The report is on the importance of Activity Based Costing commonly referred as ABC model of management accounting. It consists of two parts. The report is going to illustrate the features of Activity Based Costing model in general in the first part. In the second part of the report, the analysis is specifically focused on the Retail Food Group Limited. After a short introduction of the company, it will be assessed how the Activity Based Costing model can help the retail food group in improving its efficiency(Abdel, 2011). At the ending of the report, another tool of management accounting will be discussed.
The discussion in this report is on the Activity Based Costing model. It is a modern concept in the field of management accounting and due to its usefulness, it is now wieldy in use around the globe in management accounting models of the organizations. The detailed discussion about the Activity Based Costing model is following
The simple definition of the activity-based costing model states that
“The model of costing in which the costs are allocated to the products on the
Basis activities involved in the producing the product “(Adler, 2013)
The model is used to allocate production overheads in the costing of the products.
To understand the model it is integral to understand what does it meant by activities, products,and costs in the perspective of activity-based costing systems.
The explanation of the requires an overall perspective of the production model in the mind of the reader as well as in the mind of the writer to demonstrate what actually happens in this model.
It is implied that the production process involves a lot of activities and processes to be completed and the different products used in different facilities for different periods. In addition, the fact that not all products are using the same facilities in the same ratio is the motivating factor being the development of Activity Based Costing model. In the traditional costing system,all the factory overheads are accumulated and then divided into per unit value(Drury, 2013). In the traditional costing system, overheads are allocated to all the products in the same ratio as they are using the services in the same ratio. It was a major loophole in the traditional accounting system due to which some of the products went overpriced due to the inclusion of extra overheads even though they have not utilizes that resource(Simkin, 2014). On the other side of the picture, many products remain underpriced because the overheads are allocated to other products. Due to this loophole, the costing systems were not effective to produce effective information to the management as well as the process of the products are also unfair which is a major threat for the competitiveness of the companies in the market where it is necessary to compete with the prices of competitors(Adler, 2013). So the need for a more effective and accurate costing system was emerging, as a result, the Activity Based Costing system was designed by the management accountants due to which many of the loopholes are covered in the costing systems.
To understand the working of an activity-based costing system considers the example of a production process which is producing three products Alpha, Beta and Gamma. The production process consists of four phases namely heating, molding, finishing and packaging. Each of the products takes different time in every department for production so from the scenario related yet one thing is for sure that is the services applied on every type of product in each of the department varies.So, one cannot assume to divide the expenses incurred in the departments equally between the products rather one has to devise some other way of dividing the expenses between the products( Hopper, 2016).
For this purpose in activity-basedcosting, a proper base is selected for each of the department. The base can be defined as an activity, which indicates the work done on each of the product, and the concept of Absorption Rate is introduced into the discussion. Absorption rate is simply the rate to be exposed to incurring every unit of base activity(Nørreklit, 2017). For understanding take the example of cutting department where the main activity is done with the help of electricity so the allocation base the units of electricity consumed on each of the product from every category. Firstly, the total expense of electricity will be dividing by the total number of electricity units and then the amount to be absorbed in every unit of product can be calculated by multiplying the number of units consumed and rate per unit( Hopper, 2016). Therefore, it is the approach of allocating the expenses of cutting department between all the products in a relation, which depicts the exact amount of services obtained. It is the case with all other departments in the company.
In this way,one can allocate all different type of expenses among the products with the use of suitable bases. Some of the examples are following indirect labor can be divided on the basis of labor hours, electricity on the bases of Kilowatt hours, rent on the bases of floor area, heat,and lighting also on the bases of the area and so on. The accountant can choose a suitable base for the expense for the purpose of allocation. It is the main benefit of Activity-based costing in which expenses are classified based on activities involved and then allocated to different products(Won Kim & Matsumura, 2017).
Fig1: Activity Based Costing Model
The major benefits of activity-based costing over the traditional costing are following
The activity-based costing systems do have some negatives too. Some of which are following
This section of the report is the second part of the report, which is concerned, with the application of Activity Based Costing system to a company registered on Australian Stock Exchange. For the proposes of this report, the company selected is Retail Food Group Limited
Retail Food Group is one of the largest food chains in the world and it is the parent company of many renowned entities such as Gloria Jeans’ Coffee, CAFE2U, It’s a Grind and many more. It is a food chain, which consists of restaurants all around the world and especially in Australia and New Zealand. The company is famous for its high profile and quality services.
The company has the mission to provide high-quality coffee, beverages, foods, bakery and other services in an economic, effective, customer-focused, locally acceptable and global level services to its clients all around the world. In the part of the shareholders, the company has the objective to develop a mix in which all the parties including the customers, investors,and regulators are in a win-win situation(Abdel, 2011).
The retail food group is originally from Australia but now it is operating in almost all around the globe under its various brand names. The corporate strategy of the company involves two major points. One is the provision of high-quality gourmet food to its customers that is matchless in quality and taste and the second is the global expansion of the company and all of its brands to become a multinational food chain operating all around the globe. The company is franchising its brands very widely and has almost 1200 branches in Australia and New Zealand alone. Therefore, the global expansion is part of the long-term strategy(Abdel, 2011).
Activity-based costing system is very useful for retail food group due to the following points
Retail Food Group should consider the following recommendations at the time of implementation of Activity-based Costing system.
One of the useful tools for the retail food group considering the nature of operations and activities involved in the production processes of the company is Budgeting and Variance Analysis. In this particular tool, the company is advised to estimate all the costs of production both fixed and variable at the beginning of the period after that collect all the actual data about the incurred during the year for all the activities(Abdel, 2011).
In the end, both budgeted and actual figures are compared to know the differences between the estimated and actual figures. It will help the company in assessing the areas where the company is lacking in knowledge as well as the operational deficiencies can be assessed in this way as well. Therefore, it is a very helpful tool for the retail food group to keep track of the efficiency and accuracy of their management accounting system. In this way, the company can predict the future in a better way to the uncertainties and ambiguities about the operations can be reduced.
Activity-based costing system is a very useful and effective management accounting tool for entities which are producing multiple products at the same time. It helps I assessing the exact amount of costs. It is very useful for retail food group, which has the objective to provide cheap and high-quality food products to its customers as well as global expansion. It can help the company in assessing the correct costs, which will enhance the usefulness of management accounting systems. The company can implement this model by gathering relevant data. It is recommended to have budgeting systems too in the systems.
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