The importance of using activity-based costing.
The activity-based system uses sophisticated methods to allocate indirect costs to
cost objects, since there is increased competition in the design and manufacture of
injection-moulded plastic components, it is recommended that Precision Plastics
using the Activity-based costing.
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The activity-based system first allocates costs to activities, in this case the
activities material handling, quality inspection and machine set-ups. Secondly,
it uses second stage cost drivers such as, number of material movements,
number of machine set-ups and number of units inspected
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The Board of Directors is considering on investing in Industry 4.0
technologies, the proposed automated system reduces the reliance on direct
labor as automated support activities such as real-time production monitoring,
Internet of Things sensors and predictive maintenance system are driven by
activity complexity, rather than labor hours. Therefore, using direct labor hours
to allocate overheads would distort the cost of automotive products.
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The Financial Director emphasized that management is facing difficulties
isolating costs as trimming, quality inspection and assembly. In activity-based
costing system, the manufacturing process is broken down into activity pools
which will enable management to conclude whether the automated system
achieves the targeted unit savings.
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Precision Plastics primarily supplies to Tier 1 automative suppliers who hold
strong purchasing power and demands annual price reductions. Without the
implementation of Activity-based costing system, the company might increase
the price of high-volume components or decrease the prices of low-value
components. However, ABC ensures accurate cost-to-serve data allowing for
a sustainable pricing model.
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Limitations of standard costing
As Precision Plastics relies on monthly budget-versus-actual reporting, it is
important to take into account company costs such employee wages,
electricity, logistics and quality requirement are changing significantly which
means that historical budgets and standards may quickly become outdates.
Management must take great care to study past importation and data, if
standards are not determined correctly, all further analysis interpretation and
decisions will lead to confusion and losses.
Favorable variances are mainly ignored as management often investigates
unfavorable variances, which causes low morale for employees such that they
do not report negative exceptions to the budget to conceal inefficiency, which
ultimately diminish the effectiveness of budgeting.