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Term Paper

Activity Based Costing for Zauner Ornaments


Introduction

The pricing strategy of products of Zauner Ornaments defies all logic as fixed prices were not cost based but as per prices of similar products in the market. Zauner Ornaments when tried traditional costing reached at an alarming situation. An analysis based on activity is required to avoid the confusion created by traditional costing. In fact Activity based costing (ABC) surrounds costing and its absorption to products on activities that actually drive the cost. In this write up an approach is undertaken to make scenario clear for Zauner Ornaments on costing front and for reframing its pricing strategy. An effort has been made to establish basis of allocation plant- administration overheads based on ABC, and also to calculate total cost per box of each product using ABC. While using ABC a comparison has been established between ABC and traditional costing, and finally arriving at a conclusion that Zauner Ornaments need a change in its pricing strategy.


1. Establishing basis of allocation of plant- administration costs

Before determining the best base for allocating plant- administration costs, it is necessary to understand the logic behind ‘Activity Based Costing’ (ABC). ABC works on the following principles or rules:


  • Overheads costs are attributed to Cost Units on the basis of benefits received from indirect activities (meaning activities that cause overheads)
  • The performance of such indirect activities coupled with demands made of these activities helps in arriving at quantum of each such activity performed to produce a product. These activities consume resources (i.e. overheads costs) as per cost drivers (activities that generate cost)
  • Cost centers pay for such resources depending upon number of activities used or required for the product.
  • Therefore overhead costs are recognized and attributable to such activity that is acting as cost driver; and the numbers of such cost drivers used depend upon the complexities of operations to produce a product.
  • Thus, overhead costs of each cost center are then attributed to each unit of product as per cost drivers (activity) required for each unit of the product.
  • Occupational Health and Safety
  • Testing of Structural Vibration
  • Environmental Noise Measurements

Accordingly, in order to absorb or allocate plant- administration cost among categories of production, cost drivers are required to be ascertained. As per information available Plant administration costs constitute costs incurred on 'Supervisions', 'Labor relations', and 'Clerical costs'.


Supervision cost is directly related to supervision or inspection of the working of the plant. Accordingly the best cost driver that comes to mind is 'Inspection per batch' or 'percentage of plant capacity used'. Exhibit 5 provides that only 70% of the plant is used but further information about usage of 70% of plant among three categories of products is not provided. Therefore as per information available, inspection per box is the next suitable cost driver.


The next component of plant- administration cost is cost incurred on 'labor relations'. Here the most suitable cost driver is Direct Labor Cost as provided in Exhibit 5.


The third component of production- administration costs is clerical cost. Naturally clerical work is related to work in proportionate of production of ornaments. For this we have two alternatives from Exhibit 3, one is 'number of ornaments' in each category of production or 'number of batches'.


You gathered the total cost of production- administration overheads, but the information about exact expenditure on each of its above stated components is not available. Accordingly a common cost driver for three components can best be the basis of allocation of production- administration overheads


References:

Exact Costs, Traditional costing vs. Activate Based Costing, viewed on March 8, 2008, http://www.exactcost.com/Traditional_Costing_vs_Activity_Based_Methods


Michael S. Luehfling, Activate Based Costing, Encyclopedia of Management, page 1, viewed on March 8, 2008, http://gale.cengage.com/pdf/samples/sp665568.pdf


TCM Bulletin on Activate Costing System (ABC), ABC- the road to Cost Management, Vol.2, August 2002 http://greenbusinesscentre.com/Documents/TCM%20bulletin-ABC.pdf



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