Evaluation of the Options Available

Introduction

There are a few options for S.B. Ltd to consider getting through difficult times. The five main options are firstly, to discontinue the Nottingham division and Leicester and Loughborough divisions could use their spare capacity to produce 60% of Nottingham’s 2010 output in addition to their own 2010 output, close the Nottingham division and outsource Nottingham’s 2010 output, to launch a major campaign for all 3 products to increase their sales, to introduce a transfer pricing system between the division and the head office to increase motivation among the staff in each division and rightsizing the organisation.

Discontinuation

As seen Nottingham is not making growth, in response to market forces, the first option is to discontinue Nottingham division by selling its assets and settling its liabilities and shifting production from Nottingham to Leicester and Loughborough. The discontinuation decision is a decision when the division profitability highlights the potential of unprofitable (Drury, 2010, pp.91-92). In this option, assuming that Leicester and Loughborough have some spare capacity to produce 60% of Nottingham’s 2010 output on top of their own 2010 output. According to Drury (2010, p.92), discontinuing the Nottingham division could aid the company in eliminating cost of goods sold, and other variable costs in the division.

			Leicester		Loughborough		Derby
	Sales - Strawberry jam						280.00
	Sales - Orange Marmalade						240.00
	Sales - Raspberry jam (60%)						96.00
	Total Sales						616.00
	Cost of goods produced and sold		173.00		153.00		326.00
	Gross Profit						290.00
	Advertising costs						30.00
	Distribution costs						50.00
	Local administration expenses		30.00		30.00		60.00
	Head Office Costs						150.00
	Net Profit						-

Other cost such as advertising costs, distribution costs and Head Office costs remain unchanged and is not affected by the discontinuation of the Nottingham division. O’Hare (2010, Management Accounting Lecture 3) suggested other factors which will affect an organisation to discontinue a division, the division is making a loss, to identify avoidable costs or to discover other saving.

Outsourcing

Outsourcing option is also known as sub-contracting option has become increasingly common in organisations, which enables organisations to concentrate on their core performance while outsource other specialist their secondary activities (Collier et al, 2007, pp.220-221). In S.B. Ltd case, according to Oxford University Press (2009), outsourcing could help to get through this hard time by going on a process of business process downsizing. Outsourcing allows operations that have seasonal demands to bring in additional resources in time of needs. Other advantages of outsourcing are, outsource activities will allow S.B. Ltd to focus on important functions without sacrificing quality or service, outsource specialist could help improve the quality and standard of the jam. It may also be able to purchase the jam more cheaply or perhaps more quickly.

Assuming the outsource price for raspberry jam is 20% more then the cost of goods produced and sold for raspberry jam. Hence, the sales of raspberry jam remains the same and Leicester division and Loughborough division have spare capacity which gives them room for expansion of 30% more sales each. All other expenses remain the same for both Leicester and Loughborough divisions. This gives the Head Office a net profit of £76,000

			Leicester		Loughborough		Derby
	Sales - Strawberry jam						364.00
	Sales - Orange Marmalade						312.00
	Sales - Raspberry jam (Outsource)						160.00
	Total Sales						836.00
	Cost of goods produced and sold		182.00		156.00		338.00
	Outsource price						132.00
	Gross Profit						366.00
	Advertising costs						30.00
	Distribution costs						50.00
	Local administration expenses		30.00		30.00		60.00
	Head Office Costs						150.00
	Net Loss						76.00

On contrary to the advantages, outsourcing the jam to some specialist could lead to risk of unsatisfactory quality and standard of the jam. Other disadvantages could be leak of procedures and techniques of making the jam, outsourcing usually focuses on short-term cost-saving, and ignores the unchanged overhead burden.

Major Campaign

Another option is to launch a major advertising campaign for all three products to increase their sales and keep all three divisions. Advertising could boost awareness and generate demand of the sales of jams of S.B. Ltd. and hence acquiring more orders.

