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Activity Based Costing – Glaser Health Products Case

Introduction

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Glaser Health Products manufactures medical items for the health care business. Production involves machining, meeting and portray. Finished units are then packed and shipped. The financial controller is involved to introduce an activity-based costing (ABC) system to allocate (or distribute) indirect costs to products. Indirect prices, as distinct from direct costs, can’t be unambiguously linked to specific merchandise. The controller want to calculate product costs primarily based on ABC for planning and management, not stock valuation. Under an ABC system, the allocation of costs to merchandise is achieved through a minimal of four analytical steps.

Firstly, costs are grouped into exercise levels.

Secondly, cost drivers are chosen for each activity stage to hyperlink activities with prices. Thirdly, for every exercise level, a value perform is defined to arithmetically describe the relationship between cost drivers and prices. Finally, a unit allotted price is calculated for each product (Schneider, 2012). This paper outlines a process for introducing an ABC system at Glaser. The paper is divided into six sections.

The first section teams price categories recognized at Glaser by division. The second section teams value categories by division and activity degree. The third part identifies particular price drivers for each activity degree. The fourth part explains preliminary stage allocation. The fifth section explains primary stage allocation. The final part summarizes the main conclusions.

Cost Categories by Division

Glaser is organized into three functional divisions – Operations, Sales, and Administration. Operations is the only price or activity center. Glaser acknowledges 22 price categories. These cost classes are grouped by division in Table 1, proven in the appendix.

Cost Categories by Division by Activity Level

The second step in an ABC system entails grouping costs primarily based on the extent of exercise at which they’re generated. An exercise entails the movement or dealing with of any half, part, or finished product throughout the related organizational unit. The rationale for this grouping is that costs at each activity degree are determined by different price drivers. Four ranges of exercise are commonly acknowledged – unit, batch, product and facility degree. Unit-level actions are probably the most granular level of exercise. They are performed every time a sub-unit is produced. Unit-level actions are on-going and mirror basic manufacturing tasks. Direct labor or direct materials are examples. Costs of these actions mainly differ according to the variety of items produced. Batch-level actions are related to batch (rather than continuous) manufacturing processes.

They are carried out every time a batch of product sub-units is produced. Typical examples of those prices relate to machine setups, order processing, and materials han¬dling. Costs of these activities vary mainly according to the number of batches produced, not the variety of items in every the batch. Product-level actions support production of every product. The prices of these actions range mainly according to the number of separate product models. Examples embrace sustaining payments of materials, processing engineering modifications, and product testing routines. Facility-level actions are frequent to a big selection of totally different products and are essentially the most difficult to hyperlink to individual product-specific activities. These actions sustain the production process at an general manufacturing plant or facil¬ity. Examples embrace plant supervision, rental expense and other constructing occupancy prices. Some companies, together with Glaser, choose not to allocate facility-level prices to product costs.

Based on these exercise degree distinctions, the 22 Glaser cost categories could also be grouped by division and activity degree as proven in Table 2. By means of digression, it is value mentioning that as a broad generalization, unit-level actions tend to generate mainly variable prices while and facility-level activities tend to generate mainly mounted prices, although there can be exceptions. Activities within the different two activity levels are inclined to generate a combination of variable and fixed (Hansen & Mowen, 2006).

Cost Drivers by Activity Level by Division

Cost drivers may be identified for every exercise or value category based on statement, discussions with administration, simulations and statistical studies. The secret is to determine the habits of oblique prices with respect to exercise or resource utilization in every activity middle (Leslie, 2009). These efforts have identified the eight price drivers proven in Table 3. Direct labor assembly costs are, by their nature, immediately traceable to individual products. Therefore the related cost driver for this value is the variety of Direct Assembly Labor Hours. The different 21 value classes are indirect costs. At the unit exercise degree, electricity meeting prices are likely to range with Direct Labor Hours, Assembly. Similarly, the three machining prices grouped on the unit-activity stage are prone to vary with by the variety of Direct Labor Hours, Machining. Secondly, on the batch exercise degree, paint price is prone to differ primarily with the Number of Batches Processed. Painting exercise is the only batch exercise at Glaser.

