You are required to explain how you would calculate the cost of an individual product, service or activity using relevant examples. In doing this you should clearly explain any areas where judgement was required or limitations in your methodology. Finnally you should comment on whether or not you would be happy to use your calculations for decision making purposes.
Cost accounting as an important job of cost management, it aims to reflect the costs of organizational operation. To maintain long term profitability, the business must sell their production at a price which exceeds their costs of productions. So mangers make better decision and achieve greater control in the material costs by analyzing their cost accounting. However, there are many intrinsic limitations and flaws in the traditional cost calculation methods. So in this paper, we are going to calculate the cost of cooking food by using traditional costing. Next, we would like to compare the traditional costing method with absorption costing and activity-based costing, to discuss whether the traditional approach effectively reflects the correct cost, and what the limitation in these costing methods. At last, we would like to explain which costing methods should use for decision making purposes.
Traditional costing methods
Whatever the nature of the business, all will produce costs. The manufacturing costs are divided mainly into two categories: prime costs and production overhead costs. The prime cost consist of direct materials and direct labor and any others costs that can be directly identifiable with a product. (Weetman, 2003)There are disparate methods used to absorb overhead costs into products. Such as the conventional volume based costing, it allocates production overhead costs to a single cost pool--production overheads, and then the production overheads are shared by apportionment to products which lie on the number of units manufactured. (Pizzey, 1998) However, its method is so simple that it ineffectively reflects the correct cost. Next, eight traditional methods will be used to analyse the cost of cooking. For example: I cook dinner by myself in UK. The following tables show costs incurred by the cooking per month:
Indirect costs incurred by cooking
Total cost this month
Power for machines
Information about each food
Number of cooking food (units produced)
Direct labour hours worked
Machine hours used
Specific units: OAR= TCCO/ Number of units = ￡6/30= ￡ 0.50 per unit Direct material cost: OAR=TCCO/direct material cost×100= ￡6/ 50= 12% Direct labour cost: OAR= TCCO/ direct labour cost×100=￡6/150= 4% Prime cost: OAR=TCCO/ prime cost×100= ￡6/ 50+150= 3%
Direct labour hours: OAR=TCCO/ direct labour hours= ￡6/ 30= ￡0.20 per direct labour hour Machine hours: OAR= TCCO/ Machine hours= ￡6/30= ￡0.20 per machine hour.
The limitation of traditional costing methods
The limitation of traditional costing methods is because it applies a volume based cost accounting. However, it can be no causality relation between each other. As shown above, the cost of maintenance equipment has no relation with any direct costs. This distribution ratio resulted in an inaccurate cost of production. At the beginning of last century, the production overheads have a small proportion of the direct costs. Most factories were labor-intensive manufacturing. It resulted in a high proportion of the cost of direct labour and direct material in total product costs. Thus, lower production overhead could not significantly affect the total cost of production. With the development of modern manufacturing industry, traditional unitary-breed, huge-batch, rigid production has been already changed to multi-breeds, few-batch, high-accuracy flexible production. The larger numbers of...
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