Introduction

There are a few options for S.B. Ltd to consider getting through difficult times. The five main options are firstly, to discontinue the Nottingham division and Leicester and Loughborough divisions could use their spare capacity to produce 60% of Nottingham’s 2010 output in addition to their own 2010 output, close the Nottingham division and outsource Nottingham’s 2010 output, to launch a major campaign for all 3 products to increase their sales, to introduce a transfer pricing system between the division and the head office to increase motivation among the staff in each division and rightsizing the organisation.

Discontinuation

As seen Nottingham is not making growth, in response to market forces, the first option is to discontinue Nottingham division by selling its assets and settling its liabilities and shifting production from Nottingham to Leicester and Loughborough. The discontinuation decision is a decision when the division profitability highlights the potential of unprofitable (Drury, 2010, pp.91-92). In this option, assuming that Leicester and Loughborough have some spare capacity to produce 60% of Nottingham’s 2010 output on top of their own 2010 output. According to Drury (2010, p.92), discontinuing the Nottingham division could aid the company in eliminating cost of goods sold, and other variable costs in the division.

Leicester

Loughborough

Derby

Sales - Strawberry jam

280.00

Sales - Orange Marmalade

240.00

Sales - Raspberry jam (60%)

96.00

Total Sales

616.00

Cost of goods produced and sold

173.00

153.00

326.00

Gross Profit

290.00

Advertising costs

30.00

Distribution costs

50.00

Local administration expenses

30.00

30.00

60.00

Head Office Costs

150.00

Net Profit

-

Other cost such as advertising costs, distribution costs and Head Office costs remain unchanged and is not affected by the discontinuation of the Nottingham division. O’Hare (2010, Management Accounting Lecture 3) suggested other factors which will affect an organisation to discontinue a division, the division is making a loss, to identify avoidable costs or to discover other saving.

Outsourcing

Outsourcing option is also known as sub-contracting option has become increasingly common in organisations, which enables organisations to concentrate on their core performance while outsource other specialist their secondary activities (Collier et al, 2007, pp.220-221). In S.B. Ltd case, according to Oxford University Press (2009), outsourcing could help to get through this hard time by going on a process of business process downsizing. Outsourcing allows operations that have seasonal demands to bring in additional resources in time of needs. Other advantages of outsourcing are, outsource activities will allow S.B. Ltd to focus on important functions without sacrificing quality or service, outsource specialist could help improve the quality and standard of the jam. It may also be able to purchase the jam more cheaply or perhaps more quickly.

Assuming the outsource price for raspberry jam is 20% more then the cost of goods produced and sold for raspberry jam. Hence, the sales of raspberry jam remains the same and Leicester division and Loughborough division have spare capacity which gives them room for expansion of 30% more sales each. All other expenses remain the same for both Leicester and Loughborough divisions. This gives the Head Office a net profit of £76,000

Leicester

Loughborough

Derby

Sales - Strawberry jam

364.00

Sales - Orange Marmalade

312.00

Sales - Raspberry jam (Outsource)

160.00

Total Sales

836.00

Cost of goods produced and sold

182.00

156.00

338.00

Outsource price

132.00

Gross Profit

366.00

Advertising costs

30.00

Distribution costs

50.00

Local administration expenses

30.00

30.00

60.00

Head Office Costs

150.00

Net Loss

76.00

On contrary to the advantages, outsourcing the jam to some specialist could lead to risk of unsatisfactory quality and standard of the jam. Other disadvantages could be leak of procedures and techniques of making the jam, outsourcing usually focuses on short-term cost-saving, and ignores the unchanged overhead burden.

Major Campaign

Another option is to launch a major advertising campaign for all three products to increase their sales and keep all three divisions. Advertising could boost awareness and generate demand of the sales of jams of S.B. Ltd. and hence acquiring more orders.

In the advertising campaign, assuming the advertising cost increase by 20% and it bring the sales of each product to an increase of 20% each. It simply boost up the profit of the company to £96,000.

