ABC systems Essay Example

overheads. In this scenario, conducting calculations using such an approach would result in misinformation and a futile use of resources.

While a traditional absorption costing system may have lower operating costs than an activity-based costing system, its inaccuracies can result in costly errors. However, the decreasing cost of information technology is an important factor in making ABC systems cost-effective. Advances in information systems are lowering operating costs and increasing effectiveness (Proctor R. 2000, p72). By considering all aspects of a company, including customer service and management decisions, and making activities the core of cost calculation, ABC overcomes the disadvantages of absorption costing. Adopting the ABC method is essential for accurate costing in modern manufacturing.

After discussing the reasons for the difference in product cost and profitability between two approaches, it was found that the traditional costing method is based on direct labor costs, which were 15600000 dollars for Adchlor, 15600000 dollars for Badchlor, and 4680000 dollars in overhead costs. However, this method did not take into account the difference in batches for the two products. To address this issue, activity-based costing was employed. In the traditional costing income statement, Adchlor showed a loss due to incorrect overhead allocation.

The costs associated with Cifchlor are actually allocated to Adchlor, which causes an increase in the cost of the product and results in a loss for those products. This is a crucial issue for the management, who have cash flow problems and must decide which products are generating losses in order to reduce or cease their production. However, the use of activity-based costing solves this problem by revealing that Adchlor is in fact generating good profits. According to traditional

costing methods, the overheads allocated to Adchlor, Badchlor, and Cifchlor are 2147934, 2147934, and 644379 respectively. By contrast, activity-based costing reveals that the product line costs are actually 1917459, 2838000, and 829170. This shows that the overhead costs are allocated arbitrarily and result in significant differences between products. In traditional costing, overheads are allocated based on labor costs whereas in ABC, the number of batches and lots used in production serve as the base for overhead allocation.

By using the ABC method, the profitability of the three products has been significantly altered. Despite initially being in a loss, Adchlor is actually generating profit. This indicates that traditional-based costing is less realistic than activity-based costing. E Lab can make informed decisions regarding pricing and cost reduction for their product line based on current market conditions. Increasing the number of batches and lots produced can also improve overall profitability.

The profitability of E Lab Inc. can be enhanced through the implementation of the ABC method. This method has proven to be beneficial for pharmaceutical companies as it allows for more realistic allocation of overhead costs to products that are produced in batches or lots. By doing so, pricing mechanisms can work more effectively. This information is referenced from Mats and Usry.

Activity Based Costing was utilized in 2004 for costing.