In the advertising campaign, assuming the advertising cost increase by 20% and it bring the sales of each product to an increase of 20% each. It simply boost up the profit of the company to £96,000.

			Leicester	Nottingham		Loughborough		Derby
	Sales - Strawberry jam							336.00
	Sales - Raspberry jam							192.00
	Sales - Orange Marmalade							288.00
	Total Sales							816.00
	Cost of goods produced and sold		140.00	110.00		120.00		370.00
	Gross Profit							446.00
	Advertising costs							90.00
	Distribution costs							50.00
	Local administration expenses		30.00	30.00		30.00		90.00
	Head Office Costs							150.00
	Net Profit							66.00

Transfer Pricing

The other option is when an organisation chooses to decentralise its divisions, transfer pricing helps decide what price to charge for in-company transactions (Collier et al, 2007, p.38-39) and as a form of promoting divisional autonomy (O’Hare, 2010, Management Accounting Lecture 8). It is useful when goods are transferred between divisions; hence, the performance measurement of each division is not prejudiced by the corporate objectives. The profitability of each business units will be affected and according to Solomon (1965 cited in Collier et al, 2007, pp.38-39), companies might take advantage of the transfer pricing which are suitable for evaluating divisional performance for the corporate interest, instead of the business units. Transfer pricing strategies and can produce substantial tax savings in addition to enhancing operational performance and improving cash flow. In many organisations, in order to avoid de-motivating effects on different business units, negotiated prices are adopted.

Say, each product is transferred to Derby division and it pays each division 70% of the sales it made from selling all the jams and yet still bare the cost of advertising, distribution and the head office costs. The local administrative expenses shall be bare by the respective divisions.

		Leicester		Nottingham		Loughborough		Derby
	Sales - Strawberry jam							280.00
	Sales - Raspberry jam							160.00
	Sales - Orange Marmalade							240.00
	Total Sales							680.00
	Transfer price revenues	196.00		112.00		168.00
	Cost of goods produced and sold	140.00		110.00		120.00
	Gross Profit	56.00		2.00		48.00		680.00
	Total cost of transfer							476.00
	Advertising costs							30.00
	Distribution costs							50.00
	Local administration expenses	30.00		30.00		30.00
	Head Office Costs							150.00
	Net Profit	26.00		(28.00)		18.00		(26.00)

There are downsides of transfer pricing. The political process in an organisation might affect the transfer pricing between divisions. Incorrect prices adopted can distort reported performance, by making some divisions more profitable at others expense. Opportunities exist to avoid taxes using artificial transfer prices to transfer profits from a high tax division to a low tax division.

Rightsizing

Rightsizing, or corporate restructuring, with the aim of reducing costs and improving efficiency and effectiveness is also one option in difficult times. Rightsizing is downsizing in the belief that an organisation really should operate with fewer personnel. The primary reason to engage in rightsizing is to make the daily operations of a business more productive. For example, a company may be able to replace assembly line employees with machines which will be quicker and less prone to error. In addition, rightsizing increases profits by reducing the overall overheads of a business.

S.B. Ltd operates a full cost (TAC) standard costing system. The standard costs set fot the year 31 March 2010 and information about future costs and selling prices are in Appendix 2.

Part 2 (700)

Assuming the company decided to go for the option of keeping all divisions open and launching an advertising campaign, you are required to produce a standard cost card for each product and a budget for the company showing clearly the costs attributable to each division for the year to 31 March 2011. State clearly all assumptions made.

