Question

Manufacturing companies vary greatly in how factory overhead and/or support department costs are allocated to production. Most companies use direct labor hours or machine hours to determine the allocation as the methodology is relatively simple and straightforward. Some companies invest in an activity based costing approach and have a very precise allocation to each manufactured product. If you were the controller or cost accounting manager, which method would you recommend? Why?

Answer 1

As a controller i will recommend ABC costing for improved cost allocation and better decision making in the organisation. However following considerations should be taken into account if ABC costing method is needed

· A feasibility study should be conducted to study all the activities of the firm. It should cover all kind of activities taking place in the organisation

· Co-operation and co-ordination of all the departments is necessary in implementation of ABC costing

· Cost benefit analysis study is needed to ensure the benefits from implementation of ABC costing is higher than the cost involved in implementation

· The need for ABC costing in the organisation also is one of the considerations to implement it. The need can product costing or product pricing, profitability management operational or strategic decision making aspects like continue or discontinue product lines, etc

ABC costing method is recommended due to following advantages:

· Helps in accurate product costing since cost are allocated based on rational basis like activities consumed

· Helps in accurate product pricing due to accurate product costing

· Helps in reliable decision making and improve the accuracy of decisions taken

· Helps in elimination of non value adding activities since it needs study of activities

· Helps in performance appraisal of employees since accountability is there for activities

· Helps in strategic and operational decision making like continue or discontinue of product line or service lines

· Helps in overall profitablity management of the firm through cost management because of cost control and cost reduction.