Leicester

Nottingham

Loughborough

Derby

Sales - Strawberry jam

336.00

Sales - Raspberry jam

192.00

Sales - Orange Marmalade

288.00

Total Sales

816.00

Cost of goods produced and sold

140.00

110.00

120.00

370.00

Gross Profit

446.00

Advertising costs

90.00

Distribution costs

50.00

Local administration expenses

30.00

30.00

30.00

90.00

Head Office Costs

150.00

Net Profit

66.00

Transfer Pricing

The other option is when an organisation chooses to decentralise its divisions, transfer pricing helps decide what price to charge for in-company transactions (Collier et al, 2007, p.38-39) and as a form of promoting divisional autonomy (O’Hare, 2010, Management Accounting Lecture 8). It is useful when goods are transferred between divisions; hence, the performance measurement of each division is not prejudiced by the corporate objectives. The profitability of each business units will be affected and according to Solomon (1965 cited in Collier et al, 2007, pp.38-39), companies might take advantage of the transfer pricing which are suitable for evaluating divisional performance for the corporate interest, instead of the business units. Transfer pricing strategies and can produce substantial tax savings in addition to enhancing operational performance and improving cash flow. In many organisations, in order to avoid de-motivating effects on different business units, negotiated prices are adopted.

Say, each product is transferred to Derby division and it pays each division 70% of the sales it made from selling all the jams and yet still bare the cost of advertising, distribution and the head office costs. The local administrative expenses shall be bare by the respective divisions.

Leicester

Nottingham

Loughborough

Derby

Sales - Strawberry jam

280.00

Sales - Raspberry jam

160.00

Sales - Orange Marmalade

240.00

Total Sales

680.00

Transfer price revenues

196.00

112.00

168.00

Cost of goods produced and sold

140.00

110.00

120.00

Gross Profit

56.00

2.00

48.00

680.00

Total cost of transfer

476.00

Advertising costs

30.00

Distribution costs

50.00

Local administration expenses

30.00

30.00

30.00

Head Office Costs

150.00

Net Profit

26.00

(28.00)

18.00

(26.00)

There are downsides of transfer pricing. The political process in an organisation might affect the transfer pricing between divisions. Incorrect prices adopted can distort reported performance, by making some divisions more profitable at others expense. Opportunities exist to avoid taxes using artificial transfer prices to transfer profits from a high tax division to a low tax division.

Rightsizing

Rightsizing, or corporate restructuring, with the aim of reducing costs and improving efficiency and effectiveness is also one option in difficult times. Rightsizing is downsizing in the belief that an organisation really should operate with fewer personnel. The primary reason to engage in rightsizing is to make the daily operations of a business more productive. For example, a company may be able to replace assembly line employees with machines which will be quicker and less prone to error. In addition, rightsizing increases profits by reducing the overall overheads of a business.

S.B. Ltd operates a full cost (TAC) standard costing system. The standard costs set fot the year 31 March 2010 and information about future costs and selling prices are in Appendix 2.

Part 2 (700)

Assuming the company decided to go for the option of keeping all divisions open and launching an advertising campaign, you are required to produce a standard cost card for each product and a budget for the company showing clearly the costs attributable to each division for the year to 31 March 2011. State clearly all assumptions made.

Appendix 2 - Standard cost data

Standard cost cards for the year ended 31 March 2010 (per batch of 40 jars each of 500 grams)

Strawberry Jam

Raspberry Jam

Marmalade

£

£

£

Selling price

28

32

40

Fruit

16kg

4.8

16kg

5.6

24kg

4.8

Sugar

8kg

1.6

8kg

1.6

12kg

2.4

Labour

1 hour

6

1 hour

6

2 hours

12

Other variable costs

1

2

2

Fixed overheads

1 hour

2

1 hour

2

2 hours

4

15.4

17.2

25.2

Profit

12.6

14.8

14.8

Other information

Demand

With the right promotion the company believe that they could sell 20%

more of each product at the 2010 standard selling price

Material wastage

It is considered that improvements can be made but input weight will

always be at least 10% more than output weight for jam and 50% for

marmalade

Labour

Currently operates at 80% efficiency levels

Prices

Strawberries are sourced from the UK and prices are expected to rise by

2-5%

Raspberries are sourced from the UK and prices could rise by up to 15%

due to poor weather

Oranges are imported and paid for in euros euro prices are expected to

be as 2010

Discounts on all fruit can be negotiated if quantities increase

Labour rates per hour have been the same for the last 2 years

Variable costs may rise by up to 5 %

Fixed overheads may rise by between 5 and 10%

Standard Cost Card

A standard cost card can be defined as ‘a detailed listing of the standard amounts of materials, labour and overheads that should go into a unit of product, multiplied by the standard price or rate that has been set for each elements’ (Anon 2, 2010). A standard cost card, for example must include the price, specifications, quantity and quality of material required, as well as such factors as the period of credit allowed from suppliers, cash and quantity discounts, spoilage due to wastage and deterioration. A standard cost card demands an investigation of all contributing factors that can constitute a cost before the cost is adopted. According to Drury (2010, p.278), standard costs are ‘predetermined costs’ and they are the target costs that should be incurred under efficient operating conditions. The standard cost card will be subjected to updating caused by revision of standards such as changes in prices, discounts, etc.

