Activity Based Costing - Saga Plc - Assignment Example

Management Accounting Table of Contents (a) 4 (b) 7 (i) Activity Based Costing (ABC) 7 (ii) Implementation of ABC method by Saga Plc. 9 (iii) Comparing activity-based costing over traditional absorption costing 9 Conclusion 10 Reference List 12 (a) (i) Saga Pc aims at assembling three types of motor cycle in a particular factory: 50cc Sunshine, 250cc Roadster and 1000cc Fireball. The company sells motorcycles all over the world. In order to cope up with the market demand of the cars, Saga Plc has invested more in new technological innovations and has reduced investment by downsizing the workforce. After obtaining financial data from the accountants, the profit of Saga Plc is calculated by applying two methods: existing method used by the company and activity based costing. The following data are provided by accountants: Annual output Annual direct labour (hours) Selling Price (£ per unit) Raw material cost (£ per unit) Sunshine 2000 2,00,000 8,000 800 Roadster 1600 2,20,000 12,000 1,200 Fireball 400 80,000 16,000 1,800 Total 4000 units The actual sales of the company with respect to three vehicles: Sales of each vehicle Sunshine Roadster Fireball Sales (unit sold) 400 300 100 Sales price £ 8,000.00 £ 12,000.00 £ 16,000.00 Actual annual sales £3,200,000.00 £ 3,600,000.00 £ 1,600,000.00 The purchase orders are taken as the total units of each type of motorcycles sold. The above table thus highlights the total sales amount of each type of motor cycle. According to the existing method of calculating profit the following are the result of profit of each type of motorcycle. The calculation of variable cost: Variable cost   Sunshine Roadster Fireball Raw material cost per unit £ 800.00 £ 1,200.00 £ 1,800.00 Total units sold 400 300 100 Total variable cost £ 320,000.00 £ 360,000.00 £ 180,000.00 The above table highlights the calculation of variable cost. Here the raw material cost is regarded as the fixed cost of the business. The total variable cost for manufacturing three motorcycles is £ 860,000. In this case the direct labour is regarded as the fixed cost of manufacturing the motorcycles. The total fixed cost is elaborated below in the table: Fixed cost   Sunshine Roadster Fireball Direct labor       Labor hours 200000 220000 80000 Per hour cost £ 10.00 £ 10.00 £ 10.00 Total labor cost £ 2,000,000.00 £ 2,200,000.00 £ 800,000.00 Total labor cost for three motorcycles £ 5,000,000.00     The total profit according to existing method of accounting is calculated as follows: Calculation of profit Sales £ 8,400,000.00 (-) Variable cost £ 860,000.00 Contribution £ 7,540,000.00 (-) Labour cost £ 5,000,000.00 Profit £ 2,540,000.00 From the above table it is observed that Saga Plc is earning a considerable amount of profit at the end of year. Here, the profit is calculated by considering the direct labour per hour. The total number of hours is multiplied with £ 10 per hour. The labour hour is very important in this method as the method highlights the productivity of the company with respect to labour hours. (ii) For calculating the rates per unit calculation the following steps are followed: a) Rate per activity: The total number of units for the three motor cycles is known and the cost of manufacturing it is also known. Thus, it is possible to calculate the rate per unit. It is calculated by dividing cost pools by cost drivers. Machine rate per hour Machine services 4000 Machine Hours 50000 Machine Rate per hours 0.08 (b) Cost of the activities in the manufacturing process of the motorcycle:   Sunshine Roadster Fireball Total cost Set up cost 28000 480000 400000 908000           Materials handling 1600000 1920000 720000 4240000  Total        5148000 The table above elaborates the cost of the activities that are involved in the manufacturing process of the company. (c) Calculation of profit The profit is calculated by considering the sale amount that is calculated in the previous method and the cost is the total cost from the activity that is taken into account for the manufacturing process. Calculation of profit Sales £ 8,400,000.00 Total Cost £ 5,148,000.00 Profit £ 3,252,000.00 From the above figure it can be concluded that the ABC have provided positive and considerable amount of profit just like the existing method of accounting. It can be stated that the company can consider ABC costing as the main tool for calculating the profit of the business. It will be beneficial for the company as it will take into account the cost for each activity that are undergone in the process of manufacturing the three type of motorcycles (CliffsNotes, 2013). The main advantage of applying ABC is that