Hugh Company
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Huge Company: Case Study 4.64
Today, more and more organizations prefer Activity-Based Costing System (ABC) to the functional-based costing system. ABC takes into account minute details regarding the activities and the factors that add up to the final cost. ABC is based on an activity hierarchy wherein the different activities influencing the cost build up are grouped into different categories. Such a costing method improves cost measurement by organizing information around activities (Thompson, 2003). The group will complete requirements (a) through (e) found at the end of the case. They will then, find three sources on the Internet, that compare and contrast activity-based costing and functional-based costing systems. And, to demonstrate, the group will discuss under what scenarios each system might lead to better decision making at Huge Company.
Compute the costs of each job using the current cost system.
Total Labor cost $90,000,000
Total working hours per year $2,000
Total number of employees 1,000
Average cost per hour per person — 90,000,000/ (2,000 X 1,000) = $45.00/hour/person
Job 1: $45 X 22.50 labor hours = $1,000.30
Job 2: $45 X 160.00 labor hours = $ 7,200
Job 3: $45 X 21 labor hours = $945
Job 4: $45 X 120 labor hours = $ 5,400
Job 5: $45 X 60 labor hours = $2,700
Recommend an alternate cost system that recognizes additional differences among jobs.
The activity based costing system improves the accuracy of product costs and addresses internal operating concerns. It provides for actual costs associated with each product produced by the organization. ( Dekker, 2003). Cost drivers are utilized replacing the general ledger that was heavily labor based. The ABC system provides for integration of scheduling and the cost management system and considered to be much more sophisticated than the traditional costing systems.
Recomputed the job costs using your alternative cost system
Total equipment costs $90,000,000
Total working per hour per year = 6,000/hrs
Total # work centers = 19
Average cost per hour per work center = 90,000,000/(19 X 6,000) = $789.47 (per center/hour). A machine is a center.
Job 1: 789.47 X 7.5 = 5,921.05
Job 1: 789.47 X 10 = 7,894.70
Job 1: 789.47 X 8.75 = 6,907.86
Job 1: 789.47 X 12.5= 9,868.38
Job 1: 789.47 X 6 = 4,736.82
Explain the differences in decision making at TBU.
The management of Huge Company’s tooling business unit is concerned that his unit costs do not accurately reflect actual unit work performed because other business units send them their work. TBU management computes a combined labor and overhead cost per labor hour and charges each job based on the number of labor hours used. This labor- based charge is then added to the materials cost to calculate the total job costs. This method does not provide an accurate cost per unit and can lead to over-costing or under-costing per unit.
Identify TBU’s internal customers that might be influenced by the use of the alternative cost system.
Activity based costing systems can be utilized by the entire company, individual departments or units within the company. There-fore all of the company’s internal customers can be influenced by the use of the ABC systems. Managers over the company’s major products as well as other business units within the company can be influenced by ABC systems.
CONTRASTING ACTIVITY AND FUNCTIONAL-BASED COSTING SYSTEMS
Activity-Based costing (ABC) addresses internal operating concerns by capturing the current cost of performing an activity. It also targets high cost activities and provides a context for establishing and monitoring performance measures. It provides the link between activity modeling and economic analysis. This method would prove useful with management of TBU with concerns of current method of costing unit work when other business units send them their work. Also when TBU’s principle focuses on scheduling its resources the ABC costing system would reflect cost related to scheduling and projections. This method of costing is useful for forecasting financial baselines. It provides for an accurate costing of services or products.(Briner, 2003). TBU would utilize ABC systems in computing labor, overhead which are presently being combined to get each job cost. The ABC system is a more sophisticated costing system by providing for a more accurate description of how costs are absorbed by activities and products. The improved information it provides regarding pricing and product variety helps management make better decisions regarding production and purchases. Because TBU uses several types of material as well as 19 different work centers the ABC system would breakdown individual costs for each station as well as individual totals of types of parts produced. This method can also be utilized for inventory valuation with financial statements (Tarr, 2004). The Activity-based approach strives for the ideal and so the standards are the ideal. Progress is measured over time with the expectation that performance should be continually improving. TBU’s employees are highly skilled and the highest paid within the company therefore the actual hours spent on individual machines and job would be reflected using the ABC system, Efforts are made to find new ways of doing things and or seeking a new optimal standard. The focus is system wide. It recognizes that maximizing individual performance may not produce organization wide efficiency. The concern is overall organizational performance. Process performance is emphasized. The objective is to provide low-cost, high-quantity products, delivered on a timely basis; therefore, both financial and non-financial measures are needed. ABC builds on the explicit recognition of those the firms activities