The report I made based on research that illustrates a specific method of calculating the cost of the products manufactured, which is known as Activity Based Costing (ABC). Kaplan and Bruns in the late 1980s defined Activity-Based Costing. It can be considered as an alternative to absorption costing, enhancing the understanding of a manger about his company's major and minor expenditures, and it helped me in sorting out my company's expenses (Kaplan & Atkinson, 2015).
This costing method allows direct and indirect expenses on the provided services and products. The purpose of such a model is to establish a relationship between costs, overhead activities, and manufactured items. Unlike conventional costing methods, it also calculates the indirect expenses involved in the production. However, some of the indirect costs are difficult to account, like management and employees' salaries. The ABC model is frequently used in companies that provide products to their consumers. It is a reliable method as it focusses on bringing the real costs out of all the expenditure (Drury, 2013). As a result, the reliability of data increases by classifying the various sectors of the financial requirements of a company.
The ABC system of cost accounting works on actions including all the events, work units, or any specific goal involving tasks. Activities direct the cost by taking things into account like manufacturing units and order purchasing. In this way, ABC provides a better grasp on expenses, enabling companies to develop proper pricing strategies. The following diagram depicts the formula of the ABC Method.
Activities are cost drivers, e.g. machine expenses and purchases whereas cost pool is the total expenditure allotted for production.
The calculation of cost during the manufacturing process is pivotal in charting a company's revenue. There are many models to calculate the expenses in making a product. ABC method is preferred over old models because it enhanced the capability of my company's manager of determining the range of financial requirements of the company. The interesting part I found about this method is that it keeps the record of every single minor and major activities and resource to determine the cost of units. ABC opposes traditional accounting in the way that conventional method focusses on gross production and sales hence bringing out the indirect cost (Horngran & Datar & Rajan, 2015). On the other hand, Activity-based Costing takes direct and indirect pathways of draining finance into account. Any extra charge is minimized. Traditional ways hide many expenditures while ABC focusses on noticing every expense route utilizing all the resources. The desire to understanding the correct cost of products ease the way to adapt to this modern way of accounting. The companies are inclined to this method because it brings the following benefits
The modern system of accounting taught me the mathematics of a company from a different viewpoint. Setting up a proper margin without understanding the cost is not possible. Advancement in the accounting system enabled me to foresee the potential losses and profits in business. The development of new strategies involving production, marketing, and sales depend on the actual data obtained. Although the impact of traditional and modern ways of accounting seems minimal, yet it did bring a considerable change in the growth of my organization and other organizations in general.
Traditional and modern methods of accounting coexist in businesses around the world. While comparing both systems, I can say that Activity-based Costing is a more in-depth approach to pricing than traditional Costing. A systemic approach is the essence of any business, whether local or international ( Mukhopadhyay, 2014). Hence, the preferred system is Activity Based Costing. We can see the benefits of this system in multinational companies like Caltex and Fonterra Group. These companies boosted their revenue by upgrading the accounting system.
Personal Relevant Experience:
My father started a furniture business five years ago. He used the traditional method of costing for determining the investments and profits. I developed an online store in association with the furniture display centre. The total cost of manufacturing for last year was $20,000 with budgeted labour hours of 5000. My company was calculating this on pre-determined labour costs and margins. The profit came out to be $7000. Later on, my company changed the approach of calculating fees. I included every little value, like the price of raw material, transportation charges, worker salaries, and tax returns. After considering every little detail, my company's manager found that transportation charges were skyrocketing due to the ignorance of extra fuel costs. When I controlled this leak, the profits upsurged to $12000.
A minor up-gradation of cost calculation boosted the margins of my company. Every activity relating to business should be in the notice to avoid all kinds of losses. A small amount of revenue will help to establish some business strategy for positive purposes leading to the growth of the company.
A majority of business authors mention the flaws in traditional costing methods of businesses around the world. The managers of companies support this method, as well. ABC management is one of the essential guidelines for every company seeking improvement in utilizing resources and boosting production. The data analysis of various businesses supports this method, as well. In terms of implementation, traditional ways are easy while ABC requires monitoring. The conventional way focusses on allocating a pre-determined estimate to production. On the other hand, Activity Based Costing emphasizes accounting every activity involved in the manufacturing process.
The research about the ways of accounting is interesting because it enabled me to understand various strategies that govern mega industries. Searching for the support of this model is easy, as the majority of the business tycoons like this way of accounting. Furthermore, several companies improved their revenue generation through this model. It covers all the concerned departments and unites them to work towards a common goal of boosting business.
Companies have been using a traditional costing method since the beginning because it was easy to implement. The managers need to calculate a pre-determined cost of the product. Activity-based Costing requires every department to provide financial reports to high command so that they can calculate the losses and profits faced in manufacturing a product. Both of these methods coincide at a minor level, but the effects are different at a grander scale. ABC system not only controls the use of resources, but it enabled me as a company owner to develop strategies for the future.
Drury, C. M. (2013). Management and cost accounting. Springer.
Horngren, C. T., Datar, S. M., & Rajan, M. V. (2015). Cost accounting: A managerial emphasis.
Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.
Mukhopadhyay, S. C. (2014). Wearable sensors for human activity monitoring: A review. IEEE sensors journal, 15(3), 1321-1330.
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