Standard costing is a control system which sets standards that are ideal, expected and achievable (O’Hare, 2010, Management Accounting Lecture). Collier (2007, p.36) put forward that standard costing is a control technique which compares standard cost and all of production revenues with actual results. It is to obtain variances of each division and product (O’Hare, 2010, Management Accounting Lecture 8), which are used to stimulate improved performance and to increase motivation of staff in each division. It is a detective control used to prevent problems from reoccurring as it measures variances as it occur, thus allowing management to take necessary corrective action.

The standard cost card for the year ended 31 March 2011 (per batch of 40 jars each 500 grams) for Strawberry Jam, Raspberry Jam and Orange Marmalade are as below:

Strawberry Jam

£

£

Selling price

28.00

Fruit

16/kg

0.31

4.90

Sugar

8/kg

0.20

1.60

Labour

1 hour

6.00

6.00

Other Variable Cost

1.50

Fixed Overheads

1 hour

2.10

2.10

15.65

Profit

12.35

Raspberry Jam

£

£

Selling price

32.00

Fruit

16/kg

0.40

6.44

Sugar

8/kg

0.20

1.60

Labour

1 hour

6.00

6.00

Other Variable Cost

2.10

Fixed Overheads

1 hour

2.10

2.10

18.24

Profit

13.76

Orange Marmalade

£

£

Selling price

40.00

Fruit

24/kg

0.20

4.80

Sugar

12/kg

0.20

2.40

Labour

2 hours

6.00

12.00

Other Variable Cost

2.10

Fixed Overheads

1hour

2.10

2.10

23.40

Profit

16.60

Budget

The principal tool in planning is called ‘a budget’. A budget is a collection of predictions. It is an estimation of the revenue and expenses over a specified future period of time. There are three purposes of budgets as identified by Emmanuel et al (1990 cited in Collier, 2007, pp.39-40), ‘as forecasts of future events’, ‘as motivational targets’ and ‘as standards for performance evaluation’. Budget is a financial plan or qualitative statement for implementing the various decisions to be pursued during a specific accounting period, that management has made in the previous period.

Collier (2007, pp.39-42) suggest that budgets provide a control mechanism through both the feed forward and feedback loops. The control mechanism in the budget is to provide a performance monitoring function to the appropriate managers who are responsible for implementing the various decisions by producing and presenting the performance reports. According to Drury (2010, pp.8-9), the performance report provide feedback information by comparing planned and actual results.

Generally, a functional budget is drawn up for each division of S.B. Ltd. These budgets are, then, merged together into a single combined statement, which is known as the master budget, of S.B. Ltd’s expectations for the future periods. The master budget consists of budgeted profit, which it is expected to convey to everyone in the organisation the part that they are expected to achieve in implementing management’s decisions. The master budget, usually, consists of a budgeted profit and loss, a budgeted balance sheet and a budgeted cash-flow statement. In order to finalised a budgeted profit and loss, other budgets for the individual divisions and produced, such as the sales budget, direct materials usage budget, direct materials purchase budget, direct labour budget, and selling and administration budget.

Master Budget

Budgeted Profit and Loss Account for the year ending 31 March 2011

£

£

Forecast sales (Schedule 1)

816,000

Purchases (Schedule 3)

Materials - Fruit

130,272

Materials - Sugar

46,080

Cost of raw materials consumed

176,352

Direct Labour (Schedule 4)

155,520

Factory Overheads (Schedule 5)

68,040

Cost of Sales

399,912

Gross Profit

416,088

Selling and administration expenses (S6)

350,000

Variable Costs (Schedule 7)

40,320

Budgeted operating profit for the year

25,768

Schedule 1 - Sales Budget for year ending 31 March 2011

Product

Batches Sold

Selling Price

Total Revenue

Strawberry Jam

12,000

28.00

336,000.00

Raspberry Jam

6,000

32.00

192,000.00

Orange Marmalade

7,200

40.00

288,000.00

816,000.00

Schedule 2 - Annual Direct Material Usage Budget

Leicester

Nottingham

Loughborough

Total Units

Strawberry

192,000

192,000

Raspberry

96,000

96,000

Orange

172,800

172,800

Sugar

96,000

48,000

86,400

230,400

288,000

144,000

259,200

Schedule 3 - Direct Materials Purchase Budget

Strawberry

Raspberry

Orange

Sugar

(units)

