Quiz 11: Criticisms of Absorption Cost Systems: Inaccurate Product Costs

Business

Income Statement: It is a part of the books of a company and is a most important element as it shows the performance of a company. It shows the net profit by subtracting all the expenses from the income that incurred during the fiscal year. Overhead Cost: It can be referred to as an accounting term which states all the indirect expenses incurred by an organization for operating a business. These expenses are not directly related to the manufacturing of a product or rendering of a service.a. Prepare the income statement for two ball types, using MS-excel as shown below: img The result of the above excel table is as follows: img Hence, the net income of Masters is img and the net income of Distance is img . b. Prepare the income statement for two ball types, using MS-excel as shown below: img The result of the above excel table is as follows: img Hence, the net income of Masters is img and the net income of Distance is img Working notes: 1. Prepare the schedule showing the allocation of sponsorship expenses, using MS-excel as shown below: img The result of the above-excel table is as follows: img Hence, the sponsorship expenses allocated to masters and Distance is $219,368 and $18,280,632 respectively. 2. Compute the R D expenses allocated to master, using the equation as shown below: img Hence, the R D expenses allocated to master is $1,150,000. 3. Compute the R D expenses allocated to distance, using the equation as shown below: img Hence, the R D expenses allocated to distance is $2,300,000. 4. Compute the ball division headquarters expenses allocated to master, using the equation as shown below: img Hence, the headquarters expenses allocated to master is $1,426,800. 5. Compute the ball division headquarters expenses allocated to distance, using the equation as shown below: img Hence, the headquarters expenses allocated to distance is $2,140,200. c. Activity-based costing (ABC) is a method of distribution of overheads between various jobs or products. Under this system, the main activities of the business are determined and divided into cost pools. Cost drivers of these main activities have been decided and estimated. Then, the cost pools of these activities are divided with the significant cost drivers. The profitability of the two ball type has changed when the company uses the ABC system instead of plant-wide rate. The profitability of master type ball is decreased and the profitability of distance type ball is increased.

Activity Based Costing It a practice used under the cost accounting system. Under this method, all the expenses or overheads incurred by the company for the manufacturing of the products are charged against all the activities which are being undertaken for the manufacturing. The charge is calculated by taking into consideration the burden of resources each activity has consumed. In the present case, the company is using such a system which is helpful for the company because the company works in such situation and in that country where the activity based costing is difficult to implement due to the scarcity of resources. The method of activity based costing is helpful in those conditions where the output of the company is similar to the input which is used to produce the products. So it becomes necessary for the company to conduct a detailed analysis regarding the cost of the products in each and every environment where the company is planning to adopt the activity based costing system. Moreover, the company should make an analysis for an unpredicted situation such as if the cost of any product is changing rapidly or the cost of the product is changing unconditionally i.e. the change is very high in amount. On another hand, the company should also think that the implementation of activity based costing instead of absorption costing method will be more costly to the company. But if the company is of the opinion that it wants to increase the accuracy of the production process regarding the saving of cost and the customer satisfaction then it should implement the activity based costing system.

Income Statement: It is a part of the books of a company and is a most important element as it shows the performance of a company. It shows the net profit by subtracting all the expenses from the income that incurred during the fiscal year Absorption Costing: It is a method used in the cost accounting system, under which all the expenses which are related to the production or manufacturing of a product are entered or taken into consideration. Under this method, all the expenses relating to the manufacturing are absorbed by the units that are being produced by the company at that point in time.a.In the present case, the information regarding the operations which were undertaken in the last year by the company in summarized form are provided. Prepare the required Income Statement of the company with the help of MS-Excel as follows: img The result of the above calculation is as follows: img Therefore the Net Income of the Machine and Fasteners comes out to be $8.33 and $0.68 respectively. b.First, prepare a table for the allocation and bifurcation of, manufacturing overheads as follows: img The result of the above calculation is as follows: img Now, finally compute the revised net income of the company as follows: img The result of the above calculation is as follows: img Therefore the Net Income of the company comes out to be -$17.08 for Machines and $26.09 for fasteners. c.The major difference in the profits of the company under both the methods is due to the attachment of depreciation or the whole machinery in such calculations. Such attachment of machinery in the calculations resulted in profits for the company in the first alternative. But the same has resulted in negative net income for the company by charging the amount of depreciation in it. d.In the present case, the second alternative as adopted by the company for the computation of the net income is better. This is because it has accurately charged the indirect costs of the company in a very unique manner. Thus the computation of net income is more accurate even if the products under which the company is dealing are interdependent on each other. In the latter alternative, the indirect costs were charged appropriately and hence forcing the Company to charge higher prices for the same. But under the changed method, the company has overcome the lacuna and has appropriately estimated the expenses and has also computed the amount of income accurately.