An Activity Based Costing “(ABC)”system assigns overhead costs in a different approach compared to thetraditional approach which allocates costs in accordance to direct labour hoursor machine hours.
ABC costing assigns costs to specific activities that have adirect correlation to the cause of the overhead and then assigns the cost ofthose activities strictly to products that are in need of those activities. ABCcosting is more complex and is also more precise than the traditional method asit takes key factors into consideration before assigning costs to a product.Penny Blossom Mftg.
Co would see clear advantages if they were to switch fromtheir traditional costing system to ABC costing. To begin with ABC costing can beseen as a huge advantage when looking at an internal use perspective. With largeproduction a small change in each products cost can result in an enormousdifference in the ending cost. With ABC costing assigning costs to activitieswith ties to overhead and then assigning the costs of those activities to theactual products that are in need of those activities, this provides accurateresults which the internal user can use to their benefits. The decision makerwill be able to track which items are costing more than they should be and isparticularly good for finding areas where spending can be cut down. Thiscreates the ability to allow benchmarking for the company. Secondly ABC costing thrives in themanufacturing sector because as the company allocates their indirect costs tospecific products based upon their actual usage it is easy to spot where theresources of the company are actually going.
By concluding where the money andenergy is headed to, the company can focus on products that are consuming themost time and energy and go about ways to improve this. This accuracy cannot befound in the traditional costing method that Penny Blossom currently uses. Thiscan eventually lead to lower costs as management makes the efforts to reducethe costs where they see products are taking too much time and energy. Lastly departmental costing is determined on the basis thatthe capacity is being fully utilized, therefore if the capacity is not fullyutilized the cost can be inaccurate. Overhead can be seen to be inaccurate aswell in cost accounting while using pre-determined rates this may result inover/under absorption of overheads. In conclusion Penny Blossom Mftg.
Co should switch over to the more appropriate ABC costing method that bettersuits the company. If you have any further questions feel free to contact me [email protected]