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## Calculation of cost per unit using conventional approach

Calculation of cost per unit using conventional approach

FRED: \$166

MARTHA: \$249

Table 1: Table presenting calculation of cost per unit and total labour hours

 Particular FRED MARTHA (Amount in \$) (Amount in \$) Direct Material 40 60 Direct Labour 30 45 Manufacturing Overhead 96 144 Total cost per unit 166 249 Direct labour hour for one product 2 hrs 3 hrs Total hours 100*2 500*3 2000 15000

Table 2: Table representing manufacturing overhead rate as per conventional method

 Particular Amount in \$ Total Hours 2000+15000 17000 Total Manufacturing Overhead 816000 Rate 816000/17000 48
 Machine related cost 450000 50 Set up and Inspection 180000 4500 Engineering 90000 900 Plant related cost 96000 50

Calculation of cost per activity for each activity cost pool

Table 3: Table representing allocation of cost as per ABC method

 Activity Cost Cost Driver Total Units for Cost Driver Total Cost (Amount in \$) Unit cost per cost driver Machine-related cost Machine Hours 9000 hours 450000 50 Set up and Inspection No. of production runs 40 runs 180000 4500 Engineering Engineering change order 100 change order 90000 900 Plant-related cost Square footage of space 1920 sq. feet 96000 50 Total Manufacturing cost 816000

Activity Cost per product

Table 4: Allocation of cost to in accordance with cost driver

 Expected Use Cost Assigned Activity Cost Driver Unit Cost FRED MARTHA FRED MARTHA Total Cost Machine related cost Machine Hours 50 7200 1800 360000 90000 450000 Set up and Inspection No. of production runs 4500 20 20 90000 90000 180000 Engineering Engineering change order 900 75 25 67500 22500 90000 Plant related cost Square footage of space 50 1536 384 76800 19200 96000 Total 594300 221700 816000
 FRED: \$664.3 MARTHA: \$150.42 Calculation of per unit overhead cost under ABC Per unit overhead cost for FRED (Amount in \$) Overhead cost assigned to Fred / No. of total units 594300/1000 594.3 Per unit overhead cost for Martha (Amount in \$) Overhead cost assigned to Martha/ No. of total units 227100/5000 45.42

Calculation of product cost per unit on the basis of FRED and MARTHAs using Activity Based Costing

Table 5: Calculation of total cost as per ABC method

 Particular FRED MARTHA (Amount in \$) (Amount in \$) Direct Material 40 60 Direct Labour 30 45 Manufacturing Overhead 594.3 45.42 Total cost per unit 664.3 150.42

Selling price per product

FRED: \$797.16

MARTHA: \$180.50

Calculation of  price that would be charged for FRED and MARTHA

Table 6: Calculation of selling price after allocating overhead as per ABC method

 Particular FRED MARTHA (Amount in \$) (Amount in \$) Total cost per unit 664.3 150.42 Price Charged 120% above total cost per unit 120% above total cost per unit Manufacturing Overhead 797.16 180.504 Selling price per unit 797.16 180.504

Comparison of Total Cost

 Particular FRED MARTHA Cost as per Conventional Method 166 249 Cost as per ABC Method 664.3 150.42

Comparison of Selling Price

 Particular FRED MARTHA Charging price as per Conventional Method  (Note) 199.2 298.2 Charging price  as per ABC Method 797.16 180.50

Note:

Calculation of selling price as per conventional method:

FRED:

Total cost +20%

166+ (166*.20)

\$199.2

MARTHA

Total cost +20%

249+ (249*.20)

=\$298.8

From above comparison, it can be analyzed that a major cost was apportioned to product FRED, but the same was not apportioned to it. Due to same reason the appropriate cost of the product was not ascertainable; as it was allocated on the traditional method. As per traditional method of allotting business expenses, mostly management expenditure costs are allocated in terms of such factors which are machine and labour working hours. Expressing it, in other words, traditional is involved of there is a sole driver of the overheads of the factory, that is machine and labour working hours or any other volume been produced an indicator. In fact, there is the existence of many drivers of the factory outlay; setup of machinery, exceptional inspections, handling, special warehousing and so on. Diversified portfolio or high demands, the higher there will be cost allocation if these different activities through just one activity, like the machine hours of productivity (Stapleton et al., 2004).

According to the traditional method, performing cost of the overall diversified activities will be inclusive in just one cost section, and further, it will be divided by the production machine hour’s number. The result will be considered as the average rates that will be applicable to each and every product irrespective of the number and complexity of the activities, as many diversified cost activities doesn’t relate at all along with the production machine hour’s number, the consequence of this allocation is thus misleading (Mitra, 2009). The same issues existed in case of product MARTHA, i.e. the expenses were allocated more than the amount which was relating to it. Due to it over price was charged to customers and as its competitors were able to sell the product at a lower price because they applied ABC method for allocating the expenses. Hence, they were able to allocate the expenses in more appropriate manner and ascertain appropriate selling price too (Arora, 2012). It can be said as one of the reasons that its competitors had higher sales in comparison to Jackson Ltd.

## Calculation of Manufacturing Overhead Rate as per Conventional Method

ABC is aimed to cover up the traditional method’s weakness and threats via containing different costing pools and further allocating all the costing pools based on its root cause. Thus, now Jackson Ltd will be able to improve its sales as well as provide products at appropriate selling price (Drury, 2013).

