Management Accounting
Management Accounting
Contents
1. Introduction 3
2. Traditional costing system and its limitations 3
3. Activity-Based Costing 4
4. Case Question 4
5. Analysis of the different result between traditional costing system and ABC system 5
6. Limitations of ABC system 6
7. Conclusions and Recommendations 6 8. References 7
1. Introduction
Eastside Medical Testing performs five different tests T1 to T5 to detect drug use. Nuclear Systems, Inc., is one of the few companies that required T1. It accounts for almost half of the 3500 T1 tests conducted in the prior year. Recently, Ro Worth, vice president of operations at Nuclear Systems, questioned that the relatively high price being charged for T1. The price for a T1 test is $35, which is higher than the next most expensive test by 40%. Worth thinks that his company is being taken advantage of because they are one of the few companies requiring that T1 test and Eastside Medical Testing. Emmet Wilson is the founder and owner of the company. Before he responding to Worth’s letter, he reviewed the revenue and costs related to the tests. T1 produces a profit of $6.5 per test, which is much higher than the profit of any other test. But he has wondered whether the profitability of T1 is distorted by the company’s simple approach to allocating overhead. The company is using traditional costing system and the overhead allocation is based on direct labor cost. Direct labor is only 10% of the total overhead. And he began to analyze the overhead costs and calculate the ABC cost of the five tests. This
Contents
1. Introduction 3
2. Traditional costing system and its limitations 3
3. Activity-Based Costing 4
4. Case Question 4
5. Analysis of the different result between traditional costing system and ABC system 5
6. Limitations of ABC system 6
7. Conclusions and Recommendations 6 8. References 7
1. Introduction
Eastside Medical Testing performs five different tests T1 to T5 to detect drug use. Nuclear Systems, Inc., is one of the few companies that required T1. It accounts for almost half of the 3500 T1 tests conducted in the prior year. Recently, Ro Worth, vice president of operations at Nuclear Systems, questioned that the relatively high price being charged for T1. The price for a T1 test is $35, which is higher than the next most expensive test by 40%. Worth thinks that his company is being taken advantage of because they are one of the few companies requiring that T1 test and Eastside Medical Testing. Emmet Wilson is the founder and owner of the company. Before he responding to Worth’s letter, he reviewed the revenue and costs related to the tests. T1 produces a profit of $6.5 per test, which is much higher than the profit of any other test. But he has wondered whether the profitability of T1 is distorted by the company’s simple approach to allocating overhead. The company is using traditional costing system and the overhead allocation is based on direct labor cost. Direct labor is only 10% of the total overhead. And he began to analyze the overhead costs and calculate the ABC cost of the five tests. This
References: M. Ozbayrak, M.Akgün, and A.K. Türker, “Activity-based cost estimation in a push/pull advanced manufacturing system,” International Journal of Production Economics, vol. 87, pp. 49–65, 2004. R. Cooper, and R.S. Kaplan, “How cost accounting distorts product costs,” Management Accounting, vol. 69, pp. 20–27, 1988. G. Kim, C.S. Park, and M. J. Kaiser, “Pricing investment and production activities for an advanced manufacturing system,”Engineering Economist, vol. 42, no. 4, pp.303-324, 1997. A. Gunasekaran, and M.Sarhadi, “Implementation of activity-based costing in manufacturing,” International Journal of Production Economics, vol.56-57, pp. 231-242, 1998. R. J. Lewis, “Activity-based models for cost management systems,”Quorum Books, Westport, CT, 1995. Jiambalvo, J. (2010) Managerial Accounting, 4th edition. New Jersey: John Wiley & Sons.