(units)

(units)

(units)

Quantity necessary to meet production

192,000

96,000

172,800

230,400

requirements as per material usage budget

Planned unit purchase price

0.31

0.39

0.20

0.20

Total Purchases

58,752.00

36,960.00

34,560.00

46,080.00

Schedule 4 - Annual Direct Labour Budget

Leicester

Nottingham

Loughborough

Total

Budgeted production (units)

12,000

6,000

7,200

Hours per unit

0.80

0.80

1.60

Total budgeted hours

9,600

4,800

11,520

25,920

Budgeted wage rate per hour (£)

6.00

6.00

6.00

Total Wages (£)

57,600

28,800

69,120

155,520

Schedule 5 - Annual Fixed Overheads

Leicester

Nottingham

Loughborough

Total

Fixed Overheads hour

1

1

2

Fixed overheads rate

2.10

2.10

2.10

Fixed Overheads per batch

2.10

2.10

4.20

Total Fixed Overheads (£)

25,200.00

12,600.00

30,240.00

68,040.00

Schedule 6 - Annual Selling and Administration Budget

£

£

Selling:

Advertising Costs

60,000.00

Distribution Costs

50,000.00

110,000.00

Administration:

Local Administration Expenses

90,000.00

Head Office Costs

150,000.00

240,000.00

350,000.00

Schedule 7 - Annual Variable Cost Budget

Leicester

Nottingham

Loughborough

Other variable costs

1.00

2.00

2.00

Variable costs per batch

1.05

2.10

2.10

Total Variable Costs

12,600.00

12,600.00

15,120.00

40,320.00

It is now April 2011. The actual results for the year 31 March 2011 are in Appendix 3.

Part 3

You are required to:

(a) Produce an operating statement for each division based on your own budgets.

(b) Write a report to the board appraising the performance of each division using whichever indicators you feel are appropriate. You should also suggest what other information should be obtained in order to improve your appraisal.

(c) Write a report to the company management accountant on whether the company should change their traditional approach to accounting for overheads to one based on Activity Based Costing.

Appendix 3 S.B. Ltd - Trading results for the year ended 31 March 2011

Leicester

Nottingham

Loughborough

Derby

£'000s

£'000s

£'000s

£'000s

Sales - Strawberry Jam

11000 batch

330

Sales - Raspberry Jam

6250 batch

200

Sales - Marmalade

6000 batch

250

TOTAL SALES

780

Fruit

170000kg

53

100000kg

36

140000kg

30

Sugar

84000kg

21

48000kg

12

68000kg

17

Labour

10000 hours

70

6000 hours

39

6000 hours

39

Variable costs

12

10

13

Fixed Overheads

10000 hours

22

6000 hours

12

6000 hours

15

Cost of goods produced and sold

178

109

114

401

Gross Profit

379

Advertising costs

60

Distribution costs

60

Local administration expenses

32

32

32

90

Head Office Costs

155

NET PROFIT

14

Note

Sales = Production

(a) According to Anon 3 (2010) and Anon 4 (2010), an operating statement is a detailed periodic report of the financial reports or a financial statement of a firm’s operations. In many organisations, management rely on the financial and quantitative statement provided to record performance achieved by that area of the operation, for a selected budget period, for which the management is responsible (Oxford University Press, 2009). S.B. Ltd practices a decentralised control over its responsibility centres where Derby division is delegated as the controlling costs centre. Decentralisation means there is a delegation of authority in decision making in the organisation. According to CIMA Official Terminology (Collier, 2007, pp.13-14), the financial control in divisionalised businesses is the divisional performance control by producing a budget and the monitoring of actual performance towards the budget.

Each division management will carry out a significant function in analysing and interpreting financial information and will achieve the target given. Below is the operating statement for the individual division based on the budget prepared in part 2.

Operating Statement for S.B. Ltd

Description

Leicester

Nottingham

Loughborough

Derby

Sales - Strawberry Jam

336,000

336,000

Sales - Raspberry Jam

192,000

192,000

Sales - Marmalade

288,000

288,000

Total Sales

816,000

Cost of Sales

Purchases - Fruits

58,752

36,960

34,560

Purchases - Sugar

19,200

9,600

17,280

Labour

57,600

28,800

69,120

Variable Costs

12,600

12,600

15,120

Fixed Overheads

25,200

12,600

30,240

Cost of goods produced and sold

173,352

100,560

166,320

440,232

Gross Profit

162,648

91,440

121,680

375,768

Operating Expenses

Advertising costs

60,000

Distribution costs

50,000

Local administration expenses

30,000

30,000

30,000

90,000

Head office costs

150,000

30,000

30,000

30,000

350,000

Net Profit

132,648

61,440

91,680

25,768

Solomon (1965 cited in Collier, 2007, pp.13-14) highlighted three purposes for financial reporting at divisional level; to guide divisional managers and top management in decision making, and to enable top management to appraise the performance of divisional management.

