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Allocating Fixed Costs and Budgeting Case Study


Difference between ABC and Other Allocation Methods

Most of the cost allocation methods focus on the accumulation of cost; at the same time, ABC is different in its nature and is used for the purpose of maximizing the accuracy of the product cost that is normally based on the process, operations, and job cost (Martin, n.d.). Due to its major difference, ABC is not intended to replace the methods that are focused on cost accumulation but to function alongside them. ABC brings clarity and precision to the cost allocation and helps interpret the cost in a more careful manner for the internal management practices and a better understanding of overhead costs (Johnson, 2016).

Main Characteristics of ABC

Typically, the companies rely on ABC as a costing system supplemental to the other cost allocation methods even though it offers a more accurate view of the product and process cost (Johnson, 2016). One of the main characteristics of ABC is its focus on each activity involved in the production of an item and allocating cost to it that is further assigned to the end product resulting from this activity. In that way, the view of cost as associated only with the job and process value can be seen as flawed and in need of a more careful approach that is provided by ABC. The latter identifies a wider range of the activities consumed by the production and thus is able to allocate costs more carefully (Walther, 2010).

The Type of Companies That Tends to Benefit from ABC

As specified by Martin (n.d.), in articles and books, ABC is usually illustrated using two to four products; the author concludes that this approach indicates the process orientation of the method. At the same time, compared to a process cost environment, that of a job cost seems to include more product options. In that way, it is possible to make a conclusion that the companies benefiting from the use of ABC are the ones that produce many different products specified to the customer needs.

A Company That Has Implemented ABC

One of the most well-known companies that employed ABC in their operation and cost management is UPS. The need for ABC arose at UPS due to the high level of diversity of its operations in its nature. To be more precise, UPS carries out the IT, financing, accounting, and engineering operations on a daily basis in addition to a multitude of different processes involved in the delivery procedures. In that way, it was crucial for UPS to identify a range of activities associated with each of the performed operations and processes and assign their costs appropriately and carefully taking into consideration the value and use of the involved customers, operations, and products (“Activity Based Costing at UPS,” n.d.).

What Type of Company Is It?

UPS is a company whose economy transformed into a service-based one from the manufacturing one. Since the services were highly diverse and depended on a wide variety of requirements of the customers, locations, deliveries, routes, packaging, types of cargo, to name a few, the company became interested in studying different segments of their services in order to understand how the costs should be allocated (“Activity Based Costing at UPS,” n.d.).

Was It Successful?

Implementing ABC, UPS was able to assign the major priority to the type of packaging required and functional costs are driven by the products (“Activity Based Costing at UPS,” n.d.). ABC helped UPS create a database of package movement and of work measurement that is leveraged by the activity cost drivers (“Activity Based Costing at UPS,” n.d.).

General Benefits of Preparing the Budget

Budgeting is equal to the planning of the future financial performance of a business. The latter involves a multitude of components and characteristics, and each of them is associated with certain costs and values (Martin, n.d.). These factors need to be considered for the purpose of the accurate planning of the operation costs and funds required.

The Use of Budget for the Control Function

In terms of the control function, a master budget is useful as an instrument for creating a financial control system. However, the issue is that when the budget is projected beforehand and fixed, it forces the managers to spend up to the budget limit in order to avoid budget cuts. As a result, unnecessary operations and expenditures can appear in order to help the managers to stick to the fixed budget (Martin, n.d.).

Advantages and Disadvantages of Using Variance Analysis for Performance Evaluations

The advantage of variance analysis is the ability to identify the processes and operations that match their budget and the ones that tend to overrun it. This allows for forming a better idea of the required cost. However, this analysis has a long cycle and can be rather time-consuming so that by the time the activities and their agreement with the budgets are detected, it is too late to implement the change.

Suggestions for Complementary or Alternative Performance Measures

Knowing the disadvantages of the variance analysis, it is important to select a set of different performance measures for primary activities. In that way, better flexibility of measurement will be achieved and the change addressing different tendencies could be put into practice in time.

References

(n.d.). Web.

Johnson, R. (2016). Traditional costing vs. activity-based costing. Web.

Martin, J. R. (n.d.). Web.

Walther, L. M. (2010). Principles of accounting: A complete online text. Web.

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IvyPanda. "Allocating Fixed Costs and Budgeting." November 20, 2020. https://ivypanda.com/essays/allocating-fixed-costs-and-budgeting/.

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IvyPanda. 2020. "Allocating Fixed Costs and Budgeting." November 20, 2020. https://ivypanda.com/essays/allocating-fixed-costs-and-budgeting/.

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IvyPanda. (2020) 'Allocating Fixed Costs and Budgeting'. 20 November.

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