Rally Cycles Ltd is a company which manufactures bike pumps. They produce two theoretical accounts: a Regular theoretical account and a Deluxe theoretical account. Each theoretical account histories for 50 % of the gross but the gilded theoretical account has brought in a somewhat higher net income than the regular theoretical account with & A ; lb ; 181,000 compared to & A ; lb ; 179,000.
The company has hired me as a direction adviser to advice them on their cost accounting system and to supply them with recommendations.
The company presently sing altering the cost accounting system it uses to an Activity-Based Costing ( ABC ) system. The old costing system allocates service section costs based on machine hours to the machining and assembly sections. A separate cost driver of direct labor hours was so used to delegate the support costs of the machining and assembly section to the two merchandises. An ABC system identifies single activities as the cardinal cost objects. For this company, activities include puting up machines and piecing merchandises. The ABC system foremost calculates the cost these single activities and so allocates the costs to the two merchandises based on the mix of activities that is needed to bring forth each product.The two accounting systems give different net incomes for the Regular and Deluxe theoretical accounts which can be seen in Appendix 3. Under the bing cost accounting system
( Appendix 3, Table 2 ) , the Regular theoretical account gives a Net Net income of & A ; lb ; 229,000 and the Deluxe theoretical account gives a Net Net income of & A ; lb ; 131,000. This shows that the Deluxe theoretical account is less profitable than the Regular Model by & A ; lb ; 98,000. Under the new Activity-Based Costing system ( Appendix 3, Table 3 ) , the Regular theoretical account gives a Net Net income of & A ; lb ; 322,000 but the Deluxe merely gives a Net Net income of & A ; lb ; 38,000. Under this system there is a Net Net income difference of & A ; lb ; 284,000. This is much more from the & A ; lb ; 98,000 difference under the bing cost accounting system. This shows that it is really of import which bing system you use as the consequences can be really different. Using certain bing systems could take to the company under bing or over bing their merchandises. Therefore companies must be really careful when make up one’s minding on a costing system because the consequences will be taken into consideration when direction determinations are made. Decisions based on deformed information can take to unexpected or bad consequences.
Section 2 – The Old Cost Accounting System
The old cost accounting system may be falsifying the company ‘s merchandise costs and profitableness because it traces merely a little figure of costs as direct costs, and the costs are non allocated based on how the merchandises use the section where the costs are generated. This leads to a deficiency of costs being traced back to the merchandises and can give a higher net income per unit of end product than is really more realistic. If direction believe one merchandise is bring forthing a high degree of net income compared to another merchandise, under one cost accounting system so they may make up one’s mind to set more resources into bring forthing more of this merchandise. If on the other manus they had used another cost accounting system, which would possibly hold given a lower profitableness for than merchandise compared to another merchandise, so they may non hold made this determination.
Rally Cycles Ltd ‘s two merchandises besides gave two different unit cost consequences when ciphering it under the two different cost accounting systems. Under the old cost accounting system, the Regular theoretical account gave a net income per unit of & A ; lb ; 1.43 while the Deluxe theoretical account gave a net income per unit of & A ; lb ; 2.55. Under the new activity-based costing system, the Regular theoretical account gave a net income per unit of & A ; lb ; 1.74, while the Deluxe theoretical account gave a net income per unit of & A ; lb ; 1.69. This is rather a important difference between the net income per unit of the two theoretical accounts under the different cost accounting systems. If direction were faced with the old cost accounting system it would be really likely that they would make up one’s mind to bring forth more of the Deluxe theoretical account as it is more profitable. Under the new Activity-Based Costing system, the direction would likely do the opposite determination and bring forth more of the Regular theoretical account as it is somewhat more profitable. This shows that the old cost accounting system could be supplying the company with a deformed position of the merchandise costs and profitableness.
One of the chief grounds that old cost accounting system could be falsifying the company ‘s merchandise costs is that merely two cost driver rates are used throughout the analyses which are the figure of units produced and the Direct Labour Hours. Rally Cycles Ltd uses the figure of units produced to delegate the cost of Machining Department and Assembly Department to merchandises. Using the figure of units as a manner of delegating costs to merchandise could take to a deformed position of the merchandise cost. This is because the figure of units produced is non what drives the cost of these sections ; instead the Direct Labour Hours in each section is what drives the cost. This leads to the Regular theoretical account being over charged and the Deluxe theoretical account being under charged. This can be seen in Appendix 1, Table 12 compared to the Activity-Based Costing system in Appendix 2, Table 8. The Activity-Based Costing system uses a larger scope of cost drivers in order to be merchandises more accurately.
Another ground the old system is misinterpreting the merchandises cost is because the premise made by this system is that the costs are incurred when the merchandise is manufactured. This makes sense for direct costs but non for indirect costs, and this is where the system fails. For activity operating expenses, the proportion of the activity costs that is really consumed by the merchandise does non hold a direct nexus to a individual indirect cost driver. Therefore for a company that produces a merchandise utilizing a scope of activities but merely uses a individual cost driver will be falsifying its merchandise costs. These types of traditional bing systems assign costs straight to merchandises instead than first to activities and so to merchandises. It shows what costs are spent but non why it is spent. This is why when the company tries to cut entire costs that the symptoms are treated but non the causes ( Carl Marx, 2009 ) . This frequently leads to decrease in the quality of the merchandise instead than a decrease of cost in the long term. Therefore this system is non successful in the long term.
The old cost accounting system is a system in which the sum cost is spread among its assorted merchandises based on the thought that merchandises cause costs instead than the thought than activities cause costs.
Section 3 – The New Activity-Based Costing System
A new cost accounting system that the company could present is an Activity-Based Costing system. This system