Absorption Costing In The Final Distribution Accounting Essay
Wilson Sporting Goods Co. previously known as Thomas E. Wilson Company is an American based sports equipment manufacturer headquartered in Chicago, Illinois, and currently operates as a foreign subsidiary of a Finland based company, Amer Sports. Wilson employs over 1,600 people globally and their sales network serves customers in more than 100 countries across the world. Wilson manufactures equipments and apparels for various sports, which mainly includes badminton, baseball, basketball, softball, football, golf, racquetball, soccer, squash, tennis, and volleyball. The company has three strategic business units, namely, Racquet Sports, Team Sports and Golf.
Wilson’s Mission is to produce sports and fitness products that enable everyone from the enthusiastic beginner to the professional athlete to achieve the best results and most enjoyment from their sports.
As Wilson is the market leader sports Equipment Company in the world, so, their objective is to further build up their position through a consumer-focused product strategy, strong brands, innovative research and product development, first-class customer service, and an efficient supply chain. Their strategy is based on sports, leisure-time activities and well-being. Rising standards of living, the greater leisure-time people now enjoy, and growing awareness of the importance of physical and mental health open up future growth potential for the sports equipment industry. In addition to profitable organic growth, Wilson is focused on finding and effectively harnessing synergy benefits as well as cooperation within their group (Wilson Sporting Goods Co. Website, About the Wilson, 2009).
At the heart of sports history for almost a century, no other company has been as dominant and thoroughly involved in shaping the competitions of racquet sports and team sports as Wilson (Wilson Official Website, About the Wilson, 2009).
For this case study, Cost Assignment financial model have been taken into account to analyze the significance of the reflection of expenses on the profits of an organization. Wilson’s Racquet Manufacturing strategic business unit will be for costing and for the analysis purpose all the numerical figures used are based on assumptions.
Costing in terms of finance are the processes that determines the actual or budgeted costs of production or services by determining the costs, classifying, recording and by the proper allocation of the overheads. These overheads are classified into the Allocation, Apportionment, Reapportionment and Absorption. Allocation is where the overhead cost items are charged to a specific cost centre without sharing the expenses with the other cost centers, whereas, Apportionment takes place when the overhead is shared between two or more cost centers. The Allocation and Apportionment of overheads to the cost centre comes under the Primary Distribution.
The re-apportionment of the overheads occurs when the Service Cost Centre (SCC) overheads are charged to the Production Cost Centre (PCC) and this is always in a ratio to the extent of service provided. The re-apportionment of the overheads from SCC to PCC comes under the Secondary Distribution. The reapportionment has four methods which are ignore interservice, elimination method, repeated distribution, and simultaneous equation. Finally, Absorption is the item used when overheads are charged into cost units from the PCC. The Absorption of the overheads comes under the Final Distribution. There are six methods for overhead absorption rate which machine hour rate, labor hour rate, material cost, direct labor cost, prime cost, and unit method.
The series of Primary, Secondary and Final distributions will further be taken in to account for analyzing the classification of the overheads in the Wilson Sporting Goods Co. Squash Racquet manufacturing unit. Before analyzing the distributions, it is significant to mention here the six main PCC and three SCC in the manufacturing of the Squash Racquets that are the Forming of the Frame, Drilling and Sanding, Tempering, Stringing, Finishing and Packing. The SCC includes the Advertizing, Cleaning and Canteen.
In Forming the Frame the raw material is first melted and then forced through a die in the shape of the racquet frame, once the shape is formed the racquet is then ready for the Drilling and Sand Process. In the process the holes are drilled on the head of the racquet and after drilling, the frames are then placed in a Sander to smoothen the sharp edges left from the drilling process. The next process is Tempering, this is actually done to give an extra strength to the racquet, in which the aluminum frames are heated in the oven at high temperatures and then immersed in water. After this the frames are put on the Stringing machines to put the strings across the drilled holes and then the racquets are ready for Wilson’s logo imprinting and finally Squash Racquets are ready for Packing in covers and plastic wrappers.
Under the primary distribution the overheads are allocated and apportioned to the cost centers. Wilson’s Squash Racquet Overhead allocation and apportionment Analysis Sheet in Appendix B clearly identifies that how the overheads are allotted to the whole item of cost to cost centers which is called the cost allocation and the cost allocation among cost centers are done directly, in Appendix B the Supervisory Salaries are Directly Allocated among the Cost Centers, both PCC and SCC. Whereas, in the Appendix B the overheads are apportioned on the appropriate basis of Direct Wages, Number of employees, Floor Area, Number of Machine set-ups and Machinery Operating Hours and proportionately allotted overheads over the production and service cost centers, this is done on the basis of apportionment. Refer Appendix A and Appendix B for Allocation and Apportionment Calculations.
