My company of choice is Hindustan Construction Co. Ltd., which, as the name suggests, is a construction company that deals with all forms of machinery and equipment. The sections that follow make an analysis of the various costing methods used by companies, and how they apply to Hindustan. It concludes by making a recommendation of the best method for the company to use.
What are the differences between the two costing methods, and how do these apply to your company?
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The two common costing methods used by companies are the activity-based costing and process/product costing. One of these costing techniques is inexpensive to implement and easy to use, while the other one is more expensive to use but it is more accurate. Product costing and activity-based costing are two techniques that are used in the allocation of indirect overhead cost to a product. The process/product costing method adds the direct costs incurred when manufacturing products to the average overhead rate. In this case, the overhead rate is applied based on a cost driver, say the number of hours that are required to manufacture a product. This costing method is best applicable in a situation where the company has a low overhead in comparison to the direct costs incurred during production. Then, it will give accurate cost figures, especially in situations where the volume of production in large. Also, process/product costing is inexpensive to implement (Woodruff, 2018) .
On the other hand, when using activity-based costing, you identify all of the specific overhead operations that are related to each product’s manufacture. The advantage of the activity-based costing method is that it is the most accurate. However, it is also very difficult and costly to implement. It is best suited for businesses that have high overhead costs and manufacture products, compare to companies that mainly offer services. These two costing methods come to play in the case of Hindustan Construction Co. Ltd because it is a manufacturer of products, and there is need for accurate and efficient costing techniques
What are some ABC cost drivers the company might use?
The ABC method was created with an aim of solving the issues of inaccuracy that result from the process/product costing method. There was need for the managers to have a more accurate costing technique that determines the profits that are actually profitable and the ones that are not. The key difference that there is between process/product costing and ABC costing is the fact that the ABC techniques expand the amount of indirect cost pools that can be assigned to a specific product.
All the same when it comes to the ABC costing technique, overhead is assigned based on the all costs pool, where the cost pools account for the activities that are undertaken in the production process. These activities include machinery and labour, among others. ABC then measures the cost pool based on each cost driver, and this is the activity measurement basis for instance machine operation hours and labour hours. The ABC cost drivers that are applicable for the case of Hindustan are outlined below:
Cost Pool: Machine setup, product packing, and maintenance.
Cost Driver: No. of machine setups, no. of products packed, and the no. of batches.
How could the costs differ if one method is chosen over the other?
All the discussed factors are put into consideration when using the ABC costing to allow for an appropriate overhead allocation. The difference in costs in this case comes in the allocation of the overhead costs and also depends on the accuracy of the technique used. As already stated, the process/product costing technique is not accurate, meaning that it will result in a higher value of the allocated overhead as the amount of basis increases (Maverick, 2019) .
Which method would you recommend for your company, and why?
The costing method that a company chooses it totally dependent on the level of activity and the size of the company. While ABC is the most accurate method, it is complex when it comes to calculations and implementation. However, I would still recommend the ABC method for Hindustan Construction Co. Ltd, which is a big company that needs the most accurate costing technique available.
References
Maverick, J. (2019). The Two Ways Companies Account for Costs. Retrieved from https://www.investopedia.com/ask/answers/052515/what-are-differences-between-absorption-costing-and-variable-costing.asp
Woodruff, J. (2018). Traditional Costing Vs. Activity-Based Costing. Retrieved from https://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html
