Question

4. Prior to the accountant's efforts, the CEO was quoted a £10,000 request in order to implement an ABC system. Frustrated, the CEO initially turned down this quote, believing that this cost will not provide much benefit, saying: "If I had the choice, I would rather spend the £10,000 in creating a third waffle product, or develop the marketing of the company further. How does a customer truly benefit from a so-called investment of £10,000 into a better accounting system?" Explain how should the accountant respond in a balanced manner. (15 marks)

Answer 1

ABC Costing

In the given case the accountant should help CEO in understanding the importance of the ABC Costing system and how it helps the firm in achieving strategic cost advantage. The account should explain what is ABC costing all about, steps involved in it briefly and how it helps in Cost management.

ABC costing is a method of costing which allocates the overheads based on the activities consumed rather than one single predetermined overhead based on traditional method like direct labor hour or machine hour. The single predetermined overhead rate computed under the traditional method of costing does not correlate the overheads with the activities consumed for the product. Hence it is arbitrary allocation of the overheads without seeing actually which cost drivers are driving the cost.

ABC method of costing helps in identifying the cost driver and then allocating overhead based on the actual consumption of activities. Following are the 5 step activities

• Identification of activities which are involved in production
• Identification of cost driver for each activity
• Assignment of Cost to the activity cost pools
• Calculation of activity cost driver rates
• Allocate cost to products based on actual consumption of activities

ABC method gives superior advantages over traditional costing method when implemented in an organization. Below are the advantages when it is implemented in an organization.

• It helps in accurate and reliable product costing. Traditional methods may not reflect accurate product cost since it is not based on resources consumed. But ABC method helps in identifying the actual drivers of cost and calculating accurate product cost
• It helps in decision making like evaluation of product line profitability, evaluation of customer wise profitability, launching new products, pricing decisions, etc
• It helps in Better Cost management through better cost control and cost reduction
• It helps in elimination of non value adding activities and thereby improving the process efficiency.
• It helps in performance evaluation and helps in growth of organisation
• It helps in gaining strategic competitive advantage to the firm over its competitors