Appendix 2 - Standard cost data
Standard cost cards for the year ended 31 March 2010 (per batch of 40 jars each of 500 grams)
	Strawberry Jam		Raspberry Jam		Marmalade
		£		£		£
Selling price		28		32		40
Fruit	16kg	4.8	16kg	5.6	24kg	4.8
Sugar	8kg	1.6	8kg	1.6	12kg	2.4
Labour	1 hour	6	1 hour	6	2 hours	12
Other variable costs		1		2		2
Fixed overheads	1 hour	2	1 hour	2	2 hours	4
		15.4		17.2		25.2
Profit		12.6		14.8		14.8
Other information
Demand	With the right promotion the company believe that they could sell 20%
	more of each product at the 2010 standard selling price
Material wastage	It is considered that improvements can be made but input weight will
	always be at least 10% more than output weight for jam and 50% for
	marmalade
Labour	Currently operates at 80% efficiency levels
Prices	Strawberries are sourced from the UK and prices are expected to rise by
	2-5%
	Raspberries are sourced from the UK and prices could rise by up to 15%
	due to poor weather
	Oranges are imported and paid for in euros euro prices are expected to
	be as 2010
	Discounts on all fruit can be negotiated if quantities increase
	Labour rates per hour have been the same for the last 2 years
	Variable costs may rise by up to 5 %
	Fixed overheads may rise by between 5 and 10%

Standard Cost Card

A standard cost card can be defined as ‘a detailed listing of the standard amounts of materials, labour and overheads that should go into a unit of product, multiplied by the standard price or rate that has been set for each elements’ (Anon 2, 2010). A standard cost card, for example must include the price, specifications, quantity and quality of material required, as well as such factors as the period of credit allowed from suppliers, cash and quantity discounts, spoilage due to wastage and deterioration. A standard cost card demands an investigation of all contributing factors that can constitute a cost before the cost is adopted. According to Drury (2010, p.278), standard costs are ‘predetermined costs’ and they are the target costs that should be incurred under efficient operating conditions. The standard cost card will be subjected to updating caused by revision of standards such as changes in prices, discounts, etc.

Standard costing is a control system which sets standards that are ideal, expected and achievable (O’Hare, 2010, Management Accounting Lecture). Collier (2007, p.36) put forward that standard costing is a control technique which compares standard cost and all of production revenues with actual results. It is to obtain variances of each division and product (O’Hare, 2010, Management Accounting Lecture 8), which are used to stimulate improved performance and to increase motivation of staff in each division. It is a detective control used to prevent problems from reoccurring as it measures variances as it occur, thus allowing management to take necessary corrective action.

The standard cost card for the year ended 31 March 2011 (per batch of 40 jars each 500 grams) for Strawberry Jam, Raspberry Jam and Orange Marmalade are as below:

		Strawberry Jam
				£	£
	Selling price				28.00
	Fruit	16/kg	0.31	4.90
	Sugar	8/kg	0.20	1.60
	Labour	1 hour	6.00	6.00
	Other Variable Cost			1.50
	Fixed Overheads	1 hour	2.10	2.10
					15.65
	Profit				12.35

		Raspberry Jam
						£		£
	Selling price							32.00
	Fruit	16/kg		0.40		6.44
	Sugar	8/kg		0.20		1.60
	Labour	1 hour		6.00		6.00
	Other Variable Cost					2.10
	Fixed Overheads	1 hour		2.10		2.10
								18.24
	Profit							13.76

		Orange Marmalade
						£		£
	Selling price							40.00
	Fruit	24/kg		0.20		4.80
	Sugar	12/kg		0.20		2.40
	Labour	2 hours		6.00		12.00
	Other Variable Cost					2.10
	Fixed Overheads	1hour		2.10		2.10
								23.40
	Profit							16.60

Budget

The principal tool in planning is called ‘a budget’. A budget is a collection of predictions. It is an estimation of the revenue and expenses over a specified future period of time. There are three purposes of budgets as identified by Emmanuel et al (1990 cited in Collier, 2007, pp.39-40), ‘as forecasts of future events’, ‘as motivational targets’ and ‘as standards for performance evaluation’. Budget is a financial plan or qualitative statement for implementing the various decisions to be pursued during a specific accounting period, that management has made in the previous period.

