Activity-Based Costing, Profitability Analysis, And Ethics In Accounting

Calculation of cost driver rates

Allocation of the overhead by applying the activity-based costing gives more reliable and accurate data, because in this method allocation is based on the activity of the product, and therefore the product which consumes more resources, results in the greater allocation of the overhead cost and vice versa. Therefore this method assists the manager to take the right decision (Haroun, 2015). The present study is based on the comparative evaluation of costing method for allocation of the overhead using the traditional method of costing and the activity-based costing method. The present study also describes provisions of APES 110 code of ethics for professional standards issued by accounting professional and Ethical standards boards (APESB). In addition to this, accounting for over and undervaluation of manufacturing overhead has been discussed.

It is important to ensure accurate product costing system to provide external users of financial statements with reliable information about earnings and net worth and to provide internal managers with the information they need for decision making (Ball, Tyler, and Wells, 2015). Therefore, accurate product costing provide appropriate inventory cost information and managers are able to make relevant financial decisions (Ax, and Greve, 2017). 

Traditional costing system does not provide accurate information about product costing as it makes use of blanket rate for cost allocation which is not viable. By considering the given case of Beztec Limited, overhead cost is comprised of various costs, but all costs are allocated as per blanket rate computed by using machine hours which is not viable and as a consequence overall cost information is wrong and therefore the accuracy of profitability of the business is directly affected.

Table 1: Calculation of cost driver

Sr. No. Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Activities Identified	Cost Driver	Cost Associated	Total Number of activities	Cost/ Activity
1	Soldering	Number of Solder Points	1165725	1766250	0.66
2	Shipment	Number of Shipments	1064250	22500	47.30
3	Quality Control	Number of inspection	1534500	87188	17.60
4	Purchase Orders	Number of Purchase Orders	1176120	213840	5.50
5	Machine Power	Number of Machine Hours	71280	216000	0.33
6	Machine set up	Number of Machine setups	928125	33750	27.50

Table 2: Total cost of each product under the ABC method

Particulars	Number of Activity	Cost/ Activity	Lexon	Number of Activity	Cost/ Activity	Protox
Direct Material			5491200.00			3854400.00
Direct Labor			475200.00			277200.00
Machine			3801600.00			475200.00
Production Overhead
Soldering	1333125.00	0.66	879862.50	433125.00	0.66	285862.50
Shipment	18225.00	47.30	862042.50	4275.00	47.30	202207.50
Quality Control	63225.00	17.60	1112753.62	23963.00	17.60	421746.38
Purchase Orders	90113.00	5.50	495621.50	123727.00	5.50	680498.50
Machine Power	198000.00	0.33	65340.00	18000.00	0.33	5940.00
Machine set up	18000.00	27.50	495000	15750	27.50	433125.00
Total Cost of Goods Sold			13678620.12			6636179.88
Total Production			24000.00			6000.00
Cost of Goods sold/ Unit			569.94			1106.03

Table 3: Profitability analysis

Particulars	Lexon	Protox	Total
Revenues	23760000	7524000	31284000.00
Cost of Goods Sold	13678620.12	6636179.88	20314800.00
Gross Margin	10081379.88	887820.12	10969200.00
Selling and Administrative Exp.	6996000	1613700	8609700.00
Operating Income	3085379.88	-725879.88	2359500.00
Units Produced and sold	24000	6000	30000
Operating Income / unit sold	128.5574951	-120.9799802

In the present study, Accountant of the company named Smith shows the result of the total cost and total profit by applying the activity-based costing method of the product Lexon and Protox to her manager named as Kay.  By applying the ABC costing, the cost of the product can be measured in a more accurate manner. Since, due to the ABC costing, the total cost of the products increased, which is more accurate, but the manager Kay didn’t want to remove the product from the market, therefore Kay suggest to Smith that ABC analysis is not an accurate method, as there are so many activities and if all the activities are included then result may be different, and Kay suggests to Smith about the change in figure. Smith didn’t agree with the argument of the Kay as the ABC analysis calculates the profitability of the Lexon and Protox, through making use of different activity drivers, which is fairly accurate. Analysis based on the ABC results in a number that closely approximate to those methods of detailed analysis. Further, the bonus of the accountant is also based on the revenue of the product; this is the factor which can influence the decision.

Cost analysis using ABC method

In Australia, Accounting professional and Ethical standards boards limited (APESB) issues APES 110 code of ethics for professional standards with the aim to ensure accountants are acting in the public interest. In this standard, five main principles for the professional accountant are described, which are integrity, objectivity, professional competence, due care, confidentiality and the professional behaviour (Krupenye et al., 2016).  Further, the decision of the accountant should not be influenced by unethical aspects, and they should not allow for partiality and conflict of interest. The accountant should apply the professional skills and knowledge at all level, so that client receives the competent professional services which are based on the current development and at the same time accountant should work in accordance with the applicable technical and professional standards. Moreover, the accountant should not disclose any information to the third party without any specific permission of the client and also nor use the information for the personal advantage of the member or third parties. Along with this accountant should comply with relevant laws and regulations which are applicable. 

This standard requires the framework which is applied by the accountant in respect of their professional judgment. The accountant should identify any threat to compliance with fundamental principles, and therefore evaluation of the significance of the threat is to be done. On the basis of it, safeguards are applied to removing the threats or to reduce them at the acceptable low level (George, Jones, and Harvey, 2014).  Threats may be self-interest threats, self-review threats, Advocacy threat, familiarity threat, and Intimidation threat.  The threat which is created by the financial or other interest which inappropriately impacts the decision of the accountant is a self-interest threat. Self-review threat comes into existence if the member will not appropriately review the result of the previous judgment. Further; through the advocacy threat the position of the client or the employer enhanced by compromising the objectivity of the accountant. Familiarity threat is due to a close relationship with the client, and the last intimidation threat arises due to undue influence over the accountant (Andrews, 2018).

