Introduction
Costing methods in manufacturing refer to accounting techniques used to estimate or evaluate the input and output values in a production process. The cost of production per unit can be determined with high accuracy levels by tracking and cataloging the information above (Hansen et al., 2021). This information enables senior management to make informed decisions in areas such as pricing, competitive strategy, production levels, and investment opportunities. The primary objective of the information is managerial accounting.
In the manufacturing sector, classifying overhead costs is essential due to factors such as economic considerations, technological advancements, and social considerations. These factors necessitate the increasing importance of cost control and reduction (Hansen et al., 2021). A company incurs overhead costs when manufacturing product(s) other than direct costs (Blocher et al., 2019). A firm may choose traditional or activity-based costing methods based on its strategy, preference, and size.
Company Overview
The company of choice is Ford Motor Company, an American automobile and machinery manufacturing firm. It offers a wide range of products, including cars, trucks, and engines. It has a global presence in the automotive sector, with dealerships and factories located on all seven continents.
Costing Methods
The costing method adopted by Ford Motor Company is activity-based costing (ABC). The choice was made due to several factors: ABC’s ability to identify inefficient processes and implement optimization, provision of realistic cost values for manufacturing, better allocation of manufacturing overhead to products and services, and more precise determination of product profit margins.
Job Order Costing
There are two traditional costing methods; job order costing is a system of accounting that determines the price of every output unit and ensures a reasonable profit margin is maintained (Alami & ElMaraghy, 2020). This system can track payroll records, material costs, and overhead allocations (Blocher et al., 2019). This data is gathered and computed using a job cost sheet or job order database. This tracks the expenditure on each item and current inventory stocks, all geared towards preventing sudden losses.
Ford Motor Company applies this method in its subsidiary, Ford Performance. Since the racing car division has low production volumes, it creates the ideal environment for applying this method in an enterprise where customers order relatively small and unique batches of products.
Process Costing
Process costing is a method of accounting that determines the cost per item by tracking the cumulative cost incurred. After acquiring a cumulative sum of all the costs of the production stages, it is divided by the total output units produced (Blocher et al., 2019). This method is highly suited for manufacturing companies that mass-produce similar products with similar inputs. As a mass-production pioneer and a staggering giant, Ford employed this method to reduce the cost of its mass-produced cars and trucks.
The job order costing method is more precise than the process costing method, as it is more meticulous and less generalized. Considering both costing methods, job order costing would reduce costs for a small manufacturing firm. In contrast, process costing would increase costs due to generalization, which may lead to errors.
Factory Overhead
Factory overhead refers to the costs incurred during manufacturing that do not include direct material and labor costs. It is an industrial norm to aggregate these costs to form a cost pool and allocate it to the output units produced within the period (Blocher et al., 2019). Examples of factory overhead costs in Ford Motor Company include factory utilities, equipment set-up costs, factory building insurance, equipment maintenance, property taxes, depreciation, and production supervisor salaries (Enthroven, 2019). Ford Motor Company uses activity-based costing for reasons discussed below.
Activity-Based Costing at Ford Motor
Benefits
Activity-based costing (ABC) enables Ford Motor to classify and assign the company’s overhead to specific products and services. The ABC is less arbitrary in assigning overheads and indirect costs than traditional approaches (Hansen et al., 2021). This approach improves the costing process and optimizes the accuracy of the results. ABC increases the number of cost pools, enabling the identification of activities performed by Ford’s resources. It also pools the costs based on each activity in the production process; this augmented approach provides a clear view and aids decision-making.
Phases
Ford Motor Company’s process for implementing the ABC method involved four phases: initiation, design phase, implementation stage, and information application (Enthoven, 2019). In the initiation stage, Ford Motor’s chairman, William Ford Jr., had his team discuss the ABC method’s application in cost management.
The team then identified all the processes and cost drivers in the design stage. The four main cost drivers identified were raw materials, research and development, marketing, and labor costs. The implementation stage involved employee training in using ABC, which was achieved through mentorship, seminars, and webinars worldwide. The information application stage involves utilizing the cost data from ABC in cost management, specifically in areas such as target cost setting, product pricing, and profit analysis.
Conclusion
In conclusion, I recommend expanding the use of the ABC system in other Ford subsidiaries, such as Ford Performance. From this essay, it is easily evident how industrial expansion and technological revolution have influenced the approach to costing systems. Increased efficiency and productivity are demanded from every company when resources are scarce and competition is stiff (Hansen et al., 2021). The effectiveness of the ABC system over traditional costing methods makes it the prime system to be implemented, compounded by its ability to leverage the increased computing power of computers in the present age.
References
Alami, D., & ElMaraghy, W. (2020). Traditional and activity-based aggregate job costing model. Procedia Cirp, 93, 610-615.
Blocher, E. J., Stout, D. E., Juras, P. E., & Smith, S. (2019). Cost management: A strategic emphasis (8th ed.). McGraw-Hill Education.
Enthoven, A. (2019). How systems analysis, cost-effectiveness analysis, or benefit-cost analysis first became influential in federal government program decision-making. Journal of Benefit-Cost Analysis, 10(2), 146–155.
Hansen, D. R., Mowen, M. M., & Heitger, D. L. (2021). Cost management. Cengage Learning.