Collier (2007, pp.39-42) suggest that budgets provide a control mechanism through both the feed forward and feedback loops. The control mechanism in the budget is to provide a performance monitoring function to the appropriate managers who are responsible for implementing the various decisions by producing and presenting the performance reports. According to Drury (2010, pp.8-9), the performance report provide feedback information by comparing planned and actual results.

Generally, a functional budget is drawn up for each division of S.B. Ltd. These budgets are, then, merged together into a single combined statement, which is known as the master budget, of S.B. Ltd’s expectations for the future periods. The master budget consists of budgeted profit, which it is expected to convey to everyone in the organisation the part that they are expected to achieve in implementing management’s decisions. The master budget, usually, consists of a budgeted profit and loss, a budgeted balance sheet and a budgeted cash-flow statement. In order to finalised a budgeted profit and loss, other budgets for the individual divisions and produced, such as the sales budget, direct materials usage budget, direct materials purchase budget, direct labour budget, and selling and administration budget.

	Master Budget Budgeted Profit and Loss Account for the year ending 31 March 2011
			£		£
	Forecast sales (Schedule 1)				816,000
	Purchases (Schedule 3)
	Materials - Fruit		130,272
	Materials - Sugar		46,080
	Cost of raw materials consumed		176,352
	Direct Labour (Schedule 4)		155,520
	Factory Overheads (Schedule 5)		68,040
	Cost of Sales				399,912
	Gross Profit				416,088
	Selling and administration expenses (S6)				350,000
	Variable Costs (Schedule 7)				40,320
	Budgeted operating profit for the year				25,768

	Schedule 1 - Sales Budget for year ending 31 March 2011
	Product			Batches Sold		Selling Price		Total Revenue
	Strawberry Jam			12,000		28.00		336,000.00
	Raspberry Jam			6,000		32.00		192,000.00
	Orange Marmalade			7,200		40.00		288,000.00
								816,000.00
	Schedule 2 - Annual Direct Material Usage Budget
			Leicester		Nottingham		Loughborough		Total Units
	Strawberry		192,000						192,000
	Raspberry				96,000				96,000
	Orange						172,800		172,800
	Sugar		96,000		48,000		86,400		230,400
			288,000		144,000		259,200

	Schedule 3 - Direct Materials Purchase Budget
		Strawberry		Raspberry		Orange		Sugar
		(units)		(units)		(units)		(units)
	Quantity necessary to meet production	192,000		96,000		172,800		230,400
	requirements as per material usage budget
	Planned unit purchase price	0.31		0.39		0.20		0.20
	Total Purchases	58,752.00		36,960.00		34,560.00		46,080.00

	Schedule 4 - Annual Direct Labour Budget
		Leicester		Nottingham		Loughborough		Total
	Budgeted production (units)	12,000		6,000		7,200
	Hours per unit	0.80		0.80		1.60
	Total budgeted hours	9,600		4,800		11,520		25,920
	Budgeted wage rate per hour (£)	6.00		6.00		6.00
	Total Wages (£)	57,600		28,800		69,120		155,520

	Schedule 5 - Annual Fixed Overheads
		Leicester		Nottingham		Loughborough		Total
	Fixed Overheads hour	1		1		2
	Fixed overheads rate	2.10		2.10		2.10
	Fixed Overheads per batch	2.10		2.10		4.20
	Total Fixed Overheads (£)	25,200.00		12,600.00		30,240.00		68,040.00

	Schedule 6 - Annual Selling and Administration Budget
		£	£
	Selling:
	Advertising Costs	60,000.00
	Distribution Costs	50,000.00
			110,000.00
	Administration:
	Local Administration Expenses	90,000.00
	Head Office Costs	150,000.00
			240,000.00
			350,000.00

	Schedule 7 - Annual Variable Cost Budget
		Leicester		Nottingham		Loughborough
	Other variable costs	1.00		2.00		2.00
	Variable costs per batch	1.05		2.10		2.10
	Total Variable Costs	12,600.00		12,600.00		15,120.00		40,320.00

It is now April 2011. The actual results for the year 31 March 2011 are in Appendix 3.

