The method emphasizes on the total costs incurred and the cost volume profits of the relationship are not considered. As far as the decision provided by the accountant, it is solely based on absorption costing. It is imperative to note that a major part of the costs of the two products are due to fixed overheads and administrative expenses. Moreover, these expenses are incurred even if the production of these two products is dropped. Hence a better costing method has to be adopted to effectively allocate the overheads. The two methods suited for Rothfield Plc are activity based costing and marginal costing.
Activity Based Costing: ABC is a modern accounting system in which the expenses and overheads are segregated based on the functions of the organisation, which is followed by allocation of the costs to each of the items in respect to the volume of the activity (Kaplan & Anderson, 2007). The use of ABC costing allows the company to accurately assign the costs for all the activities of each of the product or service (Drury, 2005). Rothfield Plc can allocate the fixed overheads based on the usage of these resources by the various production processes.
Marginal Costing or Variable Costing: Marginal Costing provides a clear explanation of the impact of changes in volume of output on the profits and the changes on the profits. There is also a clear differentiation between the fixed and variable costs as well. As explained by Dyson (2007), the fixed costs are never charged to the production and instead the fixed costs are treated as period charges. Hence Rothfield Plc can adopt this method to estimate the potential profits effectively.
The total labor hours required to meet the estimated production levels are slightly higher (by 333 hours). Hence, it is evident that some of level of production of either one or some of the products has to be reduced.
It is essential that whatever the production combination, the contributions from the sales are significant