Costing system of Solar Power Company

Question: Discuss about the Costing system of Solar Power Company. Answer: Introduction Management accounting or costing is being used in the business to determine the cost of manufacturing the products and to know what cast has been occurred to produce per unit of product. Costing help the management to know the overhead cost of production and how these costs can be divided in the product cost so that proper profits can be determined. Mainly there are two major costing systems used to divide the product or service cost, namely traditional costing system and other one is Activity Based Costing System (Besley and Brigham, 2008). In this report Costing system of Solar Power Company (SPC) will be evaluated in detail and recommendations will be provided to improve their costing system. Currently SPC uses traditional costing system to allocate their overheads and to calculate per unit costing. Company is in view to change the system of costing so that proper profit can be divided among panel A and panel B. Use of Activity Based Costing System over traditional or current costing system Conventional or traditional costing system assigns the costs to the different products on the basis of average overhead rate. For example, labor hr rate can be used to assign the overheads costs to the products. According to this system all the indirect costs used in the production or administration are divided equally amount all products irrespectively such products are being part of particular indirect cost. On the other hand activity based costing system, firstly identifies all the activities in the process of production and appropriate cost driver is being used to find out cost pool of activities. ABC system divides the overhead cost according to activity being used in manufacturing the particular product. It helps in identifying the actual cost of product and profit earned during the period (Friedman, 2009). In this report, both traditional and ABC costing system is being used to find out the profits of panel A and panel B, in order to make comments on how accurate the activity based costing is to allocate the overhead cost in panel A and panel B. Calculations are performed on the given product cost data and per unit product cost has been calculated using both traditional costing system and activity based costing system. There has been noted wide difference in method of costing and per unit product cost of panel A and panel B. When traditional or current costing method has been used to calculate the per unit product cost than cost of panel A occur to be $14.75 and cost of panel B occurs to $ 30.00 per unit. This cost has been arrived through allocating the prime cost and per unit overhead cost to both panel A and panel B. The overhead rate has been calculated using the labor hour rate. Through using the activity based costing system it has been found that per unit cost of panel A was $21.50 and that of panel B was $ 25.50. This difference in per unit cost arrives due to proper allocation of each overhead cost when arriving at total cost occurred for panel A and panel B. While estimating the per unit product cost of panel A and panel B using the ABC costing all the overhead costs are divided among the panels as according to their usage of particular activity in their manufacturing process. When calculating the net profit for both the categories of products according to reign through using the current costing method, it has been found that net profit in southern reign for the panels is $13,199.40 and in northern reign it is $4,572.00. On the other hand, when estimating the profits of both the panels for each reign through using the activity based costing it has been found that net profit for southern reign was $17,559.67 and for northern reign it was $212.33. This difference was due to proper allocation of activity cost in each product in activity based costing system (Pratt, 2003). On the other hand in traditional costing system all allocations have been using the labor hour rate. Wrong Decision made by management while using the current costing method It has been found that management has using the traditional costing system to allocate all the overhead cost in both the products. Prime costs are divided directly using the usage of labor hours and raw materials in each products (Drury, 2005). In case of overheads cost all the costs are sum up and are divided using the labor hours used by each product in their manufacturing process. This costing process ignores the actual usage of different activities by each product. Limitations of using the Activity Based Costing System It has seen that there have been many limitations while adopting the activity based costing system. Firstly, it is very expensive to implement the activity based costing system as against using the traditional costing method. In case of activity based costing system there is requirement to breakdown all the business process into activities and division of each activity has to be made according to the usage by each product. It requires huge time and manpower to make such allocation of each activity (Bierman and Smidt, 2007). Conclusion It has been found that while using the activity based costing system, proper allocation of all the cost has been made. Division of cost using the activity based costing system gives actual net profit earned in each reign and it helps to focus on reign that provides low profits. While using the traditional costing all the overhead cost is dividing on single recovery rate and it provide wrong results. It is highly recommended to the SPC Company to use the ABC costing for division of overhead cost. References Besley, S. and Brigham, E. F. 2008. Essentials of Managerial Finance. Cengage Learning. Bierman, H., and Smidt, S. 2007. The Capital Budgeting Decision, Ninth Edition: Economic Analysis of Investment Projects. Routledge. Drury, C. 2005. Management Accounting for Business Decisions. Cengage Learning EMEA. Friedman, M. 2009. Price Theory. Transaction Publishers. Pratt, S. P. 2003. Cost of Capital: Estimation and Applications. John Wiley Sons.