(b) TO: The Directors of S.B. Ltd

From the earlier budget, the performances of all four divisions are appraised. The overall company’s performance as seen on Derby division operating statement seems to have achieved the budgeted gross profit. However, all the other costs, such as the advertising costs, distribution costs, local administration expenses and head office costs, influence the net profit not achieving the budgeted figure. The overall sales, although did not attain the budgeted sales, did make a good number and managed to produce the goods at a much lower price compared to the budgeted figure.

Operating Statement for Derby Division

Description

Current Period

Budgeted

Sales - Strawberry Jam

330,000

336,000

Sales - Raspberry Jam

200,000

192,000

Sales - Orange Marmalade

250,000

288,000

Total Sales

780,000

816,000

Cost of goods produced and sold

401,000

440,232

Gross Profit

379,000

375,768

Operating Expenses

Advertising costs

60,000

60,000

Distribution costs

60,000

50,000

Local administration expenses

90,000

90,000

Head office costs

155,000

150,000

365,000

350,000

Net Profit

14,000

25,768

The performance of Leicester division is seen not to be performing to the budgeted figures in the operating statement. The actual sales of the strawberry jam was just £6,000 less than thee budget and managed to pull off a noteworthy net profit, although not as expected as in the budget. According to ACCA (1988, p.54), preparing a set of costing will be a waste of time unless it has a purpose. Comparing the current period figures with the budgeted figures, in order to establish costs control and efficiency in the division and to prevent unnecessary use of services.

Operating Statement for Leicester Division

Description

Current Period

Budgeted

Sales

330,000

336,000

Cost of Sales

Purchases - Strawberries

53,000

58,752

Purchases - Sugar

21,000

19,200

Labour

70,000

57,600

Variable Costs

12,000

12,600

Fixed Overheads

22,000

25,200

Cost of goods produced and sold

178,000

173,352

Gross Profit

152,000

162,648

Operating Expenses

Local administration expenses

32,000

30,000

Net Profit

120,000

132,648

The actual sales of the raspberry show a positive comparison. However, the gross profit figure is slightly lower than the budgeted figure. Unfortunately the increase in local administration expenses razed the actual net profit figure. The cost of purchasing sugar was expected to be lower in the budget as well as the labour costs was projected to be lower. Auspiciously, the current period net profit has achieved a positive figure.

Operating Statement for Nottingham Division

Description

Current Period

Budgeted

Sales

200,000

192,000

Cost of Sales

Purchases - Raspberries

36,000

36,960

Purchases - Sugar

12,000

9,600

Labour

39,000

28,800

Variable Costs

10,000

12,600

Fixed Overheads

12,000

12,600

Cost of good produced and sold

109,000

100,560

Gross Profit

91,000

91,440

Operating Expenses

Local administration expenses

32,000

30,000

Net Profit

59,000

61,440

The Loughborough division, on the other hand, is making a good profit from the sales of marmalade. The sales of marmalade were projected to be higher; however, the current period gross profit and net profit are more than the budgeted figure mainly attributed to competitive purchase prices of oranges and sugar, low labour costs, low variable costs and low fixed overheads.

Operating Statement for Loughborough Division

Description

Current Period

Budgeted

Sales

250,000

288,000

Cost of Sales

Purchases - Oranges

30,000

34,560

Purchases - Sugar

17,000

17,280

Labour

39,000

69,120

Variable Costs

13,000

15,120

Fixed Overheads

15,000

30,240

Cost of good produced and sold

114,000

166,320

Gross Profit

136,000

121,680

Operating Expenses

Local administration expenses

32,000

30,000

Net Profit

104,000

91,680

(c) TO: The Management Accountant

Traditional Costing System

The traditional costing approaches were developed in the early 1900s and they are still widely used by organisations today. They rely broadly on arbitrary cost allocations. These approaches rely on an essentially arbitrary allocation of indirect costs. Such approaches do not give managers accurate product cost information; therefore, accurate production profitability calculation is not possible. The overhead rate in traditional costing approaches would typically by calculated using direct labour hours, machine hours or units. Consequently, this could lead to accurate product costs when direct costs were high and indirect costs were low.

