Craving for Cake Ltd.’s Activity-Based Costing

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Introduction

At the outset I may state that undoubtedly implementation of ABC, does posses certain advantages which I will narrate here, though it may be costlier than traditional costing systems due to need for additional data bases and information requirements:

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  • The foremost and most important advantage is the accuracy in the progression of costing with regard to the product line, the end-users of the product, the stock-keeping units employed by the management and channels and categories which streamline the flow of the product from Craving for Cakes shop to the end user.

It is thus ensured that pricing of pastries is based on accurate and genuine costs and not arbitrary decided on archaic norms which do not suit current trade practices.

  • ABC system helps in the process of comprehending concept of overhead costs i.e. the distribution of general business resources as they are used by specific product lines and their relation to specific cost driver. In the case of pastry making business it could be seen in terms of controlling the inputs and outputs of baking process.
  • The system is easy to comprehend and it is easily accessed, useable and practically workable in the context of the cake business since the activities involved in cake baking are well known and thus better controlled and executed.
  • It makes system more hassle free and smooth, eliminating bottlenecks and ensuring efficacies and control mechanisms over the various processes that constitute batch production of pastries.

The main disadvantages of ABC could be seen in terms of being expensive to maintain since it involves additional data preservation and monitoring and also it does not consider the direct materials aspect of costs, but only the activity part of it. Again, it could be seen that ABC is a transparent system by which the inefficiencies and cost control drawbacks of management could be visible. For this reason many managers would no opt for it, since their deficient areas would become publicly known. However, it is seen that ABC produces better results than conventional machine or labour hour method, which has inherent defects they being volume based rather than activity based.

It is now necessary to come to the actual aspects of ABC in the context of Craving for Cake co Pvt Ltd.

Computation of Cost per unit of Activity Driver of Danish Pastries:

= Activity Cost /Annual Quantity of Activity Driver

= $65,977.63/1000 = $65.98

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The cost of unit of Lamington pastries is $64.898, and that of Danish is $65.980

Question 1 (B): As per Statement attached at end of this paper.

It is seen that batch costing takes into account, direct material costs, direct labour and direct overheads. Besides this, the apportionment of indirect overheads to total costs also need to be made. A Prototype of Statement of Cost is appended below:

Statement of Cost

Direct Materials

Opening stock
Add : Purchase of Raw Materials

Less : Closing Stock

Direct Labour

Direct expenses

Prime Cost

Cake shop overheads:

Power
Depreciation of machines and equipment
Cake shop wages and salaries

Cakeshop stocks consumed :

Works costs

Total costs( prime costs + works
costs)

Thus it is seen that while quantitative aspects of pastry making have been integrated into the Statement of Activity, it does not present direct material costs. Thus, materials costs which form a sizeable part of cost is not considered during activity costing.

Causes for higher costs for Danish pastries

The activity cost of Danish is much higher because the cost of procurement and pastry making costs of the pastry is higher than that of Lamington. For instance the rates of load mixers, filing of trays and other baking activities are much higher than the latter. Again, the higher batch costs are incurred by Testing and Inspection department which needs to get approval for sale of products, etc.

The batch sizes for Danish is lesser than that of Lamington since possibly they are larger pastries and so need to be eaten less.

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Would this difference be reflected in conventional costing system?

Under conventional costing, absorption of common overheads is done on predetermined parameters like machine hour or labour hour rate, which would tend to be volume driven and not activity driven. It is quite possible that products may have low outputs, but involve a large variety of activities and similarly, here may be products that have high outputs but involve little activities, as such. In such cases, distortion of costs would take place resulting in inaccurate costs. A simple example would be lead-acid batteries which are process driven but outputs are less, when compared to tyres which are mass produced.

Therefore, it could be said that it is the level of activities that determine absorption of common costs and not really the machine hour, labour hour or floor space that needs to be the drivers of costs.

The main aspect to be considered in the case of Craving for Cake case is that, for costing purposes, pastry making is a kind of art that involves a number of identical items made as a group or lot. The process of Batch Costing has been defined as “that form of specific order costing which applies where similar articles are manufactured in batches either for sale, or for use, within the undertaking. In most cases the costing is similar to job costing.” (Khan & Jain 2000).

It is seen that all direct costs (material, labour and direct expenses) relating to the batch of pastries are charged to it and the indirect costs need to be charged to it in a suitable and predetermined manner. The per unit cost is ascertained by dividing total cost of batch by the number of units produced in the batch.

In this case it is seen that the cost of baking Danish is higher than baking Lamington since labour and operational costs are higher and there is a substantial cost by way of inspection charges for testing and approving the pastries made to seek congruence with food laws of the country.

Conclusions and Recommendations

This paper needs to consider the ABC in the context of bakery products, pastries, to be specific. It is seen that the characteristics under ABC is quite different from that of conventional accounting, in that it is concerned about various activities like cleaning, loading , mixing and setting etc. which are all separate operations involving costs.

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The main aspect a management accountant would be concerned about is the optimum use of resources and inputs, efficient and hassle free transformation of raw material and goods in progress into finished products and making them ready for sale.

The main recommendations would be in terms of least losses or wastes, damages or spoilages, and also optimum efficacies being met in making of bakery items.

It could also be seen in terms of realistic and accurate costs being determined for the bakery products that would reflect on selling prices. This is because incorrect measurement and assessment of costs would affect the selling prices; too high selling rates would render them unpopular and less sought after. On the flip side, lower incidence of absorption would provide lower sales prices, which may affect demand.

Thus, whichever model or method is pursued, it is necessary that costs are readily amenable to scrutiny, whether at an institutional level, or individual level.

References

Khan, M Y & Jain P K 2000, Cost accounting, Tata McGraw Hill.

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BusinessEssay. 2022. "Craving for Cake Ltd.'s Activity-Based Costing." February 10, 2022. https://business-essay.com/craving-for-cake-ltd-s-activity-based-costing/.

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