it takes into account the product cost determination which is more accurate than the existing method of calculation. It focuses on the cause and effect of the activities pertaining to cost attached with the production of the goods. The sales and overhead prices are fixed on the basis of the allocation of units of production of each type of motorcycles. The control over the variable and fixed overheads is possible only by monitoring the activities involved in the process of production. The detailed information of the process of manufacturing is very important and thus ABC helps in providing a reliable source of information. The overheads are evenly allocated among the units and are attached to the total cost components. (b) The following report refers the advantages of ABC to the Broad of Directors of Saga Plc from the viewpoint of a management accountant. The advantages of ABC are compared with respect to traditional absorption method. The labor hours of Saga Plc are evaluated based on ABC and the process of implementing ABC method is also discussed (i) Activity Based Costing (ABC) ABC refers to the measurement in accounting that assigns cost to different activities that taken place during a production process. Hence, it does not consider in the costs of individual services or products (Marsh, 2012; Babad and Balachandran, 2003). This method, ABC, allows an accurate and correct measurement of the resources that are required during the manufacturing and also considers the overhead costs. Therefore, in order to associate the costs with each product and service, the technique considers the each activity that is resource based. In the next step, the costs are allotted to each of cost objects. These objects are consumable whose manufacturing in dependent on the activities that are used. It also measures the established link between flows of activities among different activities of a company (Accounting Coach, 2014). The link is developed by assigning cost to each activity or consumption of resources. The flow that is generated within the costing technique considers four key areas: cost driver, resources cost, cost object, of driver and activity cost driver (Cokins, 2002). However, the traditional costing measure associates the overheads to cost centres that are regarded as the production centre or service centre. This is followed by the assigning of cost objects or products. In ABC costing method, overheads are first connected with each activity and then classified or grouped into their respective cost pools. The cost pools are designated only when the products and services are assigned their respective cost objects (Kaplan and Anderson, 2013; Gupta and Galloway, 2003). After associating the above discussion with the case of Saga Plc it can be stated that the labour hour of the company is evaluated based on the cost of the labour per unit and the total number of hours devoted by the workers for manufacturing the total units of three types of motorcycles. The workers are paid £10 per hour which denotes that the cost allocated for each unit does not comply with the total hours worked. Their pay is based on hours worked and not on the total units manufactured (Drury, 2008; Maiga and Jacobs, 2003). (ii) Implementation of ABC method by Saga Plc. The steps for implementing ABC costing that are followed by Saga Plc are as follows: 1) Identification and assessment of the needs pertaining to ABC. The viability of the ABC method is determined within the organisation. 2) The training requirements for implementing ABC methods are designed so as to train the employees accordingly. 3) The project scope is defined and the objective and mission are evaluated 4) The activities and drivers are identified so as to specify the drivers of each activity. 5) The diagram for cost and operational flow is created and the association between activities and resources determined in case of each products and services. 6) The data are collected which related to the diagram showing the operational relationship between the activities (Izhar and Hontoir, 2001). 7) The software model for ABC technique is developed, reconciled and validated. 8) The results are interpreted and management reports are prepared. 