Part 3

You are required to:

(a) Produce an operating statement for each division based on your own budgets.

(b) Write a report to the board appraising the performance of each division using whichever indicators you feel are appropriate. You should also suggest what other information should be obtained in order to improve your appraisal.

(c) Write a report to the company management accountant on whether the company should change their traditional approach to accounting for overheads to one based on Activity Based Costing.

Appendix 3 S.B. Ltd - Trading results for the year ended 31 March 2011
	Leicester				Nottingham					Loughborough				Derby
			£'000s					£'000s				£'000s		£'000s
Sales - Strawberry Jam	11000 batch													330
Sales - Raspberry Jam					6250 batch									200
Sales - Marmalade										6000 batch				250
TOTAL SALES														780
Fruit	170000kg		53		100000kg			36		140000kg		30
Sugar	84000kg		21		48000kg			12		68000kg		17
Labour	10000 hours		70		6000 hours			39		6000 hours		39
Variable costs			12					10				13
Fixed Overheads	10000 hours		22		6000 hours			12		6000 hours		15
Cost of goods produced and sold			178					109				114		401
Gross Profit														379
Advertising costs														60
Distribution costs														60
Local administration expenses			32					32				32		90
Head Office Costs														155
NET PROFIT														14
Note		Sales = Production

(a) According to Anon 3 (2010) and Anon 4 (2010), an operating statement is a detailed periodic report of the financial reports or a financial statement of a firm’s operations. In many organisations, management rely on the financial and quantitative statement provided to record performance achieved by that area of the operation, for a selected budget period, for which the management is responsible (Oxford University Press, 2009). S.B. Ltd practices a decentralised control over its responsibility centres where Derby division is delegated as the controlling costs centre. Decentralisation means there is a delegation of authority in decision making in the organisation. According to CIMA Official Terminology (Collier, 2007, pp.13-14), the financial control in divisionalised businesses is the divisional performance control by producing a budget and the monitoring of actual performance towards the budget.

Each division management will carry out a significant function in analysing and interpreting financial information and will achieve the target given. Below is the operating statement for the individual division based on the budget prepared in part 2.

Operating Statement for S.B. Ltd
Description	Leicester			Nottingham				Loughborough				Derby
Sales - Strawberry Jam		336,000										336,000
Sales - Raspberry Jam						192,000						192,000
Sales - Marmalade										288,000		288,000
Total Sales													816,000
Cost of Sales
Purchases - Fruits	58,752			36,960				34,560
Purchases - Sugar	19,200			9,600				17,280
Labour	57,600			28,800				69,120
Variable Costs	12,600			12,600				15,120
Fixed Overheads	25,200			12,600				30,240
Cost of goods produced and sold		173,352				100,560				166,320			440,232
Gross Profit		162,648				91,440				121,680			375,768
Operating Expenses
Advertising costs												60,000
Distribution costs												50,000
Local administration expenses	30,000			30,000				30,000				90,000
Head office costs												150,000
		30,000				30,000				30,000			350,000
Net Profit		132,648				61,440				91,680			25,768

Solomon (1965 cited in Collier, 2007, pp.13-14) highlighted three purposes for financial reporting at divisional level; to guide divisional managers and top management in decision making, and to enable top management to appraise the performance of divisional management.

(b) TO: The Directors of S.B. Ltd

From the earlier budget, the performances of all four divisions are appraised. The overall company’s performance as seen on Derby division operating statement seems to have achieved the budgeted gross profit. However, all the other costs, such as the advertising costs, distribution costs, local administration expenses and head office costs, influence the net profit not achieving the budgeted figure. The overall sales, although did not attain the budgeted sales, did make a good number and managed to produce the goods at a much lower price compared to the budgeted figure.

