accurate controlling of the inventory costing could be done by making accurate segregation of the total cost (variable cost and fixed cost). There lie the relevance and benefit of traditional costing.
Advantages of Traditional Costing
Applying at Ease
Traditional costing is much easier in using as it assists the managers of the company in tracking all the direct costs, which are incurred by the company as it includes the costs of direct material and includes the cost of labor too. However, in the environment of traditional manufacturing, there is a simple way for the direct labor hours to support the cost of overhead. While developing the traditional costing methods, one of the largest production cost was the direct labor. Thus, it helped the system to use as a proxy for allocating the overheads with the assistance provided to the managers to assign the jobs with much greater labor hours.
In case of a business producing larger scales or volumes of products, this traditional costing used to provide easily a fair idea of the manufacturing cost of the products. However, with the diverse increase in the output, there is a less reliability of this traditional costing method. The firms, which have huge expenses of the overload, need to trust on a better reliable method for allocating the cost of overhead to various products. Lower flexibility and use of simpler costing mechanism makes the process inaccurate. Thus, it gets reduced flexibility, lead to the introduction of the ABC costing.
6.0 Support of the Activity Based Costing (ABC) costing and the use ABC Approach
ABC based costing helps in identifying and assigning the activities related to the overhead and after that assigning the same to the products. It helps in establishing a good relationship among the manufactured products, costs and the activities of overhead too. As in the case synopsis, it is seen the implementation of the ABC system of a farm in Australia, which had been getting enough benefits in its business (cmawebline.org, 2018). With the help of this relationship, it can assign the indirect costs to the products in a less arbitrary manner than any other traditional methods. However, some of the costs are much difficult in assigning through this method of cost accounting. The indirect cost such as salaries of the office staffs and management are quite often difficult to get assigned for a product. As a result, this method had found a place in the sectors of manufacturing industry.
This method of ABC system of accounting of cost is very dependent on the activities, which include the work unit, distribution of the finished products, production machines, and even the operating machines. Therefore, with the help of the usage of this method of costing, this activity is also based on the event or transaction of a cost driver. A few examples of the cost driver include the requests for the maintenance, consumption of power, purchase orders, inspections on quality, setting up of the machines or even orders of the production too.
Advantages of the Activity Based Costing Approach
This type of costing system enhances and benefits the organisation in three several ways, which are of the following:
Firstly, it enhances in the expansion of the number of pools cost which are required in assembling the cost of overhead. It helps in pooling the cost by activity rather than accumulating all the cost in the company pool. Secondly, it assists in creating new bases for the assigning purpose cost of the overhead to the costs, which are allocated based on the activities with the help of the generation of the costs rather than volume. These include the direct cost of the labor or machine hours. Lastly, this type of system helps in altering the nature of various indirect costs and thereby enabling the cost to consider indirect costs such as power traceable, inspection or depreciation to certain activities. In the other hand, ABC costing method passes the cost of the overhead to the products of low-volume from the products of their high volume, thereby increasing the total unit cost of various products of the low volume.
This report had analysed the allocation of the indirect costs to the objects of cost and highlighted the benefits of the traditional costing system. It also had given enough emphasis on the alternate of the traditional costing system thereby providing the ABC Costing system. A thorough analysation of the ABC costing system, stating its working, features and benefits is includes in this report. Various case studies are also summarised along with the peer review had been highlighted in this project report.
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