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Managerial Accounting Questions

Managerial Accounting

Abstract

Activity based costing system is a method under which the overhead costs are assigned to particular products or services which are rendered. ABC costing system differentiates between manufacturing cost, overhead cost and indirect costs. The two Australian companies for which Activity based costing is suitable are Orica and Orora. Orica is a chemical manufacturing company and Orora is a pulp and paper product manufacturing. Orica is the biggest provider of quarrying oil and mining services. There are lot of uses of cost information in decision making to the managers. It plays an irreplaceable role in the decision making process of each and every organisation. The organisation which is chosen for the analysis ABC analysis is RBTS (Regional Blood Transfusion Service). The idea of implementing activity based cost structure in RBTS came into the mind of managers in the year 1993. RBTS satisfies all the features of ABC. RBTS have implemented ABC system very effectively. RBTS costing system provides a better understanding of cost. Cost information is useful to both external as well as internal users. The focus here is on the usefulness of cost information to the internal users of the company. This study was very useful to understand the practical use of the chosen costing system and provided with a lot of lessons that can be suggested to the organisations.

Introduction

Activity based Costing is one of the methods of costing. ABC costing system differentiates between manufacturing cost, overhead cost and indirect costs. Sometimes it becomes difficult to assign and allocate costs to particular heads. In this study two Australian companies Orora and Orica are selected to find out the amount of suitability of activity based costing in the organisation. Orica is a chemical manufacturing company and Orora is a pulp and paper product manufacturing. Orica is the biggest provider of quarrying oil and mining services. The organisation which is chosen for the analysis of activity based costing is RBTS (Regional Blood Transfusion Service). They deal in manufacturing of clinical products, collecting and testing blood. The report contains a detailed study of the way in which RBTS designs implements and uses the information provided by ABC.

This system first sets cost for different activities and then assigns them to different products. Activity based costing follows the principle that products are end results of activities and for conducting activities there is need of resources.

PART – A

The chosen costing system is Activity based costing (ABC)

Question 1 – features of ABC costing

Activity based costing system is a method under which the overhead costs are assigned to particular products or services which are rendered. ABC costing system differentiates between manufacturing cost, overhead cost and indirect costs. Sometimes it becomes difficult to assign and allocate costs to particular heads. Under activity based costing the first step is to identify the various activities which are required to develop the product. Then each activity is grouped all together will similar activities. The cost of each similar group is determined. The next step is to divide the total cost to each group. ABC costing gives a brief estimate about the amount of resources used by each activity as expenses are directly related to resources used. Some of the key features are mentioned here. Under ABC costing differentiation is made between different costs and its behaviour. An appropriate method is used to measure the overhead of each and every activity, product and service. The cost of any product is decided according to the resources, time and events related to the product. Under ABC costing method the total costing is differentiated and divided into various segments like variable costs and fixed costs. There is a differentiation to ensure that quality is maintained. ABC system provides a better understanding of cost. It gives a detailed explanation regarding manufacturing cost and product cost. Another important feature of Activity based costing is that it divided cost into a segment of pool. Each pool contains similar kind of costs.

Question 2 – suitability of ABC

The two Australian companies for which Activity based costing is suitable are Orica and Orora. Orica is a chemical manufacturing company and Orora is a pulp and paper product manufacturing. Orica is the biggest provider of quarrying oil and mining services. It plays a major role in gold extraction and also is a major supplier in the field of sodium cyanide. Orora is a paper manufacturing company and generates pulp. The common

Point here is both are manufacturing companies. Activity based costing plays an important role in any manufacturing company. Activity based costing is a system that provides accurate costs related to all products which are manufactured by the company. Activity based costing has replaced traditional method of costing and is considered as an important modern method of costing. Such a costing method is very necessary in the changing and technological advancing manufacturing sector. Under manufacturing products are not purchased. They are rather produced and producing any product is a difficult task which requires proper allocation of costs and proper allocation of costs is possible with use the use of ABC system. Determining the profit margin is very difficult in manufacturing units. Through the use of ABC system the cost of each product is known which makes the process to determine cost easier. For example, in the company named Orora management can know the costing of each type of paper produced and can easily estimate the profit which will be generated. Activity based costing also gives information about the raw materials and gives insight into the fact that whether raw materials can be procured from any different source at cheaper price. For example, Orica can look at the costing of different raw material used in extraction of gold and if it thinks that the cost of raw material is higher than it can look for other sources to procure raw materials. This is not possible unless and until the company or the organisation knows about the cost of each raw material which is used for production of different products.

