Compare and Contrast the Two Approaches to Costing

2021-04-22 13:11:31
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Companies can take different approaches in developing their job order costing systems. Among some of the approaches that companies can use to allocate costs to their production processes include process costing or job costing technique and activity based costing (Needles, Powers & Crosson, 2011). Process costing is mostly used in mass production of goods and services where the production process is similar across many products. The two approaches used in the costing process for the fashion company are activity based costing and traditional costing. These two methods have various similarities and differences that make each of the unique. The main fundamental components of job costing include revenues, items, direct costs, time and material jobs, fixed fee jobs, and quotes or job estimates. Quotes are an important element in job costing despite the fact that they do not affect ledger transactions (Needles, Powers & Crosson, 2011). Activity based costing is an emerging complementary approach that offers better options to manufactures in job costing (Jackson, Sawyers & Jenkins, 2009). Activity based costing classifies costs in to various generic categories such as direct materials, overheads and labor and associate them with different tasks in the manufacturing process. Activity based approach is very advantageous because it allows the management to easily identify tasks that cost the most in relation with tasks that bring in more additional value. Activity based costing improved the accuracy of costing because it ensures all costs are appropriately allocated to their tasks. Management can make appropriate decisions for instance if the company is spending more on less valuable tasks.

Activity based costing is also known as activity management (Needles, Powers & Crosson, 2011). Time and material jobs in job costing refer to types of jobs where the customer caters for the costs of labor and materials involved in production. Items are the final products and services that a business sells to clients. Direct costs are production costs that can be directly associated with the final products. Direct costs are often distinguished from overheads or indirect cost, which cannot be directly linked to the finished product. Overhead costs are the costs that a company incurs beyond material costs and wages in order to maintain day-to-day operations of the business. The overhead costs include expenses such as rent, insurance, utilities, and depreciation among others (Vanderbeck, 2013). Overhead costs are not directly related to the manufacturing tasks, but they help to create a conducive environment for production to take place. Therefore, it is important for companies to allocate overhead costs in costing their manufacturing tasks. Allocating overheads gives businesses an absorption costing advantage (Jackson, Sawyers & Jenkins, 2009). This implies that when the company allocates its manufacturing overheads, it is likely to get a huge profit for its products. Manufacturing overheads are deductible expenses in taxation. Companies will also benefit from these tax deductions as it will lower the companys tax burden within given period.

On the other hand, traditional costing mainly focuses on allocating overhead costs to different units produce. In the case of the fashion company, traditional costing entails allocating overhead costs to each item of clothing that is produced. The traditional method of costing is based on the assumption that volume metric is the main underlying driver for the manufacturing overhead costs. As such, overheads are only allocated to the units produced. Therefore, this method fails to allocate other nonmanufacturing costs that may be associated with a specific unit of production. The main advantage of this method of costing is that it works within the framework of the Generally Accepted Accounting Principles (GAAP). The traditional method is also easier to implement for most companies in different industries. Nevertheless, this method mostly considered outdated and is not widely used in contemporary businesses due to emergence of advanced technological systems that can be used in tracking production costs. Besides, traditional costing negates other important costs that may affect the total costs of the product. This makes it weak method of cost allocation since it can lead to poor managerial decisions as it leaves out many of the costs that can have a significant impact on the total production costs.

These two methods of budgeting have very many similarities as well as differences. They two methods are similar in that they both help the managers to predict and plan for the future finances of their organizations only that they differ in their approaches (Mancino, J. 2007).

Based on their approaches to budgeting the two methods differ significantly. Activity based budgeting takes a more holistic approach in budgeting which requires manager to look at all the processes involved in generation of profits of the company and critically analyze them and align them to the objectives of the company. Activity based budgeting also requires that managers consider only those activities that are likely to incur costs within the next financial period. The operating budget methodology takes a very different approach to budgeting. Here, a general financial objective for the company will be set by the top managers and each department given a threshold by which they need to deliver so as to enable the company achieve its main objective.

Activity based budgeting takes in to consideration the needs of the customer in to the budgeting process. By analyzing the various business activities, the top executives are more likely to mainly focus on those that meet the customers needs. This helps to ensure improved service delivery and efficiency of operations. Operating budgets on the other hand are mainly built on past financial records and do not therefore consider the end product to the customer (Mancino, J. 2007).

The potential Impact on Profits

The two methods discussed above have a wide range of impact on the profits of an organization. For instance, company can benefit a great deal by implementing the activity based or overhead approach in allocating cost for the products, for instance, through reduction of tax burdens and increased profits. On the other hand, the traditional method of costing makes it quite difficult for the management to make appropriate decisions based on the profits resulting from this method as it may not accurately represent all the costs involved in the manufacturing process.

References

Edward, J. Collins, M, (2005) Budget Making, Theory and Practice. Cambridge, MA: Cantabrigia, Inc.

Jackson, S., Sawyers, R., & Jenkins, J. G. (2009). Managerial accounting: A focus on ethical decision making. Mason, OH: South-Western.

Mancino, J. (2007). "The Auditor and Fraud." Journal of Accountancy April: 32-36.

Needles, B. E., Powers, M., & Crosson, S. V. (2011). Principles of accounting. Mason, Ohio: Cengage Learning.

Vanderbeck, E. J. (2013). Principles of cost accounting. Mason, OH: South-Western, Cengage Learning.

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