Assignment 1: Absorption Variable And Activity-Based Costing

Assignment 1 Absorption Variable And Activity Based Costingby The D

Continuing the scenario from the Module 2 discussion, think about the costs to manufacture your product. Review the concepts of activity based costing. If you implemented activity based costing for your division, what additional costs would you consider as manufacturing costs? How would you allocate those costs to your division? Would activity based costing give you a more or less realistic picture of your divisions costs incurred to produce revenue? If you chose to not fully implement activity based costing, what would you have learned about your department’s costs that would help you operate more profitably?

Paper For Above instruction

Cost accounting is fundamental for understanding a company's financial health and guiding managerial decision-making. Among the various costing methods, absorption costing, variable costing, and activity-based costing (ABC) each offer unique perspectives on how costs are allocated and understood within a manufacturing context. This essay explores these costing methods, with particular emphasis on the implementation of activity-based costing, its impact on cost allocation, and implications for managerial decision-making.

Understanding Costing Methods

Absorption costing, also known as full costing, allocates all manufacturing costs—both fixed and variable—to each unit produced. This approach aligns with generally accepted accounting principles (GAAP) and is mandatory for external financial reporting. Variable costing, by contrast, allocates only variable manufacturing costs to products, treating fixed manufacturing overheads as period expenses. This method provides clearer insight into the variable cost structure and contribution margins.

Activity-based costing (ABC) advances beyond traditional methods by assigning costs to products based on the activities that generate costs. Instead of spreading fixed overhead equally across all products, ABC recognizes that different products consume resources at different rates, and it attributes costs accordingly. This approach enhances the accuracy of product costing, thereby facilitating better managerial insights and strategic decisions.

Additional Costs Considered in Activity-Based Costing

If ABC is implemented within a division, it considers a broader spectrum of costs as manufacturing costs. These often include activities such as setup times, quality inspections, machine maintenance, order processing, and material handling. For example, the costs associated with frequent changeovers or specialized equipment setups would be directly linked to the activities involved in producing specific product types.

Moreover, indirect activities like engineering support, logistics, and supplier interactions could also be accounted for as manufacturing costs under ABC. This detailed attribution helps management pinpoint the true cost drivers, leading to more precise product costing and enabling better resource allocation.

Allocation of Costs Using ABC

Allocating costs through ABC involves identifying distinct activities involved in production, establishing cost pools for each activity, and assigning costs based on each product’s consumption of the activities. These costs are allocated through predetermined activity rates, calculated by dividing total activity costs by total activity measures (such as machine hours, setups, inspections, or labor hours).

This method ensures that products consuming more resources or engaging more frequently in particular activities bear a proportionate share of the costs. Consequently, ABC provides a more nuanced and accurate picture of the expenses associated with each product line or division.

Realism and Benefits of Activity-Based Costing

Compared to traditional costing methods, activity-based costing generally offers a more realistic view of a division's costs because it more accurately reflects the actual consumption of resources. This improved accuracy is particularly beneficial in complex manufacturing environments where overheads constitute a significant portion of total costs and where products have varying resource requirements.

By illuminating cost drivers and activity costs, ABC assists managers in identifying unprofitable products, optimizing resource utilization, and making strategic decisions about pricing, product line expansion or contraction, and process improvements.

Limitations and Learning Opportunities Without Full ABC Implementation

However, implementing ABC can be resource-intensive and costly, requiring detailed data collection and analysis. For divisions unable or unwilling to commit to full ABC deployment, a partial or simplified version can still offer valuable insights. Even without complete implementation, managers can learn about the major cost drivers within their departments, identify activities with disproportionate costs, and develop strategies to eliminate waste or improve efficiency.

For instance, understanding that setup times significantly influence manufacturing costs could lead managers to introduce setup reduction initiatives or process standardization, thereby improving profitability without adopting a full ABC system.

Conclusion

In conclusion, activity-based costing represents a sophisticated approach to understanding manufacturing costs with enhanced accuracy compared to traditional methods. Its implementation can empower managers to make more informed decisions, optimize resource allocation, and improve profitability. Even partial insights gleaned from ABC principles can guide managerial actions toward more efficient operations and better financial performance. Therefore, integrating ABC or its insights into cost management is a valuable strategy for manufacturing divisions aiming to operate more profitably in competitive environments.

References

1. Cooper, R., & Kaplan, R. S. (1991). Profit Planning and Analysis: Path to Continuous Improvement. Productivity Press.
2. Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2021). Managerial Accounting (K extended 16th ed.). McGraw-Hill Education.
3. Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard Business Review, 82(11), 131-138.
4. Hansen, D. R., & Mowen, M. M. (2018). Cost Management: Strategies for Business Decisions. Cengage Learning.
5. Drury, C. (2018). Management and Cost Accounting. Cengage Learning.
6. Blocher, E., Stout, D. E., Juras, P., & Cokins, G. (2019). Cost Management: A Strategic Emphasis. McGraw-Hill Education.
7. Innis, R., & McCall, J. (2010). Activity-based costing: Principles and practice. Management Accounting Quarterly, 11(2), 1-9.
8. Cooper, R., & Kaplan, R. S. (1988). Measure costs right: make the right decisions. Harvard Business Review, 66(5), 96-103.
9. Young, S. M., & Griffin, R. W. (2019). Cost and Management Accounting. Cengage Learning.
10. Jacobs, F. R., & Chase, R. B. (2018). Operations and Supply Chain Management. McGraw-Hill Education.