Management Accounting Systems For Allocating Product Costs

Use of Management Accounting Systems for Allocating Product Costs

The management accountants are presently emphasizing over the use of new method of costing such as Activity-Based Costing (ABC) over the traditional method of costing. This is largely due to criticism that the conventional system of accounting is receiving on account of its inadequacy to determine the overhead costs related with the products. In this context, the essay discusses the use of different management accounting system for calculating the cost of an individual project, service or activity.

Use of Management Accounting Systems for Allocating Product Costs

Calculating the Cost of an Individual Project with the use of Management Accounting System

            Management accounting systems are proving to be highly useful for the business managers to gain accurate information related to the product costs that assist them in making short as well as long-term decisions. As such, the management accountants are largely emphasizing on adopting the use of quality cost accounting systems for taking short as well as long-term managerial decisions.

The effectiveness of decisions taken by the business manager requires the use of an adequate costing tool that leads to determination of accurate prices of products (Akgün, 2004).  The costing systems are known as information systems primarily used by management accountants to attribute the costs on the basis of products or services. This requires the management to acquire information about the costs of product which is useful in determination of their selling price and assessing the product profitability (Akyol, 2007).

            The business managers are emphasizing on the use of Activity-Based Costing (ABC) system for taking accurate decisions regarding the product costs. This is because the system of ABC is proving to be highly useful for taking accurate decisions regarding the overhead costs that are actually consumed by the product (Kim, 2017). The usefulness of ABC system for calculating the cost of an individual project can be demonstrated with the use of following example:

Example on Activity based costing

Information for example purpose
Type of products	Type 1	Type 2
Total units	2000	3500
Sale price of per unit of product	$             350.00	$                                                    400.00
Cost per unit:
Direct material	$             120.00	$                                                    130.00
Direct labour	$               45.00	$                                                      65.00
Machine hours required	1000	2000
Machine Set up rounds	50	75
No of rounds material is handled	35	65
No of deliveries	40	85

Overhead	Annual Budgeted cost	Cost Driver
Cost in machine department	$     300,000.00	Total machine Hours
Machine set up cost	$       25,000.00	No of times machine is set up
Machine inspection and quality control	$       59,000.00	No of times machine is set up
Cost of material handling	$       39,000.00	No of rounds material is handled
Cost of deliveries	$       30,000.00	No of deliveries
Total Overheads	$     453,000.00

Cost per driver unit
Overhead	Cost	Cost Driver	Driver units	Overhead cost per driver unit
Cost in machine department	$  300,000.00	Total machine Hours	3000	$             100.00
Machine set up cost	$    25,000.00	No of times machine is set up	125	$             200.00
Machine inspection and quality control	$    59,000.00	No of times machine is set up	125	$             472.00
Cost of material handling	$    39,000.00	No of rounds material is handled	100	$             390.00
Cost of deliveries	$    30,000.00	No of deliveries	125	$             240.00

Statement of overhead cost distribution
Overhead	Overhead cost per driver unit	Units of Type 1 product	Type 1	Units of Type 2 product	Type 2
Cost in machine department	$             100.00	1000	$  100,000.00	2000	$  200,000.00
Machine set up cost	$             200.00	50	$    10,000.00	75	$    15,000.00
Machine inspection and quality control	$             472.00	50	$    23,600.00	75	$    35,400.00
Cost of material handling	$             390.00	35	$    13,650.00	65	$    25,350.00
Cost of deliveries	$             240.00	40	$      9,600.00	85	$    20,400.00
Total			$  156,850.00		$  296,150.00

Statement of profit and loss
Particulars	Type 1	Type 2
Sale price of per unit of product	$  350.00	$  400.00
Less:
Cost per unit:
Direct material	$  120.00	$  130.00
Direct labour	$    45.00	$    65.00
Cost of overhead per unit	$  156.85	$  148.08
Profit per unit	$    28.15	$    56.93

Areas Requiring Judgment and Limitations in the Proposed Accounting System

In activity based costing there is requirement to look after the cost estimates for each activity and allocate the cost to each activity or department wisely. For that purpose there is required to make various judgments. There is need to make judgments regarding the cost drivers as some overhead costs do not directly indicate the drivers for their allocation in the costing system of ABC. Thus, in few cases it is required to make the judgments for selecting the appropriate cost driver for each overhead cost (Garrison, 2012).

Calculating the Cost of an Individual Project with the use of Management Accounting System

Limitations of activity based costing

Activity based costing is very difficult to implement as it requires substantial resources and after the implementation it is very costly to maintain the activity based costing. It is very difficult to understand the concept used in activity based costing and it requires experts knowledge to make it understand (Shaban and Mazhar, 2014).

Usefulness of Management Accounting System for Decision-Making

            The use of ABC system of helps in assigning the products costs on the basis of number if activities required for its manufacturing. As such, it enables in gathering the accurate information regarding the actual amount of resources consumed for manufacturing a product and thus assists the managers in making rational financial decisions (Wiese, 2009). Thus, the calculation of product costs would largely help in identification of the activities that does not seem to be valuable. The use of ABC would enable the managers to control the fixed overhead costs by having more control over the activities that are responsible for maximizing these costs.

The elimination of wasteful activities would have a direct impact on the profitability of a firm and thus promoting the sustainable growth and development of a firm. Thus, the use of ABC model enables a business manager to gain an understanding of its fixed and overhead costs related with product manufacturing and thus leading to best utilization of resources available (Wagener, 2013).

Conclusion

It can be summarized from the overall discussion held in the essay that business managers should adopt the use of ABC costing system as compared with the traditional method of costing. This is because it will help in assigning the cost on the basis of actual resources consumed and thus provides accurate cost information to the managers.

References

Akgün, M. 2004. Activity-based cost estimation in a push/pull advanced manufacturing system.  International Journal of Production Economics 87, pp. 49–65.

Akyol, D. 2007. A comparative analysis of activity-based costing and traditional costing. International Journal of Industrial and Manufacturing Engineering 1 (3), pp. 136-139.

Garrison, T. 2012. Managerial Accounting. McGraw-Hill Education.

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

Shaban, E.A., and Mazhar, S. 2014. The Benefits of the Application of Activity Based Cost System Field Study on Manufacturing Companies Operating In Allahabad City – India. Journal of Business and Management, 11(1), pp. 39-45.

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

Wiese, N. 2009. Activity-Based-Costing (ABC). GRIN Verlag.