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Case Scenario 1

Order Number 377
Summary total cost statement

For example.000 items included in the batch.(b) Cost driver or we can called as cost generator or cost determinant is a factor which causes the amount of cost incurred to change. the cost to set up a machine to run a batch of 1. 1. 3. (i) Direct material costs are driven by the quantity. This cost must then be allocated to the 1. (i) The number of marketing visits to a client per order is the cost driver for marketing cost chargeable to the order. quality and price of materials required per product unit according to the specification for the order. range. For example. This cost must then be allocated to the 1. . This may be explained by considering costs for each of the four levels in Order Number 377. For example. For example.000 items is a batchlevel cost. (i) The number of machine set-ups per batch is the cost driver for machines used. Batch related costs are costs incurred every time a group or batch of units is produced or a series of steps is performed. For example. For examples. Unit based costs occur every time a service is performed or a product is made. (ii) The number of design hours per batch is the cost driver for design work. Product sustaining costs are performed to enable the production and sales of individual products. the costs of marketing visit to clients are based on the number of visit per order regardless of the number of units or batches in which the units are produced. 2. the direct material cost for product Zeta is based on cost per unit. (ii) The number of hours of production line maintenance per order is the cost driver for production line cost.000 items is a batch-level cost. the activities that are needed to support an entire product line but are not performed every time a new unit or batch of products is produced. plant management and property costs.000 items included in the batch. Total direct material cost = cost per unit × total unit (ii) Direct labour costs are driven by the number of hours required per product unit and the rate per hour that has been agreed for each labour grade. Business sustaining costs are performed to support the facility’s general manufacturing process and include general administrative staff. if a firm produces 20% more units it will consume 20% more labour cost. 4. the cost incur in the number of design hours to run a batch of 1.

For the inefficiency material procurement. (iii) Product sustaining (order level) costs The production line maintenance cost may be reduced by either outsourcing services or internal sourcing. it can also reduce the cost directly. Production line maintenance includes machine installation. Inflation is the cause that no one is able to control therefore this is an unavoidable problem. parts assembly and so on.250 units to reduce the number of batches from 5 batches to 4 batches. company may provide additional training program to the purchasing department on sensitivity on the material price and the way of communication with suppliers to avoid displease them.(i) These costs are absorbed at a rate of 30% of total cost excluding business sustaining costs. This is an arbitrary rate which indicates the difficulty in identifying suitable cost driver/drivers for the range of residual costs in this category. Wherever possible efforts should be made to identify aspects of this residual cost that can be added to the unit. This approach will not only reduce the number of machine set up per batch.related cost The number of machine set up per batch may be affected by the units of product Zeta per batch. problem of inflation might be solved by establishing good relationship with suppliers and try to get more discounts by purchasing larger amount of materials for each times. Company can plan to increase the number of units in each batch up to 1. Inefficiency material procurement can be the unpleasure relationship between purchasing department and supplier and the negligence of staff to wrongly buy the high price material. Number of machine set up per batch can be reduced with proper planning on the units per batch in order to reduce cost by maintaining the number of orders of 5000 units that needed to fulfill. cabling. However. batch or product related analysis. (ii) Batch. control panels. (c) The likely cause of cost driver for each level as the following: (i) Unit-based cost The material price may be higher due to the inflation or inefficiency of material procurement. For internal .

This is because high quality professional services in their maintenance can help to avoid time consuming on parts assembly. Besides. It provides the accurate allocation of cost of resources used in each order. GMB Company can provide training to existing employees in production department to improve the level of skill of maintenance. it requires substantial resources such as management time and cost in order to implement an activity-based system. It is costly to maintain the system as the data concerning numerous activity measures must be updated on a regular basis. When the problem of time consuming can be solve the cost will also reduce since when high efficiency can increase the production of a company. Moreover. Activity-based system requires management to not only estimate the costs for each of the activities but also identify and measure the cost drivers for such activities. As the result. GMB Company can also use outsourcing with low price and high quality professional services in reducing production line maintenance cost. Firstly. identification of causes of cost drivers also provides great assistance to the management. activity-based system data need be used with care because the date can easily be misinterpreted.sourcing. On the other hand. The training and outsourcing may be lead to high cost in temporary but this two types of option can help the company to save cost and may make higher profit in the long run. Managers that used this system required identifying which costs are really relevant before making any significant . The main benefit to identify the cause or causes of cost driver is to help the company in reducing the costs per unit of cost driver. (d) There are many problems that may be encountered in the implementation of an activitybased system of product cost management. the organization will take wrong decisions. It offers the information about causes that affecting each cost and help management to know which costs can be reduced and not necessary to incur. This may help the company to save time in produce more products when employees have sufficient knowledge on maintenance.

Thus. filings. Moreover. and statutory compliance. activity-based costing system does not conform to generally accepted accounting principles. an organization that involved in activity-based costing system should have two cost systems. This is because most of the companies are using traditional costing systems and reports produced by activity-based system are different from the profit and loss reports produced through traditional costing systems. . Activity-based costing system produces numbers such as product margins that are at odds with the numbers produced by traditional costing systems. most of the managers will allocate all costs to products. This will lead to overstating the costs and understanding the margins and mistakes in pricing and other critical decisions. The selection of relevant activities and cost drivers may also be complicated where there are many activities and cost drivers in complex business situations. fire safety campaign attended by an employee does not add any value to the end product or service although it is a productive activity. An extensive data collection and analysis system may be required in order to solve this problem. Management should know that not all productive activities need to add value to products. it will create some difficulties in the collection of data which will affect the accurately of the cost driver rates to be calculated. This means that organization need to duplicate their efforts by maintaining two cost systems and separate accounting books for internal use and external reports. customers. Lastly. Thus. Furthermore. This is costlier than maintaining just one system and may cause confusion about which system is to be believed and relied on. organization that choose to use activity-based system cannot compare its result with others companies of the same industry. the managers will include the cost of idle capacity and organization-sustaining costs.decisions. One system is for internal use and one is for preparing external reports. and other costing objects in an activity-based costing system. For example. For instance. in practice.