An vital selection the manufacturing companies have to make is to determine the product mix that maximizes the earnings of the organization given that a agency has a resource constraint. The quality motion the business enterprise wants to take is to choose a right product mix that utilizes the present sources and precise cost estimation approach which assigns gorgeous fee for the duration of in the manufacturing process. In the establishing of 1980s, the manufacturers started to recognize the boundaries of common product costing systems. At first, the companies manufactured a narrow vary of products, direct materials, and labor were the key costs. But later overhead fee has come to be a extensive part of manufacturing cost. A sophisticated overhead allocation system was needed. The activity-based costing has emerged for the demand of more accurate estimation of product cost. Many manufacturers today use ABC costing method to get a precise estimation of cost.
Many international traders and marketers come to China for motor vehicles, Tyres, and other parts of automobiles. The market of Hong Kong is very large and it is one of the largest manufacturing zones in the world. The profit margin of motor vehicles and tire industry becomes unimpressive. In other western industrially developed countries cost of a product is allocated considering the volume, working hours, and machine hours. To get more precise estimation the manufacturers started allocating the costs based on the activity of a machine or equipment. There are some differences between the traditional and Activity based costing when applying it to get overall cost estimation. The batch processing system is also introduced with the new costing system which has brought a revolutionary change in manufacturing industries (Louderback and Holmen, 2003).
Lenovo grouped limited is a Hong Kong-based Chinese multination company which produces technological products such as Smartphone, laptop, computer accessories etc. It is world’s one of the largest high-tech company having operations in 60 countries and products in 160 countries. Lenovo has a different manufacturing operations practice from the traditional industries (Hussein and Tam, 2014). It outsources to outside manufacturer. The company has analyzed the cost and benefits of in-house manufacturing. The vertical integration of the company relieves the company from heavy reliance on the original equipment manufacturer. It helps to keep down the cost. The business model of Lenovo is ideal for implementing the activity-based costing system. The CEO of the company has decided to produce 50% of the manufacturing in-house. As every technology-based company focuses on innovation and product development the management needs to know the implication of activity-based costing if implemented (Murray, 2013). This paper will help the management to take a better decision.
Why implementation of activity-based costing method gives a better estimation of the cost?
The purpose of the research is to provide relevant information to the management that leads better decision making regarding the assigning cost of product mix within the limited resources.
The main objective of the research is to find a strategic way which identifies why activity-based costing is a better estimation of cost. The main goal is divided into three objectives. the objectives are based on the research question of the study.
1. To investigate the reasons behind the precise estimation of ABC costing.
2. To find the difficulties implementing ABC costing
2. To investigate the possible benefits of ABC costing and limitations of ABC costing.
Scope and Limitations of the research
The performance of Lenovo is getting better. The company has an international presence. But for better manufacturing costing to improve the profitability of the company some changes need to make. This research will enable the company to make strategic approach based on the information provided by the study. To improve the competency of the organization management needs to know the weakness in costing system (Evans, 2018). This study will provide some insight into the costing system how it creates favorable results in cost estimation will be presented. There are also some limitations such as the testing hypothesis. The appropriateness of ABC system can be possible in a paper but in practice, many things are customized which may not fall under it. There are ethical issues which may cause bias such as the responses from the employees of the organization. Though this research has kept anonymity of the respondents some employees didn’t give some critical question’s answer thinking of insider’s information.
A relevant literature review is an essential part to achieve the objective of the study. Reviewing the related literature of ABC will provide a conceptual framework. Various sources such as journals, books, electronic data, and internet are an important source of information.
