Activity Based Costing and Manufacturing Mix Report
March 25, 2015
1. Recommend whether the company should change its costing method to activity-based costing. Activity Based Costing (ABC) is an accounting methodology which assigns manufacturing costs in a more logical manner by taking into account not only the production costs in terms of machine time and labor but the additional and often hidden costs associated with production. These hidden costs if not properly allocated distort the actual costs of production. The hidden costs which include, engineering, machine setups and quality control are incurred within specific models during the manufacturing process often are not properly assigned to the specific product line. As the product mix expands the value of ABC becomes more evident and its effects more pronounced as each additional product line is added to the production mix. With our expansion into a titanium line and the resulting diversification of production an examination of the effects and benefits of ABC is warranted. Below are the results of our examination of manufacturing overhead costs including the hidden costs associated with each specific product, and the actual costs of production which the application of activity based costing principles discovered. Failing to adopt ABC could result in lower than expected profitability based on the misidentification of costs within manufacturing overhead and therefore a misallocated unit cost.
The following is based on the anticipated production mix of 900 Carbon Light Units and 500 Titanium Units 1. Carbon Light, Manufacturing Overhead, (900 units)
Traditional Costing $232,380 versus the (ABC) costing of $471,400
DM and DL remain unchanged with ABC methodology, $ 335,000 and $112,000 respectively.
The resulting cost variance per unit of Carbon Lite production at (900 units) is +$101.00. The $101 variance per unit was determined using the ABC methodology resulted in the following reallocations to manufacturing overhead costs associated with the Carbon Lite model.
Total (ABC) versus Traditional
$282,986 (ABC) versus $232,380 current
The reallocation of costs via ABC assigned a total of $282,986 to the Carbon Lite production versus the traditional cost method which assigned $232,380 or $50,606. The ABC methodology revealed a true unit cost of $ 1460.00 versus the projected and budgeted costs of $1359 utilizing the traditional approach. The traditional approach misallocates costs to the tune of $56.23 per unit ($50,606/900). While not fatal this misallocation of costs and failure to identify the true costs of production undermines our capacity to calculate the ideal production mix and therefore undermines our efficiency and profitability. The misallocation also creates an overestimation of the costs associated with the new Titanium Model (see below).
2. Titanium (500 units) current manufacturing overhead $239,020 versus ABC $ 188,415 the $50,605 misallocation distorts the true costs of the titanium model ($50,605/500 units or $101 per unit). ABC reveals actual costs per unit to be $656 versus the current $713 the variance derived from the actual manufacturing overhead costs per unit of $376.82 utilizing ABC versus the current of $464.04. Net result, under the traditional or current approach to costing we are underestimating the costs of Carbon Lite production and overestimating the costs of the titanium models. Utilizing ABC we can correctly identify the true cost drivers and properly assign he costs to the correct product line. By properly identifying and assigning manufacturing costs to the specific model we can estimate the ideal product mix for both maximum efficiency and properly price our products to increase their