Case # 4.64
Huge Company Tooling Business Unit (TBU) Choice of Cost System
Huge Company's tooling business unit manufactures metal and carbon fiber parts for the company's major products. They currently use the Functional-Based Costing system or FBC. In this costing system they compute a combined labor and overhead cost per labor hour and charges each job based on the number of labor hours used. This labor-based charge is added to the materials cost to calculate the total job cost. TBU works for internal customers only and not allowed to seek outside work. Management is concerned that the current costing system is causing other business units to send it work that does not use TBU's strengths to the company's overall advantage.
We will investigate the current Functional-Based Costing System (FBC) to determine if management's concerns are justified. We accomplish this by the following process: ·
Explain the steps to compute job costing under the current standard costing system (Functional-Based Costing system - FBC) ·
Provide a recommendation for another cost accounting system that recognizes additional differences among jobs (Activity Based Costing ABC) ·
Compute and explain the steps for job costing under the newly recommended costing system (Activity Based Costing ABC) ·
Explain differences in decision making at TBU
Identify TBY's internal customers that might be influenced by use of the alternative cost system. ·
Discuss under what scenarios each system might lead to better decision making at Huge Company
Explain the steps and compute the job costing under the current standard costing system (functional-based costing system - FBC)
Step 1 Divide total overhead of 300,000,000 by total labor hours of 2,000,000 (2,000 hours x 1000 employees) = $150.00 labor cost per hour
Step 2 Multiply $150.00 by the total labor hours
Step 3 Add total labor charge to material costs for the final answer.
Job 1. $150.00 x 22.50 = 3,375.00 (total labor charge)
$3,375.00 + $30,000.00 = $33,375.00 (Cost of job 1)
Job 2. $150.00 x 160 = 24,000.00 (total labor charge)
$24,000.00 + $100,000.00 = $124,000.00 (Cost of job 2)
Job 3. $150.00 x 21 = 3,150.00 (total labor charge)
$3,150.00 + $28,000.00 = $31,150.00 (Cost of job 3)
Job 4. $150.00 x 120 = 18,000.00 (total labor charge)
$18,000.00 + $40,000.00 = $58,000.00 (Cost of job 4)
Job5. $150.00 x 60 = 9,000.00 (total labor charge)
$9,000.00 + $20,000.00 = $29,000.00 (Cost of job 5)
Shown on a chart, the costing under FBC is as follows:
Labor charge per job
Materials charge per job
Total cost per job 1
Provide a recommendation for another cost accounting system that recognizes additional differences among jobs (Activity Based Costing ABC)
Under the current FBC system, materials consumed during the course of a job are applied to that job according to their use, however, allocation of labor and machine time are allocated as if they we all of equal cost per unit of time. This produces an unrealistic and inaccurate costing of items produced. We recommend using an Activity Based Costing System (ABC) with machine hours as a base. Machine hours on M machines are three times more expensive than machine hours on S Machines and Machine time is ten to twenty times more expensive than employee Labor costs. (The McGraw−Hill, 2003). To show the under and over costing that is currently being employed with the FBC system, we will recalculate the five jobs, as shown above, using the ABC system.
Compute and explain the steps for job costing under the newly recommended costing system (Activity Based Costing ABC)
Calculations for using...
References: Fry, T. D., Steele, D. C. & Saladin, B. A. (1998, February). The use of management
accounting systems in manufacturing. International Journal of Production Research, 36(2), 503.
Hilton: Cost Management Strategies for Business Decisions. Second Edition
Innes, J. (1999, December). The use of activity-based information: A managerial
perspective. Financial Management, 77(11), 80.
Sharma, R. & Ratnatunga, J. (1997, December). Teaching note: Traditional and activity
based costing systems. Accounting Education, 6(4), 337.
Gering, M. & de Beer, D (2005 April), Reaping the full benefits of ABC (part IV)
Retrieved on 4/9/05 from: http://www.accountancysa.org.za/archives/1998oct/features/abc.htm
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