Costing Systems

Qs C8.48

Submitted by: Zeeshan Murtaza

Submission Date: October 4th, 2013

 1. Changes in Cost Structure at Cravings for Cakes

Cost structure can best be defined as

“The expenses that the firm must take into account when manufacturing a product or
providing a service. The cost structure of the firm is the ratio of fixed costs to variable costs”

(Definition of “Cost Structure”, www.investorwords.com, dated Oct 1, 2013)

Due to the introduction of recent new products like Danish pastries, donuts and vanilla slices
compared to the products supplied by the bakery for past 20 years when the bakery only
produced three product lines, the cost structure for Cravings for cakes have changed
significantly. The significant change in the cost structure has been witnessed due to the
complex production methods of new products that not only requires extra hard work and
working hours from employees but have immensely increased the cost of production by
means of shorter production runs, extra machine hours, complex processing and material
handling costs.

In the past the bakery used to manufacture the products manually that required more
manual work from the employees and the cost of the good consumed so the variable cost of
producing goods was high while the fixed cost was low, but in recent times due to more
complex production and equipment required for production, the fixed cost have increased
considerably while the variable cost for producing the new range of products is low.

2. The existing costing system understated or overstated the cost of;

a) Lamington
b) Danish Pastries

a) Lamington: After analysing the case study I can infer that the existing costing system has
overstated the cost of lamington. By using the traditional volume based costing the bakery
lacks the understanding of how costs are incurred, as the accountant is not able to clearly
determine the overhead costs associated with the product therefore overstating the price of
lamington.
 b) Danish Pastries: From the case study, we can comprehend that the price of Danish
Pastries has been understated; the accountant has given a green signal and informed the
bakery that these are low cost product with high profit margin. The accountant has not been
able to analyse the overhead costs associated with the product which is causing bakery not
being profitable.

3. How Activity Based Costing overcome the short comings of traditional costing;

The deployment of Activity based costing in place of traditional volume based costing will
result in better understanding of how costs are incurred, along with providing information
that will result in better decisions being made about product pricing, product mix and that
will also lead to improved financial performance. (Cooper and Kaplan 1991,CPA Module 4,
“Strategic Management Accounting”)

Activity based costing which is commonly known as “ABC” better reflects the underlying
drivers of costs. It provides more accurate allocations of indirect costs in the products
manufactured therefore leading to improved decision making.

To sum up, we can say that Activity Based Costing overcomes the short comings of
traditional costing by providing;

a) More accurate cost information to support both strategic and tactical decisions.
b) Improved cost management capability.
c) A better understanding of the profitability of individual products and customers.

4. Factors that U.B. Bright considers for deciding which costing method to use;

There are number of factors that U.B. Bright need to consider before deciding the costing
method to use. The factors include;

a) Operational Diversity and Complexity: When the organization is involved in producing

range of product lines and as each unique product requires unique components and
greater number of process options become available to manufacture products,
complexity increases like in the case of cravings for cakes it is advisable for the bakery to
reconsider its costing system.
b) The Strategic and Tactical Importance of Cost: When cost is of significance importance
for the organization and important for the strategic future like for cravings for cakes, and
when it is used as the basis for decision making. The organization need to give a serious
thought in considering using ABC costing.
c) Competition Intensity: When the competition increases it is more likely that a
competitor will exploit any costing errors made by the organization. Therefore, as the
competition increases more reliable cost information must be required to better
understand the costing of the products.
(Factors leading to implementation of ABC, CPA Module 4, “Strategic Management
Accounting”)

After analysing the above factors we can say that it is advisable for cravings for cakes to
consider using ABC costing compared to other two methods the reason being the
traditional costing method is no more beneficial for the organization as it is not serving
the purpose for the organization by not providing the accurate cost information.
Furthermore, comprehensive Activity based costing is also not suitable for cravings for
cakes as it is generally recommended for large businesses due to its complexity and
higher costs. For the cravings for cakes, a small retailer business it is suitable to use
Activity based costing to determine the accurate costing of its products so that it can
manipulate the product range accordingly based on the profit margin provided by the
products.