May 3, 2012.Outline Question 1Question 2Question 3Question 4Question 5Question 6ReferencesQuestion 1Wallen Manufacturing uses Volume-based-product costing system to allocate overheads. It thus utilizes only one cost driver that is direct labour dollars as shown by the Wallen’s current accounting information. This implies that the firm’s overhead costs are assigned to the products on basis of utilization of the direct labour. That is manufacturing overhead costs to be incurred by the firm were divided by budgeted direct labour dollars to obtain predetermined overhead rate of 875%. Firm may have used this method because it is easy to use than Activity Based Costing (ABC) as it allocates total overhead costs altogether.
Wallen has assigned manufacturing overhead costs directly to Jaza, Nance and Meliss. For instance, Jaza, Nance and Meliss are assigned manufacturing overheads of $420.00, $315.00 and $210.00, respectively. This costing system has a problem in that some overhead activities costs consumed by Jaza, Nance and Meliss do not match up with direct labour dollar cost driver which is also true for many other modern firms that use technology and manpower to produce their products.
This system uses cost drivers such as direct labour dollars, machine hours for overheads allocation. Therefore, the product costs are based on the absorption costing which include both variable and fixed costs (total cost) (Marx, 2009). Another problem is that this system is outdated because many firms and particularly Wallen uses computers and machines for manufacturing. Computes and machines make firm’s system redundant as they utilize direct labour hours in cost calculation. Manufacturing costs are not assigned appropriately since direct labour hours as cost driver is not one of the best drivers to use, in this case Wallen should have combined machine hours with direct labour dollars for better results.
The volume-based costing contradicts other drivers of cost that might contribute to products cost. Finally, this system may initiate bad management judgments since it does not include specific non-manufacturing costs (Johnson, 2012). Question 2ABC offers more correct analysis of the product cost; however, firms normally utilize it as additional costing system. Cost allocation bases employed in ABC vary from Volume-based costing bases (Johnson, 2012). ABC establishes every activity related with manufacturing a product as well as allocating cost to such activity.
Cost allocated to activity is eventually allocated to the products which need activity for the production (Johnson, 2012). For instance, Wallen has activities like machinery, machine setup, inspection, material handling and engineering which can use activity drivers like machine hours, number of setups, number of inspections, raw materials costs and number of charge orders, respectively. ABC is an accurate system of product costing because firms allocate costs only to items that need activity for the production such as Machinery, inspection, machine setup, material handling and engineering.
Which means that it is able to estimate individual product’s cost precisely. Through process of assigning overhead cost to the product, ABC assists in recognizing non-profitable products or inefficient activities that consume the firm’s profitability of the effective processes or greatly profitable products. Thus, ABC eliminates assigning costs that are irrelevant to the product. In addition ABC is easy to interpret and understanding of the internal management cost; it also enables benchmarking of the overhead costs (Nayab, 2011).