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This report provides a critical analysis comparing the current costing system of Pronto Plastics against activity-based costing (ABC) technique.Â To do this, the conditions of Pronto with and without ABC are presented with emphasis on financial data.Â It is found that major advantage of ABC is to enhance the profitability of Pronto due to more accurate allocation of costs.Â The explanation and supporting details are illustrated below.
IntroductionÂ Â Â
Â Â Â Â Â Â Â Â Â Â Â Even though the up-market Glamour product is gaining prominence in the market since its inception four years ago, the financial performance of Pronto for the last three years continued to decline.Â Due to this there is a need for an investigation that includes both financial and explanatory components for understanding the case.Â This will aid Ana Lyst in her proposal to adopt a new costing method under ABC approach.Â The scope of this report will include analysis of distinctive features of normal and activity-based costing systems.Â In addition, it will also discuss the reasons behind the financial performance issues that Pronto is facing.Â There are also recommendations to improve the situation and a conclusion.Â Most of the analysis is supported with financial data and computations and also facts of the Pronto case.Â Although certain costing techniques are also useful to determine the relative advantages/ disadvantages of ABC like standard or value-based costing, the discussion is limited to ABC versus normal costing systems.Â Â Â Â
Problems in the current costing system
It only considered manufacturing costs where in fact the results of the latest financial data showed that transportation costs accounted for 35% of the expenses incurred under selling and distribution.Â Second, when estimating the overhead costs, the system used plant-wide overhead rate under the variable "machine hours".Â However, the design of processes is semi-automatic and manual work is necessary to complete such phases of manufacturing such as purchasing and scheduling including set-up.Â There is a lack of coverage when "machine hours" is used as lone and main variable.Â Third, the system cannot handle various changes in the business plan. Â The drastic rise in overhead rate is a symptom that machine variable alone is an insufficient representation of real costs of the company.Â Since the company is under increasing use of machines due to introduction of up-market products (i.e. Glamour), the system undermined other costs (i.e. transportation).Â Â
More generally, normal costing system uses budgeted overhead rates which can distort actual results from operations.Â As a result, the increasing machine-based overhead rate pushed the costs requiring more cash to pay, more accounts payable to incur and other reduction in income-related accounts.Â In the past four years when the firm started to produce Glamour, the financial alarm did not erupt instantly and required the current financial position and overhead rate to provide their obvious aggravations.Â Due to this, the system is responsible for the three-year poor financial performance despite good turnover of the newest product line.Â The use of machine hours does not only understated indirect manufacturing costs but also the substantial contribution of labor in the completion of Glamour products.Â Â Â Â Â Â Â
Contribution for improvement and Other Advantages of ABC system
The firm is basically under the problem of having good products, production on-demand, successful operations except prior to introduction of Glamour and currently anxious about its future profitability.Â Activity based costing (ABC) will aid in determination of true cost of the product particularly the high cost Glamour.Â ABC can propose cost improvement and even strategic plans to increase productivity.Â This can reserve the right for more innovative products to be continuously manufactured and polish the view of the manufacturing manager .Â Manufacturing costs have minimal insight on how to price products and ABC will broaden this lacking to obtain full benefits.Â ABC also focuses on indirect costs or the overhead that is very relevant to the problem of the firm.Â Since it intends to trace the cost rather than allocate, the confusion earlier rejected by Chan can be clarified (i.e. seeing transportation as cost) and strategies be streamlined (i.e. management of overhead) accordingly.Â Â Â Â Â Â Â
Findings in Comparing ABC and Existing Costing System
As observed in the spreadsheet, the unit cost for the Pronto Plates and Pronto cups are overstated in the existing system while Glamour containers and Glamour bowls are understated also in the existing systems compared to ABC results.Â This is possible for the existing system because it used machine hours as basis for overhead rate computation and allocation (i.e. highlighted in green).Â As observed, Pronto product lines are high in volume but required no special activities such as stopping the production lines to remove plastic remnants in machines eminent in producing Glamour product lines.Â In effect, machines hours as basis for allocation undermines the presence of labor-intensive requirements of Glamour products under ABC approach.Â Little overhead costs are allocated in Glamour products because it did not have many machine hours rather set-up processes while the reverse is true (i.e. enormous overhead) for Pronto products whose production is less critical and can be mass produced easily.Â However, Glamour products require much personnel attention that labor hours have substantially jumped under ABC approach.Â Â Â Â Â Â Â