The traditional practice of categorizing the manufacturing cost is direct material, direct labor, and overhead. As the traditional system allocates the cost based on volume it is also called volume-based cost system (Crosson and Needles, 2014). The overhead cost is allocated to the product costs based on the notion that the product causes the costs. Some examples of variable overheads are power supply costs, minor parts, supplies etc. The amount of overhead is allocated to the products is linear with the volume produced. According to Douglas (1999) the cost is determined considering the hours used on the product. Identifying variable elements is not a problem. The inclusion of fixed overhead cost as a part of product cost is a problematic one. Since the fixed cost doesn’t change with the increase of the volume produced some costs are not utilized (Lucey, 2002). Though fixed cost doesn’t change with volume the unitization makes the cost as a variable.
Bhimani and Pigott states (1992) all costs are assigned to the activity in activity centers based on the resource drivers. The amount paid for an activity is called cost element. Baines (1992) mentioned the cost pool is the grouping of all cost elements associated with a particular cost which may contain more than one activity. A large number of activities are classified and grouped in a few. To form cost pools regression analysis is used.
The traditional costing method is overhauled by implementing activity-based costing. A careful analysis is made to define the activities rather than the conventional cost pool and driver method is selected to allocate the costs (Flesher, 1992). Horngren (2016) also mentioned some fixed costs are defined as the variable costs by redefining the behavior of the cost. The unit cost of a product is estimated by categorizing the activities into four levels. These are Unit-level activities, Batch-level activities, product-line activities and facilities support activities (Jiambalvo, 2013).
Kaplan and Anderson (2003) argued the company might have some problems implementing the activity-based costing method. Such has any organization has too many or too few identified cost drivers and activities. If the company has overly complex system design it will create difficulties overhauling the system. According to Lebas (1999) the reciprocal cost allocation system will deter the system from functioning. Lack of technical expertise and the analysis of the activities it not possible yet to apply the system. Due to the inherent nature of a business, an internal barrier exists.
There are some benefits of activity-based costing. Fei and Isa (2010) state the most important benefit is as the accuracy of the cost estimation process increases the understanding of the behavior of overhead cost assist the allocation of business resources specified by the product lines and the relation to the specific cost driver (Olive, 2012). The system is not very difficult to understand and implement the business set up. As this process uses the marginal cost as the computation base and it gives the unitary cost concept the management can make a better decision on manufacturing (Hoozze and Hansen, 2014). Quality control and improvement program e.g. six sigma can work in a better way. Some issues which can be a burden or stress for the business e.g. wasteful non-value adding activities can be identified and removed from costing system (Louderback and Holmen, 2003). The performance management system works exceptionally and the process allows the company to apply in other business processes such as supply chain management.
Every system has some limitations. A good understanding of the limitations can surpass the problems and difficulties. Reyhanoglu (2004) thinks the data collection process for each activity is time-consuming. To change the system a good professional should be hired which might be expensive. Resistance from the management can create difficulties implementing the system. The company has to create a new department called “activity accountancy”. The function of the department is to estimate the cost and revenue of each activity. The incorporation of a new department may create a problem in inter-department co-ordination and the company has to hire a workforce to manage it (Wilkinson, 2017).
The methodology of the research project describes the process of conducting the research. There are three types of research these are, qualitative, quantitative and hybrid. In this report, descriptive statistics will be used which is both qualitative and quantitative in nature. Data source and data collection method is also very important part of a research. The primary source of the research is the users of the company, company employees, and company management. The secondary source of the data is the statistical report, financial statements of the company and many journal articles. Since this is a case study type research project data collection technique should be questionnaire survey method. Random data sampling will be used. Sample collection will be based on stratified random sampling.
In future, activity-based costing will have more attention because of its preciseness in estimating costing. Traditional costing method has become archaic though it has a simplistic procedure. Many manufacturing firms are now adopting it as an alternative costing system. Though there are some limitations and difficulties the benefits surpass these. Lenovo’s management should take a radical decision considering all the aspects. A pilot project can be initiated to test the compatibility with the manufacturing process. To make a competitive advantage resource allocation is not the only way. Assigning the cost has been a critical factor in the success. This research proposes to the management that activity-based costing method should be used to make a better estimation of cost considering the product mix.
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