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Based on the facts of Sneakers Unlimited, schedule 6, and financial literature perspectives, the organization should consider using Activity Based Costing. Sneakers Unlimited currently uses traditional absorption work costing to assign costs to its brands. While such a scheme is suitable for external reporting, it does not have the exact cost of each finished product (Kumar & Mahto, 2013). Notably, it includes all costs, including direct labor, direct supplies, and overheads, which are assigned to each unit of output at fixed prices. Typically, the total cost of labor, materials, and overheads are obtained and divided by the number of the products.
ABC costing system is appropriate because each unit is allocated particular costs, especially the indirect expenses depending on the level of consumption and not just an equal distribution (Mahal & Hossain, 2015). For instance, the cost of supervision that could apply differently depending in the time spent by the supervisor on each type of product during production would end up being apportioned in equal amounts to all the complete units. Given that Sneakers Unlimited has three lines of products, ABC would be appropriate as it will facilitate the allocation of accurate costs to the products in each line and not just average estimates.
The fact that Sneakers Unlimited has products that have short fashion duration also requires that it adopts a costing system that can give accurate costs. Otherwise, it might end up realizing wide fluctuations in prices whenever it adjusts the products, thereby, keeping off the customers who will see the company as having unstable prices. Additionally, the availability of more indirect than the direct materials makes it possible to allocate highly inaccurate costs to the production units (Major, 2014). Apparently, the direct costs are in most cases accurate, but the apportionment of the overhead costs cannot be accurate if the cost accountants cannot establish the contribution of each product or activity towards the general charge. For example, the cost of storage which is an overhead expense needs to be allocated to the products that are often stored before completion and not the ones that have an instant supply.
The issue of Sneakers Unlimited's products having different prices from the rest in the market also points to the fact that the current costing system is inappropriate. The consumers who are sensitive to prices might boycott the commodities and chose to purchase from the competitors who sell at lower prices. However, Kumar & Mahto (2013) notes that such a scenario is avoidable because the company does not intentionally inflate or underprice some of its products, but the discrepancy comes as a result of inaccuracy in cost estimation.
From schedule 6, there are discrepancies in the overhead costs per unit as calculated under the historical costing and ABC. While the absorption costing provides the overall estimates without separating the overheads into different classes, ABC has enabled for the allocation of the overheads to the respective units after the distinction of the cost of each overhead (Kumar & Mahto, 2013). With ABC, it was possible to deal with each class of overhead distinctively and allocate them equitably to each unit. Therefore, ABC assisted in obtaining the actual costs after adding the distinct expenses unlike the absorption method failed to consider the amount of a particular overhead per each department before generating the overall overhead cost per unit. Notably, the historical costing could lead to overpricing and underpricing of some products. Such a scenario might reduce the demand for the highly priced products, thus, reducing sales of the company. At the same time, the enterprise could make losses as a result of underpricing (Qingge, 2012). The overall effect will be a loss to the firm because the items that have a higher profit margin will not sell while the ones with negative or even minimal profit margins will be the ones being bought.
Kumar, N. & Mahto, D. (2013). A Comparative analysis and implementation of activity based costing (ABC) and traditional cost accounting (TCA) methods in an automobile parts manufacturing company: A case study. Global Journal of Management and Business Research Accounting and Auditing, 13(4).
Mahal, I. & Hossain, A. (2015). Activity-based costing (ABC) ' an effective tool for better management. Research Journal of Finance and Accounting, 6(4): 66-73.
Major, J. M. (2014). Implementing activity-based costing in the telecommunications Sector: A case study. Telecommunication System & Management, 3(1): 1-5.
Qingge, Z. (2012). A new activity-based financial cost management method. Physics Procedia, 33: 1906-1912.
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