In any entrepreneurship and especially the financial based ones there has to be significant use of resources. These resources are of a wide variety with all leading to the attainment of the business objectives. Nevertheless, the rapid rate of globalisation which has increased the competition rate calls for proper allocation of these resources if at all the business is to fit in the competitive world (Atrill and McLaney, 2006, p.56). The cost and activity management programme ensures that the costs incurred in the business enterprise are well handled to ensure prosperity of the enterprise. This paper looks at some of the methods used in allocation of resources of an enterprise.
Contemporary manufacturing is a process of significant complexity and diversity. It is characterised by many activities, operations and wide variety of products produced with different designs. Unlike traditional manufacturing methods, contemporary manufacturing is automated hence increasing the proportion of the overall costs such as machine hours. The automatization therefore leads to problems of cost allocation as most of these processes are not directly linked to the physical volume of the product (Atrill and McLaney, 2006, p.58). The main difference between contemporary manufacturing and traditional manufacturing is that in contemporary manufacturing the cost allocation is done based on the process while in traditional manufacturing it is done on the basis of the product volume.
Pros and Cons of contemporary manufacturing
Contemporary manufacturing is preferred over traditional manufacturing because it has a competitive advantage due to the automotive processes as well as the wide variety of products produced.
On the other hand, the processes involved in contemporary manufacturing are the main causes of difficulty in cost allocation hence leading to high consumer prices or a loss to the enterprise if the costs are not well catered for.
Traditional manufacturing system
The traditional manufacturing system is applied in cases where there is less variation in the products. This is because the overall costs incurred are allocated on the volume produced hence it will be easier if the products are of the same variety since the cost of direct labour and other requirements is the same.
The process of allocating costs is made easier since the requirements needed are of similar type and proportion.
The products produced are of fewer varieties hence lacking competitive advantage.
This is a manufacturing system aimed at lowering the cost of production through minimization of the in-process stock levels. This therefore means that products are only produced when needed hence eliminating costs of storage among others. Another advantage of this system is that customer satisfaction and quality assurance are assured as the products are produced on specific orders.
A major disadvantage of Just-in-Time manufacturing system is that it is seriously affected by changes in demand of the product. This is mainly because it relies on past production data to produce another product.
Total Quality Management
Total quality management entails producing high quality products and services and make sure that the system continues producing standard products throughout (Garrison et al, 2010, p.130). This therefore calls for frequent checks on the system put in place. The advantage of total quality management is that consumers are always assured of high quality products and services hence customer satisfaction which in turn increases sales of the enterprise.
On the other hand the requirement of frequent checks on the processes is an extra cost that is incurred hence forwarded to the prices of the products and services.
Contemporary costing was initiated to solve the problem of cost allocation in most business enterprises. Some of the methods involved in contemporary costing include;
Activity Based Costing
Activity Based Costing (ABC) method allocates costs using all the activities that are involved in the production like, machine setups, salaries, orders among others (Weiner, 1995, p.87). It is a method used by firms whose overheads are high and have a wide variety of products. In activity based costing method, allocation of overhead costs is based on the real performance and expenditures sourced from the firm’s information records and also from the staff who are connected directly with the delivery of those products. Additionally, in activity based costing costs are apportioned to cost pools. Costs are given to services and products alike by the use of drivers of cost.
- Allocation of costs in activity based costing is more accurate especially in the circumstances where there are no similar rates of direct labour-hours. That’s why it is advisable to use it when making decisions concerning pricing and management
- Activity based accounting approach is more recommendable because it captures all the costs at the activity centres thus it gives a fair cost to each product. Besides, activity based costing approach enables decision makers figure out on how they can improve their productivity and also on how to maximize shareholder value (Weiner, 1995, p.95).
- Activity based costing method gives better results because it is highly involving. It incorporates all cost drivers thus ensuring that every cost is captured. Therefore firms are supposed to rely on activity based costing method in determining the actual prices and costs.
- ABC is also instrumental in improving organizational performance.
However, if the business enterprises use activity based costing, the costs of different products are likely to be variable while their profit margins will be more realistic.
Backflush accounting method
This is a method of accounting where costing is done once the goods have been produced. The accountant works backwards from the cost of sales among other costs to arrive at the final cost of the product. This method is simultaneously used with the just-in-time method hence there is no work-in progress incurred (Garrison et al, 2010, p.126). An advantage of backflush accounting, although arguable is that it simplifies the accounting process as work-in-progress and variations in labour costs are not included. However, the system is disadvantageous as it is only suitable for products with short production cycles. Another disadvantage is that it is only applicable in organisations that use the just-in-time system of manufacturing.
This is a method of costing where the overall cost incurred is shared on all units produced hence coming up with a similar cost per unit. It is applicable in products of the same variety. As the name suggests, costing is done on the basis of all processes involved. It is thus applicable in oil refining, food processing industries, breweries among others.
The stepped process for producing a costing for a product under this costing method
The following is the general procedure used in process costing;
- Identification of the physical units of both the inputs and outputs.
- Identification of equal output units for the inputs such as raw materials, overheads and labour.
- Distinguish period costs incurred on raw material and an aggregate of labour and overheads.
- This step includes obtaining equivalent input units derived from the division of costs incurred on the units by the equivalent units.
- The last step involves valuing the units of Work-in-progress.
Treatment of Normal and Abnormal losses
In process costing, there are two types of losses involved that are the normal and abnormal losses (Garrison et al, 2010, p.132). A normal loss is one that is expected during the production process for example in the processing and pasteurization of milk evaporation loss is a normal loss. This loss is always catered for before production since it is expected hence not valued. Abnormal loss on the other hand is an unexpected loss incurred during production. A clear example is that of broken bottles with beer in the brewery. This loss has to be valued since it is not initially accounted and failure to value it may lead to a constant repeat of the problem leading to the loss.
From the above discussion it can be deduced that each method of cost allocation has its own merits and demerits. This therefore calls for great care as the business chooses which costing method to use in cost determination and determination of selling prices. This is because wrong choice of costing method could significantly understate the appropriate selling price and thus reduce the revenue that a business generates from its products. Total quality management is also essential in the production of high quality products.
Atrill, P. & McLaney, E. Management accounting for decision makers. U.K. McMillan Publishing, 2006. Print.
Garrison, R. et al. Managerial accounting: Custom edition 2010 (12th ed.). Boston, McGraw-Hill.
Weiner, J. Activity based costing for financial institutions. Journal of Bank Cost & Management Accounting, 1995.