Allocating Fixed Costs.

Allocating Fixed Costs.

Introduction

Activity based accounting is a process that involves the application of costs to the actual

activities that cause them. The components are;

Identification of the actual activities that cause the overhead costs to be incurred. These involves

use of the concept of cost drivers which are defined as the activities which cause the costs

instead of the costs themselves. A distinction can be made among the processes that add value

and those that do not add value, the ones that do not should be removed and awarded to the

valuable sections. (Staubus, 1971)

ABC helps to distinguish and separates the fixed cost, variable cost and the overhead.

These split and separation of cost assists in identification of the cost drivers. Direct labor and the

relevant materials are mostly easy to identify and trace directly to the products. Where the

products use common or similar resources differently, then weighing may be necessary.

The cost driver is the main factor that establishes or drives the cost of each activity that has been identified. For instance, the activity cost of bank tellers can be related and associated with each product by  taking the measurements of how long each transaction of particular products take (cost driver) at the counter.  For the activity of operating machinery, the driver will be machine operating hours. That’s the machine operating hours will also drive labor, maintenance and the overall power cost during the machine’s operations and running activity. (Drucker, 1999)

Adjustment of the accounting system so as to allow costs to be collected by each activity instead of the cost system and identification of the factors that cause each and every activity’s cost to change. The allocation of short term variable cost using the volume associated cost drivers like the direct labor hours, total machine hours, or direct material cost. Items like electricity would be allocated and driven by machine hours and later apportioned in accordance to the variability of the drivers. In the same way some items may differ with the value of the materials used or with direct labor hours.

In terms of the additional support functions, it’s the nature of the transactions taken by the support section which are related to the relevant cost drivers. For instance, the number of purchase orders drives the purchases department. Similarly, the number of the total production runs undertaken in a particular department drives several other costs such as inspection or the production costs scheduled.  (Elmurugan, 2010)
Herrestad Company does produce and sell two products and the details below will be used to prepare a segmented Income statement (showing the income for each product and the total) for the company. Use ABC to allocate all fixed costs to the two products.

Herrestad Company
Segmented Income Statement For the period Ending 31st Dec 2011
Total	product A	product B
Sales	2040000	960000	1080000
less variable dire m		800000	560000	240000
variable direct labor		480000	120000	360000
Variable o/h		200000	80000	120000
Variable selling Exp		80000	26000	54000
contribution margin		480000	174000	306000
Less fixed manu		200000	130000	70000
Less fixed sell exp		100000	60000	40000
Segmented Margin		180000	-16000	196000
Less common fixed ex			0	0
Net income(loss/profit)			-16000	196000

The total net income is   180000

The variable cost per unit of direct labor for Herrestad Company is $60 for both product A and B. The total production for product A is 2000 units, the total direct labor cost is for product A is therefore $120000 and for product B is 6000 units multiplied by $60 which totals to $360000 hence the totals for the whole company for both products is $480000.Variable overheads cost per unit for product A and B is $40 and $20 respectively. The total overhead costs for product A are $80000 and $120000 for product B which totals to $200000 for the company and giving an average of $25 per unit cost. The variable selling and administration expenses per unit for product A and B are $13 and $9 respectively. The total variable selling and administration expenses for product A is $26000 and $54000 for product B which gives a total of $80000 for the company with an average of $10 per unit.

The fixed manufacturing overheads totals to $200000 and have been apportioned on the basis of the production runs which are in the ratio 65:35 for product A and B respectively. For product A, the fixed manufacturing O/H equals to 65/100 * $200000 = $130000 and for product B is 35/100* 200000 = $70000, which gives an average per unit of $100 for the company and totals to $200000 for the company. While the fixed Selling and administrative costs are $100000 for the company. Basing the apportionment on the basis of the number of sales representative equals to 15/25*100000 = $60000 for product A and 10/25*100000 = $400000. (Garrison, Noreen, Brewer, 2009)

The segmented margin for product A is a deficit of $16000 while for product B is a surplus of $196000.The net income for product A is a loss of $16000 while for product B is a profit of $196000. The net income for both products for the company is $180000.

The segmented income statement emphasizes on the segment instead of the general performance of the company and it’s used to evaluate the performance of the segments. The products performances of Herrestad Company are above average. Product A should be discontinued or subjected to some measures that will improve its performance from a negative or deficit of $16000 to a profitable margin. (Hermanson, Edwards & Invacevich, 2011)  The other product i.e. product B should be encouraged as it’s profitable and had a net income of $196000.

The segmented margin is calculated by deducting traceable costs which are fixed from the contribution margin. It usually represents the balance or the margin that’s available after the segment all its costs. Segmented margin is normally the best measure for the long run profitability of a particular segment as it includes all the costs that are attributed to that segment. A segment that can’t cover its own expenses should not in any be maintained. The contribution margin is important when making decisions that are related to the short run changes in its volume i.e. pricing orders that are special and which involve the utilization of the current or the existing capacity.

The impact of Activity based accounting has been felt mostly in management accounting. The identification and allocation of costs with the activities that cause them is clear and the cause and effect contributes to the management control. The identified cost drivers can be used as a cost measure and also as a performance measure. The identification and determination of costs from cost drivers is of great assistance to forecasting income and making budgets within each support department. The existence of cost driver rates can be used and implemented as an input into the design of all the new products and eventually modification of existing ones

References

Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.

Drucker, F. (1999) Management Challenges of the 21st Century. New York: Harper Business.

Garrison, H., Noreen, E., Brewer, C., (2009) Managerial Accounting. McGraw-Hill Irwin.

Elmurugan, M. (2010) The Success and Failure of Activity-Based Costing Systems. Journal of Performance Management. 23.2 3-33. Business Source Complete. 15 Mar
Staubus, J. (1971) Activity Costing and Input-Output Accounting. Richard D. Irwin, Inc.

 

 

Last Completed Projects

Are you looking for a similar paper or any other quality academic essay? Then look no further. Our research paper writing service is what you require. Our team of experienced writers is on standby to deliver to you an original paper as per your specified instructions with zero plagiarism guaranteed. This is the perfect way you can prepare your own unique academic paper and score the grades you deserve.

Use the order calculator below and get started! Contact our live support team for any assistance or inquiry.

[order_calculator]