Problem :
Problem in cost accounting system followed by the company
Failure in current costing methods
Problem in computing its true cost
Analysis:
Failures in the existing cost system are due to several factors. First of all,
when JDCW calculates its standard direct labour, direct machine hours, and
total overhead, the volumes are calculated on a long term basis. However, if
the actual production volume is not for the long term it becomes a problem,
this in the sense that it is difficult to modify the system as to accommodate for
any increases or decreases in the production demand.
Secondly, when JDCW updates its overhead rates for the upcoming year, its
forecasts are based on the previous years’ figures. This system is going to
result in serious inaccuracies, especially when the company attempts to tackle
production volumes that are completely “alien” to the companies’ historical
production trends.
As foreshadowed, the standard accounting cost system used by the company
is significantly out of date. This is because the system was originally designed
to handle a direct labor intensive production process with little overhead costs.
However, when the company changed its production process to a more
automated system, it simultaneously increased its overhead costs. This
dramatic overhead increase was embodied through increases in supervision,
maintenance, electricity, and setups. Since more overhead costs were now
being incurred, a new system had to be implemented to adapt to this new
environment.
These weaknesses further support the fact that JDCW’s bids were
continuously miscalculated in relation to their competitors. Using the existing
system, management at JDCW continually under-costs its low-volume parts
and over-costs its high volume parts. If its bids were to be based on the ABC
method, JDCW’s costs would be more accurate, and it would most likely
acquire a higher number of bids. Since the production of low volume parts is
less efficient than high volume parts, it is in the interest of JDCW to attain
higher volume bids. However, since its Standard Cost system is flawed, the
bid proposals submitted by JDCW are also flawed.
Recommendations
Change from standard costing to activity based costing