Allocation Overheads on a Rationale Basis †Myassignmenthelp.Com

Question: Explain Allocation Overheads on a Rationale Basis? Answer: Introduction The allocation of overheads on a rationale basis on the products is very important because it has great bearing on the managerial decision making. The overhead costs comprise a substantial portion of the total cost and hence requires rationale basis for allocation. Traditionally, the overhead costs have been allocated applying the volume based cost drivers, however, in the present era, the activity based costing has provided even better way assign the overhead costs to the products. In this context, the aim of this report is to present a critical analysis on the use of activity base costing by Stylish Ltd, which engages in the manufacturing of the coffee tables. Further, the discussion in this report also extends to identification of a suitable industrial reward system and result of the sensitivity analysis. Argument for and against the Benefits of ABC It is argued that the activity based costing provides a rationale basis for allocation of the fixed overhead cost to the products. Under the activity based costing, the overheads are allocated to the products on the basis of consumption of resource identified with reference to different activities (Salem and Mazhar, 2014). Further, it is argued that detailed analysis into the activities is carried out in the activity based costing which helps to correlate the fixed overheads to the products in a better way. The conventional costing system which allocates the overheads to the products by using volume based cost drivers such as machine hours, labor hours, and units produced may result in distorted view of the allocated cost. The cost distortion is particularly possible when the overhead cost comprises significant of fixed cost which is derived by the non-volume based cost drivers (Salem and Mazhar, 2014). Therefore, in order to avoid the situations of cost distortion, it is essential to adopt activity based costing system to allocate the overheads. Further, it is argued that since the activity based costing provides rationale basis for allocation of the overhead costs, therefore, it also helps the management in taking optimal decisions in regards to product additions and deletions (Salem and Mazhar, 2014). The true and correct picture of the cost profitability will be available with the manager and thus, possibility of suboptimal decisions is reduced. Though, the activity based costing is quite useful, but it suffers from certain limitations and challenges. In this regards, it is argued that the activity based costing requires changes in the accounting and reporting system at a large scale. The changes in the accounting and reporting system may disrupt the operations. Further, the activity based costing involves high costs; therefore, it may not be suitable for the small concerns (God il, Hasan, and Abid, 2013). Industrial award System It is crucial to understand that fair remuneration is necessary to keep the employees motivated to do hard work. In the case of Stylish Ltd, the employees are paid on hourly basis and there is no incentive plan as such in place. In this case, the employees who are being hired on monthly pay basis would be disheartened to work harder because they do not get any additional benefit for working beyond the fixed working hours. Thus, keep the employees motivated, it is essential for Luis Franco, the CEO, to formulate an attractive incentive or bonus plan (Atkinson, 2008). For this purpose, the following plan can be considered by the CEO for implementation: Hourly wages $ 20.00 Fixed hours Weekly 40 Incentive rate (150% of hourly rate) $ 30.00 Penalty for faulty work 50% of incentives earned In the plan provided above, the employees will have to work for 40 hours a week and for which they will be paid at $20 per hour. If the employee works for in excess of 40 hours in a week, he will be eligible for incentives which will be paid at 150% of the hourly rate. Further, the employees would also be liable to penalty if they provide faulty work in the greed of incentive. The penalty would be levied at the rate of 50% of the total incentives earned on production on which employee earned incentives. Results of Sensitivity Analysis The sensitivity analysis was performed to evaluate the changes in the operating income due to changes in the sales price of the finished products and changes in the material costs. The summary of changes is provided as below: Summary of sensitivity analysis Original Case-1: Sales price reduces by 10% Case-2: Material cost increases by 10% Operating income 7,200,000.00 3,647,000.00 6,172,000.00 Change (%) -49.35% -14.28% It could be observed that when the sales price of both the products falls down by 10%, the cumulated operating profit goes down by 49.35%. Further, when the price of both raw materials is increased by 10%, the operating profit could be observed to be falling down by 14.25%. Thus, it could be inferred that the operating profits are more sensitive to the changes in the sales price of finished products rather than changes in the material costs. Suggestions for Improving the problem of Frank Morton The manufacturing manager noted that frank works slow to increase the working hours to earn incentives. Due to slow working of Frank, the output is low and the labor cost increases high. In order to tackle this situation, it is necessary that the manager links the incentive plan to the output of the workers rather than the number of hours worked. Conclusion The report provides discussion on the benefits and limitation of activity based costing from which it could be concluded that the activity based costing system is quite useful for optimal decision making. However, it may be costly and it may also involve problems in implementation. Thus, it is recommended Stylish Ltd should consider implementation of the activity based costing system. Further, in regards to industrial rewards, it is recommended that the company should link the rewards and incentives of employees to the output of production. References Atkinson. 2008. ManagementManagement Accounting. Pearson Education India. Godil, D.I., Hasan, S.H., and Abid, Y. 2013. Application of Activity Based Costing in a Textile Company of Pakistan-A Case study. Interdisciplinary Journal of Contemporary Research In Business, 4(11), pp. 602-625. Salem, S.E.A. and Mazhar, S. 2014. The Benefits of the Application of Activity Based Cost System - Field Study on Manufacturing Companies Operating In Allahabad City India. IOSR Journal of Business and Management (IOSR-JBM), 16(11), pp. 39-45.