Calculation Of Total Cost And Cost Drivers Accounting Essay

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Introduction

Colgate Palmolive was initially a small American family owned soap and candle business. It has since widened its variety of products to oral care, personal care and household care. The company expanded and has subsidiaries overseas including Malaysia. Colgate Palmolive enjoys global brand loyalty and is recognized as a leading household name whose main goal is to provide consumers with high quality products that will satisfy their everyday needs.

Currently, the Board has suggested improving Activity Based Management in the company. Activity-based Costing (ABC) has become one of today's most predominant approaches of costing by using activities to apportion indirect costs and "Activity-based Management' (ABM) is a term created to mean the use of ABC to improve a business. Therefore, the primary focus of ABM is to manage and control costs by managing activities. This report will focus on how ABM can provide accurate information for decision making.

4.0 Calculation of Total Cost and Cost Drivers

Colgate-Palmolive Company has a manufacturing business in Malaysia producing consumer products for the Malaysian market. The company has decided to focus on tooth brush and tooth paste as the main products in a very competitive environment. Currently the management of Colgate is using ABC system to arrive at the product cost. In the recent board meeting the directors felt that improvement must be made to Activity Based Management in order to obtain a fairer and accurate product cost to support and provide a more reliable selling price. The board has suggested that the management should focus on the cost pool driver of each activity.

Data for the two products are: (all the data is based on assumption)

Product

Monthly production

(units)

Labor hours

per unit

Machine hours

per unit

Material cost per unit(£)

Tooth brush

4000

2

2

1.5

Tooth paste

6000

3

1

2

The labor rate is £0.2 per hour.

The following data is for overhead assignment to an activity-based approach which the data is also based on assumption:

Activity cost pool

Estimated overhead cost per month (£)

Purchasing

8,000

Material handling

5,000

Production setup

6,000

Inspection

13,000

Machine running costs

16,000

48,000

Tooth Brush

Tooth Paste

Batch size (units)

10

10

Number of orders

60

10

Material movement per batch

5

6

Number of production runs

4

5

Solution:

Step 1: Identify the company's major activities, which is shown in the cost pool

Step 2: Identify the factors which determine the size of the cost of an activity or cause the cost of the activity. These are known as cost drivers. A cost driver is a factor which causes a change in the cost of an activity. (Terry, 2002)

For example:

Cost

Possible cost driver

Order costs

Number of orders

Material handling costs

Number of production runs

Production scheduling costs

Number of production runs

Dispatching costs

Number of dispatches

Step 3: Allocate the cost associated with each cost driver into what are known as cost pools, In Colgate, the cost driver rate are calculated as follows:

Working:

Material movement= (monthly production/batch sizes) x Material movement per batch

Tooth brush= (4000/10) x 5=2000

Tooth paste = (6000/10) x 6=3600

Purchase= £8,000/(60+10)= £114/order

Material handling= £5,000/(2000+3600) = £0.89/movement

Production setup = £ 6,000/(40+35) = £80/production run

Inspection =£13,000/[(4000/10)+(6000/10)]= £1.3/batch

Machine running cost = £16,000/(4000x4+6000x2)= £0.57/machine hour

Step 4: Charge the prime cost and overhead costs to products on the basis of their usage of the activity. A product's usage of an activity is measured by the number of the activity's cost driver it generates. (ACCA, 2009) In Colgate company, this is allocated as follows:

Particular

Tooth Brush(£)

Tooth Paste(£)

Material cost

8000

6000

Labor cost

1600

3600

Purchasing

6857

1143

Material handling

1785

3214

Production set-up

3200

2800

Inspection

520

780

Machine running cost

9120

6840

Manufacturing cost

31082

24377

(÷) Quantity

4000

6000

Cost/ unit

7.7705

4.0628

ABC System used in Cost Leadership and Product Differentiation

In order for companies to survive in today's market, they need to have competitive advantage over their rivals. A competitive advantage is usually gained over other competitors when companies offer consumers greater value by either offering lower prices or providing surplus benefits that justify similar or higher prices. (Hunger & Wheeler, 2010)

The two types of competitive strategy as explained by Michael Porter are cost leadership and differentiation. Cost leadership is the competitive strategy in which companies succeed by producing at the lowest cost in the industry where as differentiation is when companies succeed by developing and maintaining a unique value for the product as perceived by customers. (Blocher, Stout, & Cokins, 2008)

One of Colgate Palmolive's priorities is to have a significant competitive advantage by reducing total delivered cost and extending technology resources. (Colgate- Palmolive, 2012) Colgate Palmolive has an expansive diversified mix of products with major product areas being oral care, personal care and household care. Colgate Palmolive has a robust brand portfolio including brands such as Colgate, Softsoap, Palmolive, Hill's and Irish Spring. (Colgate-Palmolive, 2012) One of the core tenets of its strategy is to build these brands through advertising and marketing efforts.