Question 3 – use of cost information for decision making

There are lot of uses of cost information in decision making to the managers. It plays a irreplaceable role in the decision making process of each and every organisation.

Orica – cost information can help the managers of the company in decision making in the following ways.

To control its activities – there are huge number of activities performed in manufacturing company. There are lot of tasks related to each and every product. In such big companies management can easily take decisions if proper cost information is available. With proper availability of cost data management can easily identify and differentiate between the necessary and unnecessary activities. It can also eliminate the activities which are les significant but are consuming or incurring more cost.

Quality control – A proper cost information can help the managers in taking important decisions regarding quality. Management can find whether they can incur more cost on some of the important raw materials and improve its quality. Management can also look at the cost structure and estimate that whether the cost incurred is worth the existing quality or they should reduce the cost.

Orora – cost information can help the managers of the company in decision making in the following ways.

Budgetary decisions - A proper budget is very vital for success of any business organisation. Budget should be accurate and it is one of the most important decisions that the managers take. cost is one of the core segment of budgeting. Managers can take decisions regarding budget only if they know about the total costing. The managers of Orora can use the cost information to plan and estimate the budget. The cost information of one year will help in preparing budgets for the next year. Through the available cost information decision regarding allocation of more funds to a particular product can be taken.

Decisions regarding the products- cost information provides with all the significant data and expense of a product. It can be used for deciding whether producing a particular product is beneficiary or not. If cost of production of a product is more than the benefit then management can take decisions regarding bringing the production to halt. In the company if any particular paper product’s cost is more than the benefit gained than management can stop producing it. And the only way to identify that cost is more than benefit is through the use of cost information.

PART- B

The organisation which is chosen for the analysis is from the health care industry. The name of the company is RBTS (Regional Blood Transfusion Service). The company is responsible for collection of blood and provision in UK. They deal in manufacturing of clinical products, collecting and testing blood.

Question 1- Designing and implementation of the costing system

The idea of implementing activity based cost structure came into the mind of managers in the year 1993. They started designing the cost structure right after the idea. They wanted to design such a cost structure that makes the decision making process easier. The design paid focus on human resources and development of resources. The design even focused on improvements in frame works. One of the advantages of implementing Activity based cost structure is that it does not requires any government intervention. The designing was done in four phases. The first phase included identification of activities, second phase included definition regarding each cost, third phase included identification of drivers of activity and the last phase included selection of final activities which will be included in the cost structure. The idea was further taken to all higher level of managers in 1996. In this year the cost system was applied to only sub parts of the organisation and it was not that much popular. All the activities regarding the implementation was carried by a member who was not a part of the organisation but was a consultant. The implementation of Activity based cost structure started with the advice of an ABC expert in the organisation. He guided about the advantages of using ABC system in the organisation. The first attempt which was taken to implement ABC was not formal and was not specified in any project. However in the second stage it was formalised in a project but was confined to few people as the top level executives and managers did not provide enough funds. Dividing and designing of the phase was easy but its implementation was very difficult. The division is to be made on the basis of activities and it is a difficult task to identify all the activities in the organisation among which the cost will be divided. The main motive for implementing Activity based costing was to build a routine system in RBTS. In the year 2000 there was successful implementation of ABC in RBTS. By this year each and every member of the organisation knew about the implementation of Activity based costing in the organisation. The technical elements were not included in the activity based costing method of RBTS. It focused on behavioural issues. This issue was not new to the external consultant as they are already dealt with such cases before. All total this was the way activity based costing was implemented in the company.

Question 2 – satisfaction of feature

RBTS satisfies all the features which are discussed in part A. RBTS have implemented ABC system very effectively. The discussed features which RBTS has met are stated below.

