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ABC analysis

Activity based costing seeks to seek the profitability of a business based on costing of all

activities engaged in per commodity or good and the income it brings. This enables one to tell

what a business does to bring profits rather than reporting what was spent on what. This brings

the importance of categorizing activities so the there is categorization in terms of value added

activities and non-value- adding activities. It is such differentiation that enables managers and

businessmen on what activities to cut costs and where to increase more funding. ABC is unique

from other analysis tools for these features besides indicating cost drivers.

While the profitability statement generalizes activities so that the costs are shared among the

three types of seats, it is important to note that some activities indeed don’t add value to the

production but cost the manufacturer. Generalizing costs of labor and materials without showing

specifically where these costs are generated might lead to unnecessarily costs. The costs of

materials is general, but the types of materials in place are different. For instance, wood used in

making comfort seats is more than the one used in relaxer and Scandinavia and incase of leather

used, not all seats use leather. The processes involved in using these processes might be costly

than others, which brings out the importance of having group overheads, cost pools and unit of

cost driver.

In looking for the profitability of the business, each activity should be addressed and pooled in

its own group and the income from each seat analyzed. The purchasing of leather and inspection

of the same for instance should be considered for both comfort and relaxer and ignored for

Scandinavia for it does not use it. For this, it will be evident that some activities make
commodities face more expenses than others while others need not be used for they add no value

to the product.

Activity Pool £ Cost Drivers Annual Cost driver rate

no.
Set up costs 5,600 Set ups
Purchasing and checking 4,000 Leather per 6 £ 666.67/wood purchase

leather hides chair


Purchase of wood 2,400 Wood per 28 £ 85.71/ inspection

chair
Quality inspection of 3,200 Leather per 6 £ 20/ dispatch and transport

leather seating chair


Dispatch and Transport 6,000 No of pieces 300 £ 221.67/ administration and

personnel costs
Administration and 13,30 Labor per 60 hours Total £ 2860.72

personnel costs 0 chair

Activity comfort Relaxer Scandinavia


Purchase and 2666.67 1333.3 -

checking leather

hides
Purchase of 857.14 771.43 771.43

wood
Quality 2133.33 1066.67

Inspection of

leather seating
Set up 9960 8300 6640

administration
and transport
Totals 15617.14 11471.40 7411.43
Costs per chair 520.57 95.60 49.40
Profitability -125.57 189.40 175.6

index per seat

ABC analysis clearly indicates different profitability for the different seats. The comfort is

operating at loss. Relaxer on the other hand in a generalized costing analysis appears to make no

profit but in the ABC makes biggest profit followed by the Scandinavia which makes a loss in

the previous analysis.

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