Operating Statement for Derby Division
Description	Current Period		Budgeted
Sales - Strawberry Jam	330,000		336,000
Sales - Raspberry Jam	200,000		192,000
Sales - Orange Marmalade	250,000		288,000
Total Sales		780,000		816,000
Cost of goods produced and sold		401,000		440,232
Gross Profit		379,000		375,768
Operating Expenses
Advertising costs	60,000		60,000
Distribution costs	60,000		50,000
Local administration expenses	90,000		90,000
Head office costs	155,000		150,000
		365,000		350,000
Net Profit		14,000		25,768

The performance of Leicester division is seen not to be performing to the budgeted figures in the operating statement. The actual sales of the strawberry jam was just £6,000 less than thee budget and managed to pull off a noteworthy net profit, although not as expected as in the budget. According to ACCA (1988, p.54), preparing a set of costing will be a waste of time unless it has a purpose. Comparing the current period figures with the budgeted figures, in order to establish costs control and efficiency in the division and to prevent unnecessary use of services.

Operating Statement for Leicester Division
Description	Current Period		Budgeted
Sales		330,000		336,000
Cost of Sales
Purchases - Strawberries	53,000		58,752
Purchases - Sugar	21,000		19,200
Labour	70,000		57,600
Variable Costs	12,000		12,600
Fixed Overheads	22,000		25,200
Cost of goods produced and sold		178,000		173,352
Gross Profit		152,000		162,648
Operating Expenses
Local administration expenses		32,000		30,000
Net Profit		120,000		132,648

The actual sales of the raspberry show a positive comparison. However, the gross profit figure is slightly lower than the budgeted figure. Unfortunately the increase in local administration expenses razed the actual net profit figure. The cost of purchasing sugar was expected to be lower in the budget as well as the labour costs was projected to be lower. Auspiciously, the current period net profit has achieved a positive figure.

Operating Statement for Nottingham Division
Description	Current Period		Budgeted
Sales		200,000		192,000
Cost of Sales
Purchases - Raspberries	36,000		36,960
Purchases - Sugar	12,000		9,600
Labour	39,000		28,800
Variable Costs	10,000		12,600
Fixed Overheads	12,000		12,600
Cost of good produced and sold		109,000		100,560
Gross Profit		91,000		91,440
Operating Expenses
Local administration expenses		32,000		30,000
Net Profit		59,000		61,440

The Loughborough division, on the other hand, is making a good profit from the sales of marmalade. The sales of marmalade were projected to be higher; however, the current period gross profit and net profit are more than the budgeted figure mainly attributed to competitive purchase prices of oranges and sugar, low labour costs, low variable costs and low fixed overheads.

Operating Statement for Loughborough Division
Description	Current Period			Budgeted
Sales		250,000				288,000
Cost of Sales
Purchases - Oranges	30,000			34,560
Purchases - Sugar	17,000			17,280
Labour	39,000			69,120
Variable Costs	13,000			15,120
Fixed Overheads	15,000			30,240
Cost of good produced and sold		114,000				166,320
Gross Profit		136,000				121,680
Operating Expenses
Local administration expenses		32,000				30,000
Net Profit		104,000				91,680

(c) TO: The Management Accountant

Traditional Costing System

The traditional costing approaches were developed in the early 1900s and they are still widely used by organisations today. They rely broadly on arbitrary cost allocations. These approaches rely on an essentially arbitrary allocation of indirect costs. Such approaches do not give managers accurate product cost information; therefore, accurate production profitability calculation is not possible. The overhead rate in traditional costing approaches would typically by calculated using direct labour hours, machine hours or units. Consequently, this could lead to accurate product costs when direct costs were high and indirect costs were low.

According to Collier (2007, p.60), under the traditional costing approaches, organisation production runs to obtain the lowest unit of cost production and support the mass production model that seeks economies of scale. The overhead rates calculation to the traditional costing approaches is relatively straightforward; hence, they are widely understood in the business. Although, they are relatively cheap to operate and were seen as fairly accurate until the rise of activity-based costing in 1987, many other organisations are using them after many decades.

