Activity based costing is the (Horngren et al. , 2014) is a system which regards each of the activity as the cost object. It assigns costs to products, services, tasks based on activities that carried to produce them, such as machine set up and material purchase ordering. I am going to argue that based on the case and the calculations in Schedule 6, ABC should be implemented in Sneakers unlimited. Firstly, the standard job adsorbing job costing system was applied when there was only one type of sneaker manufactured and the overhead was a smaller portion of total cost.
However, nowadays, there are three categorise of sneakers and the overheads are larger percentage of the total costs, which is about 26 per cent this year. Hence, it is important to implement ABC to get a more accurate calculation of the manufacturing overhead per unit (Micheal, 2001).In this case, the different activities involved including testing, designing and purchasing. The overheads per unit of the dance sneaker dropped from $29.00 to $21.78 based on the activities and resources go into it. This will provide a more accurate cost information for senior management to make other decisions within the firm to improve profitability and customer satisfaction, for example, to plan the development of a new product. This is called the activity based management.
Secondly, ABC can helps to identify and eliminate products that are not profitable, and hence increasing profitability without reducing costs. In this case, if the selling price for each of the shoes are relatively the same, the walking shoes is the least profitable one as its overhead per unit is about $73, while dancing shoes are more profitable with an overhead cost per unit of $22. According to the article, the company’s products have a relatively short life, then it is worth considering whether it is worth to tie up resources in products costing too much. The firm can spend money to develop more models of sneakers and hence gain larger market shares.
Thirdly, ABC can help the firm to solve the problems of price inconsistency with its competitors and then reach a market consensus (Dan,1995). By finding the true costs of individual product can support the pricing as the firm’s pricing policy is based on mark-up of the total cost. This is a more reasonable way of pricing by proportionally increasing the price of products that using more of the activity resources and decrease the price of products that using less activity resources. In this case, if the mark up is 5% percent of total cost, the price of the dance sneaker can be reduced from $30.78 to $22.8, which is about $8 difference. The sales of this sneaker will increase as a result as the price is now cheaper.
An example of successful implementation of ABC is the case of healthcare companies. In 2015, healthcare companies such as Medicare, were planning to raise prices to compensate for greater costs, driving a larger need for more accurate cost analysis. ABC allows those healthcare providers to allocate activity resources correctly and reasonable to more cost-intensive services, such as surgery, and hence adjust prices accordingly.
However, there are also limitations associated with ABC. Implementation of the system is time consuming and expensive. It requires substantial resources (Robin, 1992). Besides, activity based costing data is easily misinterpreted and managers need to use it with extra care when making significant decisions.