In the secondary distribution the costs of Wilson’s Racquet Manufacturing service cost centers is reapportioned to the production cost centers. This reapportionment of SCC to PCC is performed with the basis of ignore interservice method. Under this method the costs of SCC are directly apportioned to PCC. In Appendix B under Secondary distribution the SCC are reapportioned to PCC by taking into account the appropriate proportions for each of the PCC.
Secondary distribution is helpful because it assists in determining the product costs and the value of the stock and it is helpful in setting up a selling price of a unit which is productive to the concerned parties.
Absorption occurs when the overheads are charged into cost units from the PCC. Overhead becomes of greater importance when unlike products are made which require different production processes using identical facilities but occupy the facilities for different span of time.
To find out the overhead to be absorbed by a cost unit, it is necessary to set up an overhead absorption rate (OAR) which is calculated by using two factors; the overheads attributable to a given cost centre and number of units of the absorption base (labour hours, machine hours, etc) as shown in Appendix C Working 4. The aim of the overhead absorption process is to take in the total cost of product an appropriate share of the firm’s total overheads. But the main focus is on the Marginal Costing and Absorption Costing in the Final Distribution.
Marginal and Absorption Costing
Marginal Costing is a principle whereby variable costs are changed to cost units and the fixed cost attributable to the relevant period is written off in full against the contribution of the period. Whereas, the absorption costing is a principle whereby fixed as well as variable costs are allotted to cost units and total overheads are absorbed according to activity level.
Both of the methods are used for Wilson Sporting Goods Co. Racquet Manufacturing division, in order to compare profitability differences. Refer Appendix D for the calculations of marginal and absorption costing. Net Profit for the months of April, May and June using the Marginal and Absorption Costing Methods are as follow:
It is clear from the table above that when using the Marginal Costing method the profit margins increasing steadily throughout these three months and is higher than the profit margins that are calculated using the absorption costing method and the profit margins decreased in May as compared to the profit in April.
The variation between the profit figures calculated under absorption and marginal costing methods is caused by the treatment of fixed production overheads. In marginal costing the Full amount of fixed production overheads is written off in the period that it occurs. In absorption part of the fixed production overheads is carried between accounting periods as part of inventory valuations.
Strengths and Weaknesses
Marginal cost systems are simple to operate and do not involve the problems of overhead apportionments. Change in profits is easier to explain because they result from cost-volume interactions and not from changes in inventory. Marginal costing give emphasis to the contribution made by sales to fixed cost recovery and profit and clarifies decision making in many key areas of management accounting where volume and product mix and pricing consideration are important. The main weaknesses of marginal costing are that closing inventory is not valued in accordance with SSAP 9 principles and that fixed production overheads are not “shared” out between unit production, but written off in full instead.
The main strengths of Absorption costing are that the fixed costs are a substantial and increasing proportion of costs in modern industries. Production cannot be achieved without incurring fixed costs which thus form an inescapable part of the cost of production and analyzing under/(over) absorption of overhead is a useful exercise in controlling costs of an organization.
The main weaknesses of Absorption Costing are that it is not effective in helping management control costs. The managers responsible for pricing decisions will not be able to see if a particular price will cover the products directly attributable cost and produce a contribution towards other production costs and the general overheads.
Wilson should follow Marginal costing as this costing approach as it is based on the idea that only variable production costs are production cost and this will be of great help producing the information for decision making. It also helps Wilson Sporting Goods Company’s Squash Racquet manufacturing division for their cost-volume-profit analysis, as it will exhibit the association between cost and volume and, thus, the effect on profit of change in volume.
It figures out whether or not, in an extremely competitive situation, it may well be wise to take an order which covers marginal costs and makes some contribution towards fixed costs, rather than lose the order and contribution by insisting upon a price above full cost.
Concluding the case in accordance to the profit statement using the marginal costing that determined the impact of the fixed cost incurred on Wilson’s Racquet Manufacturing Strategic Business Unit profit margins for three months. It figures out whether or not, in an extremely competitive situation, it may well be wise to take an order which covers marginal costs and makes some contribution towards fixed costs, rather than lose the order and contribution by insisting upon a price above full cost. Finally Wilson can control the manufacturing overheads by use of standard costing method. Here, the actual overheads should be compared with the standard overheads and the variations, if any, should be analyzed and reported to the management for taking appropriate actions.
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