RBTS costing system differentiates between manufacturing cost, overhead cost and indirect costs which are one of the important features of Activity based cost. The RBTS costing method meets all the requirements and features of ABC costing method. There is a differentiation to ensure that quality is maintained. RBTS costing system provides a better understanding of cost. It gives a detailed explanation regarding manufacturing cost and product cost. Another important feature of Activity based costing in RBTS is that it divides cost into a segment of pool. Each pool contains similar kind of costs. An appropriate method is used to measure the overhead of each and every activity, product and service. The cost of any product is decided according to the resources, time and events related to the product which is one of the important feature of ABC. RBTS system first sets cost for different activities and then assigns them to different products. It gives a brief estimate about the amount of resources used by each activity as expenses are directly related to resources used. ABC costing method under RBTS segregates between different costs and its behaviour. Under RBTS costing method the total costing is differentiated and divided into various segments like variable costs and fixed costs. ABC costing method has all the features of a common Activity based costing. One of the important features of ABC costing is that it is designed in phases. The designing was mainly done in four phases. The first phase included identification of activities, second phase included definition regarding each cost, third phase included identification of drivers of activity and the last phase included selection of final activities which will be included in the cost structure. The implication was also done in phases.  The first stage of implementation was done in 1996. In this year the cost system was applied to only sub parts of the organisation and it was not that much popular. The full and second implementation was done in the year 2000. By this year each and every member of the organisation knew about the implementation of Activity based costing in the organisation. ABC costing method faces a lot of challenges. Same was the case in RBTS. Activity based costing requires a different type of software. The employees faced a lot of difficulties to upload data. To tackle this challenge the management provided training to the employees for using the software.

Question 3 – usefulness of the cost information

Cost information is useful to both external as well as internal users. The focus here is on the usefulness of cost information to the internal users of the company. Internal users generally consist of management, employees, owners, etc. The basic areas in which RBTS uses the cost information is to evaluate their stock, make decisions, measure performance and motivate the employees. There was a lot of debate in previous years of implementation of activity based costing in RBTS. There are a lot of sub units in the company which makes use of the information complex. Managers in the company use the information provided by activity based costing as soon as they are available. There is no waiting period to use the information. The managers at the operating level consider that the information is very significant for to evaluate the cost of production and manufacturing of various clinical products. Business managers also have the same view. They considered it important because earlier this information was not available and they faced a lot of difficulties. As it is a public sector organisation, activity based costing was not adopted earlier mainly because of two reasons. One is that they focus more on providing services and products to the people rather than being concerned about cost and other is that they mainly depend on the fund provided by the government because of which they do not worry about financial matters that much. The managers use the information provided by ABC for decision making. They use the information to stop the production of goods which were almost identical to each other. This reduced the cost significantly. They even take important decisions to increase profitability and increase the brand value of the company. Managers use this information to control quality.

Question 4 – practical use of ABC

This study was very useful to understand the practical use of the chosen costing system and provided with a lot of lessons that can be suggested to the organisations. The two major lessons that can be informed to the contemporary organisation about the practical use of Activity based costing is mentioned below.

Effective management – ABC improves the efficiency of the managers in the organisation. With availability of all information regarding the costs, managers can take decisions very easily. It helps the managers to value the brand value of the organisation. They can easily differentiate between the products which are contributing to profit and which are not. Managers should use the information provided by activity based costing as soon as they are available. There should not be any waiting period to use the information. The managers at the operating level consider that the information is very significant for to evaluate the cost of production and manufacturing. Business managers also have the same view.

Decisions regarding the product and manager quality – Activity based costing system can be used in the organisations to take decisions regarding which product should be continued in the organisation and which should not. This decision can be taken on the basis of profitability of the products. Even the costing system can be used to take decisions to improve the quality of product by allocating more funds to particular product if possible.

Conclusion

ABC costing system differentiates between manufacturing cost, overhead cost and indirect costs. It gives a detailed explanation regarding manufacturing cost and product cost. Orica and Orora are the two Australian companies for which Activity based costing is suitable. In Orora and Orica cost information can help the managers of the company in decision making process. RBTS satisfies all the features of activity based costing. RBTS have implemented ABC system very effectively. RBTS costing system differentiates between manufacturing cost, overhead cost and indirect costs which are one of the important features of Activity based cost. The RBTS costing method meets all the requirements and features of ABC costing method. There is a differentiation to ensure that quality is maintained. RBTS costing system provides a better understanding of cost. There are various benefits of Activity based costing. It depends on the organisations to make the best use of it.

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