International Accounting and Finance - Essay Example

REVISION   set on  2007-09-02 12:34 Dear Refer to my order no#180391, after review the paper, I have some questions to ask. Q1 - why thehour cost of machine cost is based on 150% of the direct labour hour of 4000. please kindly explain. the question states that I have copy pasted the data as follows: I am just implementing what the problem states. Thus, The above data then answers your question “why the hour cost of machine cost is based on 150% of the direct labour hour of 4000. please kindly explain”. The problem wants to compare whether overhead that based on machine hours [6,500] is a better that presenting overhead using direct labor hours ( 150% of Direct labour hours of (4,000direct labour hours x £1.50) Also the budgeted overhead is £150 or £149.825 above. as you analyze problems is different for the variance of the direct labour & machine hour. Yes, because my analysis is to answer what is being asked. What Is being asked to compare the difference between computing overhead based on direct labor hours( 150% of 4,000 direct labour hours = 6,000 hours) and computing overhead using direct labor hours (6,500) right? Yes that is right. any other point? If you look my computations, they have explanations accompanying them. Thus, all other points can be seen by looking at the computations themselves.s Q2. you are using a 3 method to calculated the total cost per unit. For the ABC based on machine hour. If calculated the total per unit. IS it using 279500/6500*3500=$150,500 because the machine cost is include the standard & specialise products. and so on for the set up & materials handling cost. Is it right? Please comment. Yes, you are right : as shown below 3,500 hours + 3,000 hours = 6,500 hours Machine 279,500 3500 79.86 3,000.00 93.17 International Accounting INTRODUCTION Davina has scrutinized the current full cost or absorption costing method in aggregating the overhead costs of the company(Louderback,2000). Unfortunately, the current method of costing has resulted to a drop in the profits of the company. Upon interviewing the present accountant, he admits that the old system is wanting but insist on continuing this cost accounting system because of the ease of computing the total factory overhead costs. The following paragraphs will dissect the current full cost accounting system and Davina’s recommendation that the activity based costing be immediately set up. BODY Analysis of the Advantages of Switching to Machine Hours as an Overhead Recovery Base Rate Factory Overhead Based on Direct Labour Hours Factory Overhead Direct Labour Hours Method Direct Unit cost Labour Machine Overhead Hours hours Machine 279,500 47 ( 279,500 /[4,000 x 1.5]) Set Up 200,200 33 ( 200,200 /[4,000 x 1.5]) Materials Handling 119,600 20 ( 119,600 /[4,000 x 1.5]) Total overhead 599,300 150% DLH = 6,000 hrs (100.) Direct Labor 170,000 4,000 hrs (42.50) DL and Overhead 769,300 Based on the above computation, the hourly cost of machine cost based on 150% of direct labour hours of 4,000 is ₤47 per hour. Likewise, the hourly cost of set up is ₤33 per hour. In addition, the materials handling cost under direct labour hours is ₤20 per hour. The direct labour remains at ₤42.50. The total cost is ₤142.50. Factory Overhead Based on Machine Hours Method Factory Overhead Machine Hours Method Direct Unit cost Labour Machine Overhead Hours hours Machine 279,500 43 (279500 / 6500 hrs) Set Up 200,200 31 (200,200 / 6500 hrs) Materials Handling 119,600 18 (119,600 / 6500 hrs) 599,300 6,500hrs (92.00) Direct Labor 170,000 4,000 hrs (42.5) DL and Overhead 769,300 Based on the above computation, the hourly cost of machine based on 6,500 machines hours is ₤43 per hour. Likewise, the hourly cost of set up is ₤31 per hour. In addition, the materials handling cost under direct labour hours is ₤18 per hour. The direct labour remains at ₤42.50. The total cost is ₤134.50. ANALYSIS OF VARIANCE Analysis of Variance Direct Labour Machine Overhead Hours Hours Variance Machine 279,500 47 43 4 Set Up 200,200 33 31 3 Materials Handling 119,600 20 18 2 Total overhead 599,300 100 92 8 6,000hrs 6,500hrs Direct Labor 170,000 4,000 hrs 4,000 hrs DL and Overhead 769,300 The per machine hours method using 6,500 hours is better than the per direct labour hours method using 150% of direct labour hours (150% x 4,000 hours = 6,000 hrs) in recovering overhead costs. The above analysis of variances shows that the per hour cost of machine is lower under the direct labour hours method as compared to the direct labour by ₤4 per hour. Also, the Set up costs under the machine hours method shows that the per machine hour cost of ₤31 per hour is definitely lower than the per hour cost using the direct labour hours method amounting to the higher ₤33 per hour. Finally, the materials handling cost under the machine hours method amounting to only ₤18 per hour is definitely lower than the per hour cost of ₤20 per hour using the direct labour method. Evidently, The per machine hours method using 6,500 hours is better than the per direct labour hours method using 150% of direct labour hours in recovering overhead costs. Analysis of Variance between Activity Based Costing and Full(Absorption) Costing Method 1 Direct Labour Hours method Direct Labour Hours Method Unit Cost Machine 279,500 Set Up 200,200 Materials Handling 119,600 Total overhead 599,300 149.825 per labour hour Direct Labor 170,000 42.500 Per hour DL and Overhead 769,300 192.325 The above computation shows that the total overhead costs(Weston, 1993) is ₤ 149.825 per hour. And, the total of the direct labour amounting to ₤ 42.50 per direct labour hour and total overhead costs of ₤ 149.825 is ₤ 192.325. Method 2 Activity Based Costing based on Machine Hours Standard Products Standard Products Total Activity Based Cost Total Total Cost Total Cost Unit Basis: Machine hrs Cost Driver Per Unit Driver Per Unit cost Computation A B A / B C D A / C Overhead Machine 279,500 3500 79.86 3,000.00 93.17 Set Up 200,200 80 2,502.50 200.00 1,001.00 Materials Handling 119,600 160 747.50 300.00 398.67 Total overhead 599,300 3,329.86 1,492.83 4,822.69 Direct labour 42.500 Total 4,865.19 Method above shows that activity based costing gives us increase cost per hour. The standard products above shows that the per hour cost (blue color) above shows that the cost using machine activity cost driver unit is ₤ 79.86 per machine hour. And, overhead cost based on number of setups is ₤ 2,502.20 per set up. Likewise, overhead computation based on materials handling costs is ₤747.50 per materials handled. The specialized products computation above show that the cost per machine is ₤93.17 per machine hour. Also, the overhead cost based on the number of set up is ₤ 1,001 per set up. Likewise, the overhead costs based on materials handling is ₤398.57. The total per activity costs for the standard products is ₤3,329.86 whereas the total per activity cost for the specialized products is ₤1,492.83. Thus, the total overhead costs per activity of the specialized products is lower than the overhead activity costs under the standard products‘ computation. The total overhead costs of both products is ₤4,822.69. Method 3 Activity Based Costing based on Labour Hours Standard Products Standard Products Activity Based Cost Total Total Cost Total Cost Unit Basis DL hrs Cost Driver Per Unit Driver Per Unit cost Computation A B A / B C D A / C Overhead Machine 279,500 2500 111.80 1,500.00 186.33 Set Up 200,200 80 2,502.50 200.00 1,001.00 Materials Handling 119,600 160 747.50 300.00 398.67 Total overhead 599,300 3,361.80 1,586.00 4,947.80 Direct labor 42.500 Total 4,990.30 Based on the above computation, the activity based costing gives us increase cost per hour. The standard products above shows that the per hour cost (blue color) above shows that the cost using machine activity cost driver unit is ₤ 111.80 per machine hour. And, overhead cost based on number of setups is ₤ 2,502.20 per set up. Likewise, overhead computation based on materials handling costs is ₤747.50 per materials handled. The specialized products computation above show that the cost per machine is ₤186.33 per machine hour. Also, the overhead cost based on the number of set up is ₤ 1,001 per set up. Likewise, the overhead costs based on materials handling is ₤398.57. The total per activity costs for the standard products is ₤3,361.80 whereas the total per activity cost for the specialized products is ₤1,586.00. Thus, the total overhead costs per activity of the specialized products is lower than the overhead activity costs under the standard products computation. The total overhead costs of both products is ₤4,947.80. Analysis of Variance ANALYSIS OF VARIANCE Overhead Labor Total 1. Direct Labour Hours = 149.825 192.33 2. ABC (Machine Hours) = 4,865.19 4,907.69 3. ABC (Labour Hours) = 4,990.30 5,032.80 The Analysis of variance above shows that the labor rate per hour is fixed at ₤42.50 per direct labour hours. The above data shows that computing for overhead using the direct labour hours methods will generate a per hour cost of ₤149.825. Also, the activity based costing using the machine hours on both the standard products as well as the specialized products will generate an activity driver cost per hour of ₤4,865.19. Lastly, the activity based costing that uses the direct labour hours as basis will generate a total activity based costing amount of ₤4,990.30 per hour. In conclusion, the method 1 above is the best way to show a higher profit. Also, the above date shows that activity based costing will generate a per hour costing because the cost is now based on activity drivers. The activity drivers here are the machine hours, labour hours, number of set up and number of materials handled. But, the third method above will give the highest cost per hour. The advantage of using activity based costing is that the company will already know the high costs of maintaining a profitable business. The, the company try to reduce the number of activities in order to make profits or stay out of the negative income statement balance (net loss). To accomplish this, the company has to sell the products higher than the activity based costs generated from the computations above. ADVISE ON THE IMPLEMENTATION OF THE Activity Based System. Davina should not fear the immediate implementation of the Activity Based Costing System. For, full costing is based on direct labour hours. In addition, full costing sets aside variable selling and administration expenses as part operating expenses and not part of the cost of goods sold statement. Activity based costing is based on driver activities. There are many advantages of activity based costing as compared to the full or absorption costing. Lastly, the cost pools used under the full costing or absorption costing traditionally include only one or a limited number of pools whereas the activity based costing uses many and different activity pools for recuperating overhead expenses(Maher, 1997). For, full costing is based on direct labour hours. Full costing which is also called traditional costing or absorption costing is the costing method that is commonly used by many companies that are listed in the stock exchanges of the United States, London and other European Union nations (Miller, 1995). This financial statement includes in the computation of total manufacturing cost