Advertising and product innovation have shaped the pedestal of the company's business strategy, enabling it to uphold its position as the global market leader in oral care while proving a formidable competitor to other companies such as Unilever in the personal and home care domains. (Forbes, 2012)

Colgate Palmolive invests a hefty amount of its resources to consistently increase brand equity and to that effect has undertaken several initiatives to boost its brand image among consumers and oral health care professionals. This assists its oral care brands in the expansion of their market share and outselling other competing brands. For example, Colgate-Palmolive Malaysia is the first international corporation to have obtained the Malaysian Halal Certification for its toothpaste and mouthwash products sold to consumers. The Halal Certification extends a new level of consumer assurance, confidence and satisfaction. This also respects the customs and values of consumers in the country. Additionally, Colgate Palmolive forms partnerships with dental care professionals to not only offer oral health education but provide dental screenings and free samples to consumers to encourage the usage of oral care. (Colgate Palmolive, 2012)

Colgate's Technology Centers around the world are dedicated to improving oral health through the development of leading-edge technologies that achieve the highest standards of products as well as patient care and safety. (Colgate- Palmolive, 2012) Colgate Palmolive views product innovation as a vital strategy to drive growth and increase market share. Consistent product innovation and launch of quality priced products have ensured that Colgate expand its sales while at the same help defend its market share from lower-priced brands. Additionally, the distinctive features of these products allow for higher pricing, which favorably impacts margins. Colgate Palmolive has a better chance of gaining higher market share as compared to other global players in Asia due to the fact that it offers an entire portfolio of oral care ranging frm mouthwashes, toothpaste and toothbrushes etc. (Trefis, 2012)

One of the ways in which a company can have a low cost edge over its rivals is to perform essential value chains and revamp value chains to eliminate costs and reduce waste. (Charles, 2011) According to Colgate Palmolive, the one area is which a consumer products company can be firmly in charge of its own internal business is cost control. To that effect, Colgate Palmolive Asia rolled out a system called Project Dragon in 2007 aimed at eliminating waste and wringing out costs by using the same automated system throughout Asia. (Witton, 2000)

Cost leadership and product differentiation are therefore two important factors needed to retain and increase market share and help companies become cost leaders in the market.

Advantages of using ABC system:

Activity Based Costing helps to improve cost control, and at the same time get a more accurate cost of products and product lines. In addition to the direct materials, direct labor directly imputation products, manufacturing costs were also the work activities imputation to the homogeneity of the cost driver, then choose reasonable cost pool allocation criteria, the manufacturing cost-sharing in the cost driver, thereby increasing the cost can be attributed prompted managers to re-work activities on the design of the entire value chain, and get more accurate cost projections.

Secondly, Activity Based Costing will give support of strategic management information. Cost control affects the strategic decision-making, which the determination of product prices and production range as well as product structure determination. Under the new product structure, direct labor and product cost in proportion dropped significantly, and only 3% -8%, resulting in a number of cost calculation mode cannot be adapted to the actual needs. Instead, Activity Based Costing considering the complexity of the production costs, detailed traceability and allocation of resources consumed, furthermore, production decisions, and thus provide a proper basis for pricing decisions.

Activity Based Costing provides a new performance measurement and assessment methods. Activity Based Costing in addition to those who have the financial indicators reserved also offers a number of non-financial indicators, such as labor productivity, product quality, market share, management capacity, human resources management. In addition, the use of a specific job information, the value-added operation efficiency can be increased to avoid invalid operations, optimize operating chain and value chain, increase customer value, provide timely and useful information, the loss, waste is reduced to the minimum, to improve decision-making, calculation, control and effectiveness, improve market competitiveness and profitability of the enterprise to increase corporate value.

Conclusion

Based on the above research, it can be concluded that activity based management is an important instrument of management that has allowed Colgate Palmolive to accurately measure the performance of activities and cost drivers. The application of the ABC system in its processes is in line with the company's objective of being the leading provider of oral, personal and household care in the Malaysian market. Cost leadership and product differentiation have propelled the company to provide high quality products and

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