9) The data are collected and integrated and there after the reporting is done. (iii) Comparing activity-based costing over traditional absorption costing The advantages of ABC method over traditional absorption method are explained below: Activity based costing focuses on the activities that are related to the manufacturing of a certain product or services (Accounting Tools, 2014; Lucey, 2007). However, absorption costing depends on the cost of the individual cost and products and thus is so accurate in calculating profit as the ABC method. The cost associated to each activity is allocated to the individual cost pools. After assignment of cost to the activities, the cost is assigned to the products or services. The assignment of the cost is dependent on the cost drivers. This is far more reliable and viable than the absorption costing. The management is responsible for managing the activities rather than the individual products (Bjørnenak and Mitchell, 2002; Goldsby and Closs, 2000). The changes that occur within the activity have huge impact on the cost structure. Therefore, when the activities are measured and managed effectively, the costs can be controlled efficiently. In order to make more effective and strong economic analysis and take appropriate decisions by the company, the managers need to recognise the association between all the activities. This association will provide more accurate results and thus the method id more reliable than absorption costing technique. ABC also helps in identifying the exact areas of difficulties within a production process and prepares detailed analysis of the activities which needs to be revised and taken care of in order to increase the profit of the company (Jawahar and Srivastava, 2009; Kaplan and Anderson, 2013; Innes, Mitchell and Sinclair, 2000; Kaplan and Anderson, 2004). ABC method helps in creating a better management system which can identify the cost of the activities that are involved in the process of developed. It assists the management to identify the rectification areas and prepare future budgets accordingly. The utilisation of the technologies is properly justified as the production cost is compared with the benefits obtained from employing the technologies. The process aims at improving the quality of products and services and also motivates the managements to make proper product design (Jain and Khan, 2006). Conclusion It can be concluded that Saga Plc should employ activity based costing in order to increase its productivity and profit. The ABC technique considers the cost of every activity involved in the production of a particular product. Thus, it is more accurate and suitable for any company as they can access the company’s profit with respect to each activity. Hence, it can be stated that ABC method is very efficient in comparison to absorption costing method. Reference List Accounting Coach, 2014. Activity Based Costing. [online] Available at: < http://www.accountingcoach.com/activity-based-costing/explanation > [Accessed 10 July 2014]. Accounting Tools, 2014. Absorption Costing. [online] Available at: < http://www.accountingtools.com/absorption-costing> [Accessed 10 July 2014]. Babad, Y. M. and Balachandran, B. V., 2003. Cost driver optimization in activity-based costing. Accounting Review, pp. 563-575. Bjørnenak, T. and Mitchell, F., 2002. The development of activity-based costing journal literature, 1987-2000. European Accounting Review, 11(3), pp. 481-508. CliffsNotes, 2013. Activity-Based Costing Activities. [online] Available at: [Accessed 10 July 2014]. Cokins, G., 2002. Activity Based Cost Management: An Executives guide. New York: John Wiley and Sons. Drury, C., 2008. Management and Cost Accounting. London: Cengage learning EMEA. Goldsby, T. J. and Closs, D. J., 2000. Using activity-based costing to reengineer the reverse logistics channel. International Journal of Physical Distribution & Logistics Management, 30(6), pp. 500-514. Gupta, M. and Galloway, K., 2003. Activity-based costing/management and its implications for operations management. Technovation, 23(2), 131-138. Innes, J., Mitchell, F. and Sinclair, D., 2000. Activity-based costing in the UK’s largest companies: a comparison of 1994 and 1999 survey results. Management Accounting Research, 11(3), pp. 349-362. Izhar, R. and Hontoir, J., 2001. Accounting, Costing and Management. Oxford: Oxford University Press. Jain, P. K. and Khan, M. Y., 2006. Management Accounting. New Delhi: Tata McGraw-Hill Education. Jawahar, L. and Srivastava, S., 2009. Cost Accounting. New Delhi: Tata McGraw-Hill Education. Kaplan, R. and Anderson, S. R., 2013. Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. London: Harvard Business Press. Kaplan, R. S. and Anderson, S. R., 2004. Time-driven activity-based costing. Harvard Business Review, 82(11), pp. 131-140. Lucey, T., 2007. Costing. London: Thompson learning. Maiga, A. S. And Jacobs, F. A., 2003. Balanced scorecard, activity-based costing and company performance: an empirical analysis. Journal of Managerial Issues, 283-301. Marsh, C., 2012. Financial Management for Non-Financial Managers. London: Kogan Page. Read More