Traditional costing approach is a systematic costing approach that prevailed before the rise of the activity-based costing in 1987. Since then, the traditional costing approaches weaknesses were fairly visible. Their reliance on arbitrary rather than cause-and-effect allocation of overheads and their inability to produce accurate product costs in multiproduct companies were very much clearer. Their failure to analyse non-manufacturing costs made it less appropriate for modern costing approach in organisations.

Activity-based Costing

As proposed by Professor Johnson and Kaplan in their book Relevance Lost: The Rise and Fall of Management Accounting (1987 cited in Oxford University Press, 2009), they question the widespread misconception exists that using accounting information and the inadequacy of conventional approaches arises from a lag in replacing the modern cost accounting approach. The new approach is designed with modern information and accounting systems for financial reporting and tax purposes, hence it recognises that costs are incurred by each activity that takes place within the organisation and that products should bear costs according to the activities use.

In Professor Johnson and Kaplan’s method, the cost drivers are identified, together with the appropriate activity cost pools, which are used to charge costs to products. The fundamental of this approach is the view that the forces which drive overheads, undeniably most organisational costs arise from specific activities (Miller and Vollmann, 1985, p.144 cited in Ashton, 1991, pp.52-32). As a result, overheads control must focus on the management of these activities. The purpose of the activity-based costing approach are to stabilise unit costs of production per period and the reported gross profit per unit will be comparable from one period to the other by stabilising unit costs.

Comparison

In this time of rapid technological change, vigorous global and domestic competition, and enormously expanding information processing capabilities, management accounting systems are not providing useful, timely information for the process control, Johnson and Kaplan (1987, pp.144-146) suggested that the activity-based costing approach has catalysed an enthusiasm for motivating every member of the business organisation to meet profit goals. Also according to Johnson and Kaplan (1987, pp.144-146), present-day critics often note that successful Japanese and German manufacturing firms use this approach.

Both traditional costing and accounting-based costing vary in their level of sophistication (Drury, 2010, p.165). The traditional systems often tend to be simple and straightforward while activity-based costing tends to be sophisticated and more accurately assigning indirect costs to cost objects. Although the traditional accounting is simpler to prepare while the activity-based costing is highly sophisticated to prepare, the activity-based costing tend to result in lower costs of errors and high level of accuracy. The downside of activity-based costing is that it is expensive to operate and they are sophisticated. However, they minimise the costs of errors which will save the company a lot in profit in the longer run. The activity-based costing extensively use the cause-and-effect cost allocations compared to the traditional costing approached extensively use the arbitrary cost allocations.

Recommendation

ACCA (1988, p.171) recommended that the choice between the traditional costing approaches and activity-based costing approach in budgetary control depends on the method of accounting used in S.B. Ltd’s cost accounting system. If the operating expenses were charged to the respective divisions, it would reflect the use actually made by each division. Then, the overhead costs of the divisions will be established more accurately.

Traditional cost system often report inaccurate product costs and the company tend to lose out due to over priced products, incur hidden losses due to under priced products. The benefit of activity-based costing is that when it comes to improving productivity, it opens up for a much wider array of measures or methods. By examining the activities systematically, one will not only be able to identify surplus capacity if it occurs, but also lack of capacity and misallocation of capacity. A result of this might be that costs are cut the customary way, but might as well lead to a reallocation of capacity to where it is needed most which will yield better productivity.

The rapid pace of today’s technological change continues to shorten product life cycles, thus our company do not have the time to make cost adjustment once errors are detected. Today computer technology prices are decreasing and are more affordable, the cost of adopting and operating an activity based costing system has also decreased.

Therefore, the company should adopt the activity based costing in order to facilitate cost management and improve financial management. According to Karolefski (2004, p.18) “activity based costing works better if it is kept simple”. Nevertheless, when implemented properly activity based costing yields benefits to the company, its business partners, and to consumers.

Reference

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