Question

You are required to choose a company which currently using the Absorption Costing System in determining the product and selling price.
Make the research on whether they are ready to implement a new costing system called Activity Based Costing (ABC).
Your written report must include the followings:

1. Introduction / Background of the company. - Company profile, mission, vision, organizational chart, business core and etc.
(5 marks)

2. i. The introduction to the Absorption Costing system.   

ii. Should provide FOUR (4) advantages and THREE (3) disadvantages of the Absorption Costing system. (20 marks)

3. i. The introduction of the new system (ABC). You should explain the ABC system in detail for convincing them.

ii. Should provide FOUR (4) advantages and THREE (3) disadvantages of the ABC system.

iii. Or any relevant matters should be included.
(20 marks)

4. Finally, after your research is done, summaries whether the company is agree to change to ABC or remain unchanged to the old system. Your findings must be supported with the relevant justifications (You should provide at least FOUR factors to the decision made). (10 marks)

Answer 1

2 i) Absorption costing is a managerial accounting method for capturing all cost associated with manufacturing a particular product the direct and indirect costs, such as direct material direct labour ,rent and insurance are accounted for using this method. absorption costing allocate fixed overhead cost to a product whether or not it was sold in the period

ii) ADVANTAGES:

1. absorption costing takes account of the fixed overheads that are involved in the manufacturing process and includes them in to the cost of the product, which presents more realistic cost of product

2. absorption costing is the most suitable method for the purpose of preparation of account.

3.adoption of absorption costing makes calculation easier for small business as it is unlikely that these entitity have a lot of products

4.it is a suitable method for business which has a constant demand of product also it takes into account the effects of fluctuating turnover as the cost attached to the product are already absorbed into the product

DISADVANTAGES

1. unlike marginal costing it cannot be used as an effective monitoring tool to evaluate profitaility of a company

2.as the cost of product include both fixed and variable cost ,this method cannot be used for the management decision making or planning further actions like forcasting, budgeting etc.

3. absorption costing also make difficult to do CVP analysis , because with the addition of fixed cost the variations in the variable cost of the product become difficult to determine.

3 i) ABC is an alternative approach to the traditional method of absorption costing .there are number steps that organization have to go through to establish an activity based costing

step 1:identify key activities of an organisation

step 2:identify cost drivers

step 3:collect cost in to the activity cost pool

step 4:calculate cost driver rate

step 5:absorb overhead into product unit on the basis of their usage of an activity

ii) ADVANATGES:

1.helps management to identify and understaBCnd cost behavior & product costs more clearly

2.ABC can be applied to all overhead costs, not just production cost

3.ABC provides a better estimate of long-term variable cost and helps take strategic decisions

4.creates the drive to attempt to reduce costs by attempting to alter the number of drivers.

DISADVANTAGES:

1.the process of identifying activties and drivers is a tedious exercise and very time consuming.

2.abc is expensive for business in practice

3.selection of activities and activity rates may be arbitrary.

4) the use of abc as against absorption costing will have significant impact on the organsation

1.it helps determine accurate cost and profitability accurately and hence can change the sales mix and strategy of an organisation

2.abc may help the company to identify profitable and non profitable product or services

3.abc creates a belief that overhead are variable and can be contralled.this influences decisions right from product development and research phase.

4.abc can play an important role in determining the prices of product or services offerd by the organisation

so the firm can use abc costing instead of absorption costing