According to Collier (2007, p.60), under the traditional costing approaches, organisation production runs to obtain the lowest unit of cost production and support the mass production model that seeks economies of scale. The overhead rates calculation to the traditional costing approaches is relatively straightforward; hence, they are widely understood in the business. Although, they are relatively cheap to operate and were seen as fairly accurate until the rise of activity-based costing in 1987, many other organisations are using them after many decades.

Traditional costing approach is a systematic costing approach that prevailed before the rise of the activity-based costing in 1987. Since then, the traditional costing approaches weaknesses were fairly visible. Their reliance on arbitrary rather than cause-and-effect allocation of overheads and their inability to produce accurate product costs in multiproduct companies were very much clearer. Their failure to analyse non-manufacturing costs made it less appropriate for modern costing approach in organisations.

Activity-based Costing

As proposed by Professor Johnson and Kaplan in their book Relevance Lost: The Rise and Fall of Management Accounting (1987 cited in Oxford University Press, 2009), they question the widespread misconception exists that using accounting information and the inadequacy of conventional approaches arises from a lag in replacing the modern cost accounting approach. The new approach is designed with modern information and accounting systems for financial reporting and tax purposes, hence it recognises that costs are incurred by each activity that takes place within the organisation and that products should bear costs according to the activities use.

In Professor Johnson and Kaplan’s method, the cost drivers are identified, together with the appropriate activity cost pools, which are used to charge costs to products. The fundamental of this approach is the view that the forces which drive overheads, undeniably most organisational costs arise from specific activities (Miller and Vollmann, 1985, p.144 cited in Ashton, 1991, pp.52-32). As a result, overheads control must focus on the management of these activities. The purpose of the activity-based costing approach are to stabilise unit costs of production per period and the reported gross profit per unit will be comparable from one period to the other by stabilising unit costs.

Comparison

In this time of rapid technological change, vigorous global and domestic competition, and enormously expanding information processing capabilities, management accounting systems are not providing useful, timely information for the process control, Johnson and Kaplan (1987, pp.144-146) suggested that the activity-based costing approach has catalysed an enthusiasm for motivating every member of the business organisation to meet profit goals. Also according to Johnson and Kaplan (1987, pp.144-146), present-day critics often note that successful Japanese and German manufacturing firms use this approach.

Both traditional costing and accounting-based costing vary in their level of sophistication (Drury, 2010, p.165). The traditional systems often tend to be simple and straightforward while activity-based costing tends to be sophisticated and more accurately assigning indirect costs to cost objects. Although the traditional accounting is simpler to prepare while the activity-based costing is highly sophisticated to prepare, the activity-based costing tend to result in lower costs of errors and high level of accuracy. The downside of activity-based costing is that it is expensive to operate and they are sophisticated. However, they minimise the costs of errors which will save the company a lot in profit in the longer run. The activity-based costing extensively use the cause-and-effect cost allocations compared to the traditional costing approached extensively use the arbitrary cost allocations.

Recommendation

ACCA (1988, p.171) recommended that the choice between the traditional costing approaches and activity-based costing approach in budgetary control depends on the method of accounting used in S.B. Ltd’s cost accounting system. If the operating expenses were charged to the respective divisions, it would reflect the use actually made by each division. Then, the overhead costs of the divisions will be established more accurately.

Traditional cost system often report inaccurate product costs and the company tend to lose out due to over priced products, incur hidden losses due to under priced products. The benefit of activity-based costing is that when it comes to improving productivity, it opens up for a much wider array of measures or methods. By examining the activities systematically, one will not only be able to identify surplus capacity if it occurs, but also lack of capacity and misallocation of capacity. A result of this might be that costs are cut the customary way, but might as well lead to a reallocation of capacity to where it is needed most which will yield better productivity.

The rapid pace of today’s technological change continues to shorten product life cycles, thus our company do not have the time to make cost adjustment once errors are detected. Today computer technology prices are decreasing and are more affordable, the cost of adopting and operating an activity based costing system has also decreased.

Therefore, the company should adopt the activity based costing in order to facilitate cost management and improve financial management. According to Karolefski (2004, p.18) “activity based costing works better if it is kept simple”. Nevertheless, when implemented properly activity based costing yields benefits to the company, its business partners, and to consumers.

Reference

O’Hare, J. 2010. Lecture Notes: Management Accounting

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