Kaplan and Bruns firstly defined ABC costing in the late 1980s. It is normally seen as a contemporary alternative to absorption costing, enabling managers to understand the product and net profitability better. This furnishes the company with enhanced information to enable value-based and hence more efficient decisions (Abdel, 2011).

This method is focused on cost drivers, the activities which result in an increase in cost. Traditional absorption costing is focused on volume-based drivers like labour hours, on the other hand, ABC employs transaction-related drivers like the total amount of order received etc. Resultantly, long-run variable overheads, which are customarily considered as a fixed cost, could be traced to the product (Rajasekaran, 2010).

Activity-based costing (ABC) offers more of accuracy for the products regarding its costing, decision-making or leading. It boosts understanding of expenses and drivers of costs, and highlights highly expensive and non-value activities in the business, enabling managers to eliminate them from management (Kostakis, Boskou and Palisidis, 2011). ABC also effectual challenges to operating costs in such a way that it can find better ways of eliminating overheads. It also allows developed products and analysis of customer profitability. It promotes position and performance of business tools and techniques like scorecards and rapid improvements. Determination of products by using ABC method is more reliable yet accurate; it is because it aims at the impacts of activities and costs regarding the manufacturing goods (Debarshi, 2011). The complex of the selling price for multiple products as per the ABC is accurate and fair, due to the allocation of outlays in terms of related cost drivers.

Controlling overhead containing fixed/variable make it more possible in monitoring activities. The relation between activities and costs are purely visible and are determined in ABC. This, it drives opportunities to manipulate overhead costs. Adequate details and information can be acquired in order to make better decisions in regards to profitability of various lines of product. Ascertainment of cost under ABC costing can be said more accurate and reliable as it is based on cause and effect linkage of cost relating to producing goods (Mhamdia and Ghadhab, 2012). Thus, due to same reason, appropriate allocation of overhead is possible. As fixation of the selling price for various products in case ABC costing method is done in a more appropriate manner as it is allocated on the basis of relevant cost drivers. Moreover, other information can also be obtained by this method which assists in making decisions relating to the profitability of different products (Wagener, 2013).

## Calculation of cost per activity for each activity cost pool

Business entities that adopt ABC method drives the threat of spending more than earning, giving much time and efforts on collecting data. Too much focus and data can frustrate the managers who are engaged in the method of ABC. However, insufficient details can result in lack of data. One other general factor that has a hand in the collapse of ABC is the failure to perform on the consequence that the data has provided. This basically occurs in business which is unwilling to put ABC in their priority.  Another disadvantage is that is not easy to choose the most appropriate cost drivers, and it is also hard to measure cost based on the activities, that are not appropriate for concerns of small manufacturing companies. It is also difficult to determine entire activities which can impact costs (Goektuerk, 2007).

Implementation of ABC method is a big project which demands considerable resources. Once it is incorporated, an ABC system demands high maintenance and is thus expensive. Data related to several activity measures need to gathered, examined and fed into the system. This method furnishes numbers like product margins, which are odds with the figures furnished by conventional costing techniques. However, managers are habitual of using the traditional methods to keep their operations running, and this system is mostly employed in performance appraisal (Zeuner, 2012). The data from ABC method has high chances of being misinterpreted and should be dealt with care when making decisions. Cost designated to items, customers and other objects have just potential relevancy. Prior to making any important decision using ABC data, managers should determine which costs are actually crucial for decisions to be taken. Reports produced by the Activity Based Costing System are not in conformation with the generally accepted accounting principles. Resultantly, a business involved in this costing method must keep two cost systems – one to prepare its external reports and one for internal usage (Kim, 2017).

References

Abdel, M., 2011. Review of Management Accounting Research. Palgrave Macmillan.

Arora, M., 2012. A Textbook of Cost and Management Accounting. Vikas Publishing House.

Debarshi. B., 2011. Management Accounting. Pearson Education.

Drury, C., 2013. Management and Cost Accounting. Springer.

Goektuerk, H., 2007. Activity-Based Costing (ABC) - Advantages and Disadvantages. GRIN Verlag.

Kim, Y., 2017. Activity Based Costing for Construction Companies. John Wiley & Sons.

Kostakis, H., Boskou, G. and Palisidis, G., 2011. Modelling activity?based costing in restaurants. Journal of Modelling in Management, 6(3), pp.243-257.

Kostakis, H., Sarigiannidis, C., Boutsinas, B., Varvakis, K. and Tampakas, V., 2008. Integrating activity?based costing with simulation and data mining. International Journal of Accounting & Information Management, 16(1), pp.25-35.

Mhamdia, A. and Ghadhab, B., 2012. Value management and activity based costing model in the Tunisian restaurant. International Journal of Contemporary Hospitality Management, 24(2), pp.269-288.

Mitra, J., 2009. Advanced Cost Accounting. New Age International.

Rajasekaran, V., 2010. Cost Accounting. Pearson Education.

Stapleton, D., Pati, S., Beach, E. and Julmanichoti, P., 2004. Activity?based costing for logistics and marketing. Business Process Management Journal, 10(5), pp.584-597.

Wagener, D., 2013. Activity-Based Costing and Its Later Development Into Activity Based Budgeting and Management. GRIN Verlag.

Zeuner, P., 2012. Activity-Based Costing. GRIN Verlag.

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