Question

CORE Fitness Inc. is a high-end athletic gear manufacturer. The production of gear involves many complex and specialized activities that, before now, have lacked organization or procedural direction. The production manager has considered applying a systematic costing system to improve on efficiency of production, and he wants your advice about activity-based costing (ABC).

However, while the production manager wants your advice, he has argued that interrupting the existing costing system would be a detriment to the factory. In contrast, the entry-level accountant believes an ABC system would in fact assist the company more effectively in identifying the basis of costs and how to actually regulate the costs.

Role play as either the production manager or the entry-level accountant to convince the other person to agree with your stance.

Answer 1

As the company manufactures Gear which involves complex, difficult and specialized activities, Activity based costing would be the most appropriate costing technique than any other traditional costing technique and method.

As Gear production is undertaken through various different activities, ABC technique takes all important factors into account before assigning the cost of a product. On the other hand traditional costing technique uses old technique of allocating cost based on average.

In activity based costing the manufacturing overhead costs are allocated in more logical manner. Under this method costs are first traced to activities and then to product. It is assumed that activities are main constituents of costs. It uses several cost pools organised by activities to allocate overhead costs into a product. In Gear manufacturing company various activities are involved to produce the final product such as purchase of raw materials, setting up machinery, assembling of product line etc. All these activities yield costs. Under ABC techniques all costs are assigned to the final product based on product's use of activity. Therefore under this method the actual costs which are incurred in each activities are only charged to the product. But in traditional costing techniques the total overhead cost is charged to the product based on average overhead rate. This method pools all indirect costs and then it is charged into the product based on machine hour or labour hour. As Gear production involves various activities the true cost of each activity and it's chargeability is only possible it the adopts Activity based costing.