ACTIVITY BASED COSTING: HIERARCHICAL PROFITABILITY

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Business
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The Direct Material cost and Direct Labour has been calculated on the basis of total production units. The overhead costs have been allocated to products on the basis of traditional costing system…

Introduction

The cost that has been calculated shows that traditional cost systems report less accurate costs because they use cost drivers where no cause-and-effect relationships exist to assign support costs to cost objects.
These costs of two different packages of boxes have been calculated on the basis of Activity based costing system, in which the overhead costs are allocated to products on the basis of cost drivers. The Direct Material and Direct Labour costs of the two packages of boxes have been calculated on the basis of number of production units. The overheads have been allocated to products on the basis of cost drivers. i.e., the machine department costs have been calculated on the basis of machine hours, whereas the setup cost has been calculated on the basis of number of production runs.

With the traditional costing system misleading information can be reported. A small loss can be reported for a product and if it were discontinued the costing system mistakenly gives the impression that overheads will decline in the longer term.
Furthermore, the message from the costing system is to concentrate on the more profitable specialty products. In reality this strategy would be disastrous because low volume products are made in small batches and require more people for scheduling production, performing set-ups, inspection of the batches and handling a large number of customer requests for small orders.
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