Thirdly, at the product activity stage, the 2 Operations prices are more likely to range mainly with the Number of Units Produced and the three Sales costs are also prone to range primarily with the Number of Units Produced. Finally, at the facility-level, the 5 Operations costs are prone to differ primarily with the Number of Units Produced, the Square Feet of Building Space Used, Payroll Costs, the Number of Employees, and the Change in Number of Employees. The three Sales costs are also likely to differ primarily with the Number of Employees. The three Administration costs are prone to range mainly with the Number of Employees, the Change in Number of Employees and the variety of Square Feet of Space Used. In abstract, eight separate price drivers may be used by Glaser to link actions with oblique costs and at last allocate these prices to particular person products. These cost drivers are summarized by activity degree by division in Table three.

Preliminary Stage Allocation

Direct costs may be linked immediately to a product with out the necessity for a cost driver. This is not true for indirect costs. An indirect price requires a value driver to link that value with an exercise and eventually a product (Kimmel, et. al., 2010, Chapter 5). The first step in allocating indirect prices to merchandise is to complete a preliminary stage allocation. This involves allocating the assist heart costs to the activity centers. In the case of Glaser, there is solely one activity center, Operations. The Glaser controller has decided that the ABC system applied at Glaser should allocate all oblique value categories to products apart from the three Sales and three Administration classes categorised as facility-level prices. The solely non-activity center costs that have to be assigned are the three product-level Sales division prices. This allocation might best be demonstrated with an example as summarized by Table 4 supplied in the appendix.

The desk assumes Glaser produces two merchandise, A and B, with 30,000 models of every product produced during the period. It also assumes that product-level Sales division costs total $300,000. Allocation of these non-activity heart prices lead to unit costs of $5 for Product A and $5 for Product B. These unit costs are identical at $5 as a end result of the variety of models produced is equal at 30,000 models for Product A and 30,000 models for Product B. These non-activity heart unit prices must be added to unit costs derived from the primary stage allocation.

Primary Stage Allocation

In the first stage allocation, activity middle (that is, Operations division) costs are assigned to each of the 2 products. In the example summarized by Table 5, the thirteen costs assigned to Operations totaled $2,041,000. Allocation of these costs primarily based on the assorted cost drivers leads to unit costs of $40.60 for Product A and $27.43 for Product B. Once the $5 non-activity center unit cost is added to every product, the entire allotted unit cost is $45.60 and $32.forty three for Product A and B respectively.

Conclusions

Accounting offers details about the financial health of a firm. That data is utilized by a wide range of stakeholders and different involved events including managers, buyers, funding analysts, employees, suppliers, prospects, monetary journalists, and regulators. At the broadest stage, the data is used to improve resource allocation. ABC is an efficient example of accounting data being used to raise useful resource effectivity. ABC permits administration to methodically identify activities and sources used to provide a product. The system distributes indirect prices to particular person products and in that method improves product costing and pricing which in the end impacts shopping for decisions by shoppers and investment selections by management and buyers (Edmonds & McNair, 2012).

Finally, the Glaser controller determined that the ABC system at Glaser won’t allocate all indirect cost classes to merchandise. The three Sales and three Administration division cost categories categorised as facility-level prices are excluded from the allocation process. To that extent, prices are not absolutely distribute or allotted to merchandise. The excluded sales and
Administration costs should be recognized at some stage through the product value setting course of in any other case those prices will not be recovered by the resultant product prices.

References
Edmonds, T.; Olds, P. & McNair, F. (2012). Fundamental monetary accounting concepts. Kindle Edition.
Hansen, D. R. & Mowen, M. M. (2006). Cost management accounting and management. Ohio: Thomas South-Western.
Kimmel, P.D., Weygandt, J.J. & Kelso, D.E. (2010). Financial accounting: Tools for enterprise decision-making (5th ed.). John Wiley Sons: Hoboken, NJ.
Leslie, C. (ed.)(2009). Management accounting: data for creating and managing value. McGraw-Hill Australia.
Schneider, A. (2012). Managerial accounting: Decision making for the service and manufacturing sectors. San Diego, CA: Bridgepoint Education.

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