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Intermediate Management Accounting Assignment Solution
This intermediate management accounting assignment solution gives a brief introduction of the Management Accounting concepts. It explains the factors that relate to importance of having a formal product costing system and the reasons due to which the Financial Accounting Reports cannot provide adequate information. It also discusses the reasons of management accounting information being more relevant than the Financial Accounting Reports. The major difference between Traditional Costing Methods and Activity Based Costing are included along with the description of need for adoption of Activity-based Costing Methodby Farmset.?
Formal product costing system
Costing system refers to that process which is used to design the cost allocated to the business. It comprises of the process of collecting the data and reporting to the management about cost & profitability (Sigüenza Guzmán, Lorena, Alexandra Van den Abbeele, and Dirk Cattrysse, 2014).Costing systems are used by the businessesfor many purposes.The company uses costing systems for cost reduction and cost control for its business activities. The costing systems help the Company in comparing the actual cost with the budgeted cost and identify the variances which can be sued to measure the performance and to take future pricing decisions.The costing systems are used as an important tool for planning better cost allocation for the future business or product line. It can be observed that the costing system shall be necessarily implemented for the business activities of Farmset so that proper understanding of cost and cost allocation can be developed. The following are the benefits of determining the costs of business products:
Benefits of product costing
Maintaining Accuracy - It helps in increasing the accuracy when it comes to the variable cost which only assigns to the variable expenses which are incurred in the creation of these products.For example this will also help the company to know about the exact costs involved in growing coffee and processing it to be saleable.
Decision making- Top levels management decide to continue a project based on the reports of costing and profitability.For example with the help of formal costing system the budgets can be prepared for the business operations of Farm set to assist the managers in making decisions.
Product Development - This refers to the development of the new products. When a company is planning to recreate old products and a new line of products then costing serves as very important tool (Fisher, Joseph G., and Kip Krumwiede, 2012)For example with the help of costing system, the costs of raw material, direct wages, purchase cost and other cost for each business venture may be known on the basis of decision could be made.
Reasons of failure of financial accounting reports:
Financial accounting reports prepared for shareholders and banks fail to provide detailed and relevant information for effective management practices. Separate cost data are not available for the different products,departments, and processes to the management.Recording of the wages &labour cannot be traced with the financial accounting process which creates a problem in cost association with different activities.Financial accounting alone cannot provide classification the cost as a direct cost and indirect cost and the expenses are not assigned to the product line. Financial Accounting doesn’t have the system to evaluate the performance of different departments as to which product line has consumed more resource as compare to the budgeted.Financial accounting contains historical data of costs and fails to provide day to day information about the daily costs and expenses. Future expenses and costs cannot be traced on the basis of the historical data.For example the financial accounting reports of Farmset does not provide information to the various factors such as idle plant and equipment seasonal problems, in terms of the volumes of the business, starting with the new product line etc.
Management accounting Information
Management accounting is more important to provide information for effective management practices due to the following reasons:
- It is a tool to the management that provides detailed record of the cost relating to the different servicesthe process of accumulating the cost of the particular products.
- It involves the process of calculation of the cost for stock and profit measurement.
- It aims at controlling the cost to have a high-quality product at minimum cost.Controlling cost is the crux of the management accounting.
- It involves the comparison of the actual result against the planned result. An organization can be more efficient in controlling the factory overheads.
Traditional Costing v. ABC Costing
The allocation based on the activity based Costing is different from the traditionally based costing since it assigns every cost which is linked with the production of the product and associate with the product activity whereas Traditional costing comprises of the apportionment of the overhead to the units produced.For example the business of Farmset group of companies comprise of diversity of activities but under the traditional costing system single basis is used for cost allocation but by implementing Activity based costing the overheads will be allocated as per the cost drivers of various activities which will help the company in decision making with regards to all the specific activities.
In the traditional costing that the main driver is the manufacturing overhead cost is volume metric while Activity based Costing provides more accurate view of determining the product cost. Traditional costing methods fail to allocate the administrative cost related to the manufacturing of the particular product line
Activity based costing provides higher accuracy that cost is allocated only which is used in the manufacturing if the product this method eliminates the irrelevant cost to a product Top level managements have easier access to the overhead costs.
Traditional costing methods neglect the cost of the other expenses which have indirectly contributed in the cost of the product and lead to the bad management decision. It is beneficial for those company which manufacture only one product line but the business of Farmset includes a wide range of activities and thus traditional costing system is not effective for its business.
Implementing the activity based Costing within the company requires the substantial resources and is a limitation for the company having limited funds.
Reasons or warning signs for Shifting To Activity Based Technique
Business like Farmset is required to shift from Traditional Costing Technique to the Activity Based Technique due to the followings reason:
- Activity-Based Costing Approach provides detail information of the overheads incurred in the manufacture of the particular products.Some of the products of Farmset are loss making due to high fixed costs involved.The diversity in the product and service range of Farmset requires the company to make decisions about cost behaviour of operations for these products and services which can be effectively done only through Activity Based Costing under which the costs are allocated on the basis of cost driver of each activity involved in manufacturing the product.
- Traditional Costing Approach is successful where there is only one product line and the business like farm set have different products to offer it is very important for the company to decide which product is profitable and which product should be Discontinued.
- Activity-based Costing helps in comparing the actual overheads incurred in the manufacturing of the product with the budgeted overheads (Ahamadzadeh, Taha, Hossien Etemadi, and Ahmed Pifeh, 2011).This will help in the financial planning of Farmset.
This can be concluded from the above report that the business like Farmsetis required to follow the Accounting costing standard so as to find out the costing of the product served by the company and find out the profitability from the existing product. Further, the benefits of product costing system and failures of financial accounting reports for Farmset discussed above also justify the adopting of Management Accounting system by company. The company is recommended to adopt the Activity Based Costing approach for allocating the real cost which was incurred in the manufacturing of the product as per the reasons of shifting discussed.
- Ahamadzadeh, Taha, Hossien Etemadi, and Ahmed Pifeh."Exploration of factors influencing on choice the activity-based costing system in Iranian organizations."International Journal of Business Administration 2, no. 1 (2011): 61.
- Emblemsvåg, Jan, and Bert Bras.Activity-based cost and environment management: a different approach to ISO 14000 compliance. Springer Science & Business Media, 2012.
- Fisher, Joseph G., and Kip Krumwiede. "Product costing systems: Finding the right approach." Journal of Corporate Accounting & Finance 23, no. 3 (2012): 43-51.
- Sigüenza Guzmán, Lorena, Alexandra Van den Abbeele, and Dirk Cattrysse. "Time-driven activity-based costing systems for cataloguing processes: a case study." (2014).