Introduction
It is vital to realize that the accountant has so far been using the full costing traditional method that has been in use for a long time. To ensure that my friend understands what full costing means, it is all costs involved with achieving some objectives. More precisely in my friend’s case, it means all the costs involved in carrying out the business activities he is engaged in. Thus the accountant has been summing up the direct costs and the indirect costs in order to get the total costs of producing the total units of output at the end of the year. In other words, this can be explained as follows, Direct costs of the units + Fair share of indirect costs (overhead costs) = Full cost of the units. (Atkinson, 2004).
Main body
However, this method has proved unworthy using because the business has been making losses. The shortcoming of full costing method is that adding up all the costs at the end of the period does not show the relationship between direct, indirect, variable and fixed costs of a particular job. In addition it tends to use past costs and to restrict its consideration of future costs to outlay costs.
The past costs are irrelevant irrespective of the purpose for which the information is to be used. This is because it is hard to make decisions about the past but only about the future. The reason is that in carrying out a particular job the full costs or the total costs will be made up of some direct and some fixed costs elements. (Laureate, 2007)
It will also be made up of some direct and some indirect or overheads elements. The current costing system that throws up considerable overheads costs that are then allocated to the business products at the end of the year-end on the basis of labor hours has been the cause of the problem in the business.
This is because a business is divided into various departments and the costs in the different departments differ greatly. Thus the overheads costs in the production department are not the same costs in the sales department which make the overheads costing above unrealistic. The option is to divide the business into departments where each department should deal with a separate activity and the overheads allocated to these different activities.This is the reason why the accountant has decided to change the costing procedures to adopt the ABC or the Activity Based Costing.
The activity based costing is based on the realization that overheads do not just occur but they are caused by activities such as holding products in stores, which drive the cost. The accountant has so far been treating the overheads as rendering a service to costs units, the cost of which must be charged to those units. However ABC recognizes overheads as being caused by cost units and those costs units must be charged with the costs that they cause.
This calls for identification of the activities that cause costs because it enables the management to control them more effectively. This will in turn help in analyzing the cost drivers. According to Upchurch 1998, the management will be able to have a much clearer insight into the costs that are caused activity by activity. In this respect more accurate product costs can be identified and costs can be controlled more effectively thus making the business more profitable.
Conclusion
The reason as to why the accountant demands for more pay in order to shift into the ABC system is because analysis of overheads in order to identify cost drivers is very time consuming and costly as well as a tedious exercise. (Horngren, 2005) Therefore the accountant is correct on the issue of shifting into the ABC system of costing. However to do this more finances should be allocated to the new system in terms of changing the entire system and accountant salary because it is worth adopting. He should ensure that in the new accounting period the ABC system is put into use.
References
Atkinson, R. et al (2004), management accounting, 4th edition, (New York, Prentice Hall.).
Horngren, C. et al (2005), cost Accounting, 12th Edition, (New York, Prentice Hall international).
Laureate, K. (2007), managing Resources 1st Edition, (New York, Pearson Custom Publishing).
Upchurch, A. (1998), management accounting: Principles and Practice, (New York, Financial Times/ Pitman Publishing).