Part C of the APES 110, describes the conceptual framework for the members of business, industry, commerce, services and so on. Member in business faces a threat to compliance with the fundamental principles. Further section 310 of this standard describes that accountants of the organization are anticipated for the maintenance of the legitimate and ethical objectives, and rules and regulations of the organization, therefore they may face the pressure from the organization that create the threats to the fundamental principles. Moreover, section 340 of this standard suggests that a member cannot manipulate the information or use the information for their personal gain.

Profitability analysis of two products

In the present case accountant Smith should not agree with the suggestion of the Kay. As if an accountant applies the recommendation of the Kay then the fundamental principle such as integrity, professional competence, objectivity, due diligence and professional behaviour will be compromised. Further Kay decides the bonus of the smith on the basis of the revenue from the product, this creates the self-interest threat for the accountant, since if in the report by applying any other method of costing, revenue rise then, and accountant wants to use that method even if that costing method is not appropriate. Further in this case advocacy threat also comes into existence as the manager Kay, forces to Smith for change in the costing method of the product, which leads to the position of the manager achieved by compromising the objectivity of the accountant. The accountant should evaluate the significance of the threat and apply the safeguards to eliminate the threats and reduce them to an acceptable level

Allocation of the overhead by applying the predetermined overhead rate results in overvaluation and undervaluation of the overhead cost. The predetermined overhead rate is the tool to allocate the estimated manufacturing overhead cost to the product cost, during a particular period of time.  The allocation of the manufacturing overhead may be based on the direct labour hours, direct material, or machine hours (Otley, 2016). Since the predetermined rate is totally based on the estimated value, therefore it differs from the actual, the over and under applied manufacturing overhead are generally debited or the credited to the balance of manufacturing overhead account (Fullerton, Kennedy, and Widener, 2014).

The method of disposition of the over and undervalued manufacturing overhead is by allocating them into Work in process account, finished goods account or cost of goods sold account or by transferring the whole amount in the cost of goods sold account (Dekker, 2016). 

If the balance in the manufacturing overhead account is treated as immaterial, then it is adjusted to the cost of goods sold account. It is because; the cost of goods sold account is the product account which comprises with the significant manufacturing cost at the year-end. Therefore at the end of financial year, the adjustment has to be made, if the balance in the manufacturing overhead account is debit, means undervalue of the manufacturing cost then it is adjusted by debiting the cost of goods sold account and crediting the manufacturing overhead account, and if the balance in the manufacturing overhead account is credit, means overvalue of the manufacturing cost, then adjustment is made by crediting the cost of goods sold account and by debiting the manufacturing overhead account.

Ethics in accounting for professional accountants

On the other hand, if the balance in the manufacturing account is considered as material, then it is allocated proportionally to the cost of goods sold the account, work in progress account, and the finished goods account.

Another method of disposition of the over-allocated or under allocated overhead is by applying the adjusted allocation rate approach which restates all the overhead entries on the basis of the actual overhead rates in spite of the budgeted overhead cost. 

Conclusion 

On the basis of the above study, it has been concluded that the allocation of the manufacturing overhead by implementing the traditional costing system is very simple and easy since this method allowed the allocation of the overhead on the basis of direct labour hours or on the machine hours. However, the allocation of the overhead from this method does not reflect the accurate consumption of cost by the end product.  Therefore the activity-based costing system is more suitable for the allocation of the overhead since in ABC costing allocation of the overhead based on the activities used for the production of the product, and therefore it is considered as a more reliable method of allocation of the cost.

Apart from the above, accounting professional and Ethical standards boards limited (APESB), issued a standard for the accountant APES 110, which prescribe the guidelines, which have to be followed by the accountants at the workplace. In this standard, principles for the accountants have been prescribed, which lead to the fact that the decision of the accountant should not be influenced by any unethical aspect (Subiaul, 2016). APES 110 code of ethics provision has been introduced with the aim to provide guidelines for working with the professional accountants to ensure their activities must be in the public interest. The accountant has to follow all the guidelines which are prescribed in this standard so that stakeholders can get informed about the true picture of the organization. Further, this study also suggested  different methods for accounting about the undervaluation and overvaluation of the manufacturing overhead on the basis of the materiality of the amount involved in the same. 

References 

Andrews, K., 2018. Apes track false beliefs but might not understand them. Learning & behaviour, 46(1), pp.3-4.

Ax, C. and Greve, J., 2017. Adoption of management accounting innovations: Organizational culture compatibility and perceived outcomes. Management Accounting Research, 34, pp.59-74.

Ball, F., Tyler, J. and Wells, P., 2015. Is audit quality impacted by auditor relationships?. Journal of Contemporary Accounting & Economics, 11(2), pp.166-181.

Dekker, H.C., 2016. On the boundaries between intrafirm and interfirm management accounting research. Management Accounting Research, 31, pp.86-99.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7-8), pp.414-428.

George, G., Jones, A. and Harvey, J., 2014. Analysis of the language used within codes of ethical conduct. Journal of Academic and Business Ethics, 8, p.1.

Haroun, A.E., 2015. Maintenance cost estimation: application of activity-based costing as a fair estimate method. Journal of Quality in Maintenance Engineering, 21(3), pp.258-270.

Krupenye, C., Kano, F., Hirata, S., Call, J. and Tomasello, M., 2016. Great apes anticipate that other individuals will act according to false beliefs. Science, 354(6308), pp.110-114.

Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.

Subiaul, F., 2016. What’s special about human imitation? A comparison with enculturated apes. Behavioral Sciences, 6(3), p.13.