the fixed factory overhead expenses. Total manufacturing expenses includes the direct materials cost that form part of the finished goods. Also, the direct labour cost is the payment made to factory personnel actually working on the processing of the raw materials into finished goods is included in the total manufacturing costs. Lastly, all other costs expended within the factory or plant but are not part of direct materials and direct labour are lumped together under the account title overhead or factory overhead. Sad to say, full costing is based ONLY on direct labour hours. In addition, full costing sets aside variable selling and administration expenses as part operating expenses and not part of the cost of goods sold statement. The cost of goods sold includes the materials costs, the direct labor costs, the work in process cost used and the finished goods sold. Standard costing normally allocates or budgets total factory overhead, including the set up costs and materials handling costs simply as a certain percentage of the direct labor hours. The difference between the actual factory overhead and the applied factory overhead is called the factory overhead variance. In the case of Davina, the company has been using full cost or absorption costing(Meigs, 1995). The current policy is to charge factory overhead AUTOMATICALLY as one hundre fifty percent of direct labour hours. This is the main reason why the company has been having so a poor showing in its financial statements. Evidently, full costing is based on direct labour hours should be changed to a better costing method. CONCLUSION: Activity based costing is based on driver activities. This new overhead costing method has just come in time. The focus of this new costing method is to use information about the activities to manage many aspects of the company or corporation. The company concentrates its efforts on the pinning the overhead costs on the increase or decrease of various factory process activities and not simply just to mange overhead costs. In short, it is a new and innovative way of management decision making where all overhead costs (exluding direct materials and direct labour) like indirect materials, indirect labour, non-manufacturing overhead are computed based on the acitivities or processes. In Davina’s case, the activities are machine hours, labour hours, number of set ups and number of materials handles. The total machine cost is divided by the total machine hours. The total set up cost is divided by the total number of set ups and the total materials handling cost is divided by the total number of materials handled. The above computations show that activity costs per activity is definitely higher than the old system of full costing where the total overhead costs consisting of the three activities of set up costs, materials handling costs and machine hours costs simply ( or lazily?) by one hundred fifty percent (150%) of the direct labour hours. Furthermore, the system called activity based costing identifies each activity as a cost center. In this study, the entire factory is correctly considered by Davina as a cost center center and makes here budget based on the three activities mentioned here. Obviously, activity based costing is based on driver activities. There are many advantages of activity based costing as compared to the full or absorption costing. One is that Davina and the other managers can easily set the proper selling prices that should be higher than the current selling prices set up by its current accountant using the the “old system”. The prior accountant admitted that the old accounting system (full or absorption costing) has its bad points but they resists any change because “old dogs do not learn new tricks” where old means long years of repetitively boring job descriptions. Based on the above computation, activity based costing give us a higher cost structure as compared with the prior system where factory overhead is simply arrived at by basing factory overhead cost on a certain percentage of direct labour hours. The numbers in the above computations show that it is better to use in monitoring overhead costs the different processes or activities as benchmark for decision making purposes as compared to the insensitive overhead costing based on direct labour hours exhausted. For, the factory is clustered into cost pools like factories, stores, banks and others under activity based costing. Lastly, the cost pools used under the full costing or absorption costing traditionally include only one or a limited number of pools whereas the activity based costing uses many and different activity pools for recuperating overhead expenses. The activity based costing is best in a capital intensive organisation or produces diverse products as well as companies have generate high overhead expenses just like the company Davina is working for. In addition, the tradition full cost or absorption cost method is too simple and expensive and thereby is not as accurate as the acitivity based costing method in stating the product cost. Also, this new method use non –financial information for analyzing overhead costs unlike the absorption costing which is not mind challenging to compute. Adding everything up, there are many advantages of activity based costing as compared to the full or absorption costing REFERENCES Louderback et al., Managerial Accounting, Thompson, London, 2000 Weston, J., Brigham, E., Essentials of Managerial Finance, Dryden Press, 1993 Maher et al., Managerial Accounting, Dryden Press, London, 1997 Larson K., Miller P., Financial Accounting, Irwin Press, London, 1995 Meigs et al., Financial Accounting, McGraw-Hill, London, 1995 Read More