To: Senior Management
From: Lisa Li
Company name: Corgan Ltd.
Subject: Standard bed and Deluxe bed
Corgan Ltd. is a company that produces two types of bed, standard and deluxe. The standard range is sold through furniture retailers. The luxury range sells high quality hand-finish products. The company has been performing well however, in the standard bed segment, the company started to experience some competitions over the price from other competitors. Corgan is now trying to focus on the luxury beds only since the standard beds are barely profitable.
Accordingly, we analyzed the company’s costing system through ABC (absorption-based costing) and traditional costing. In the ABC basis, the standard one has higher direct material and direct labors. In regards to administration, marketing and management, the deluxe bed takes up more overheads which are approximately twice size as the standard one, same applied to the purchasing part. For the machine set-ups, the overheads which are spent on the deluxe one is four times more than on the standard one, which are 120,000 and 30,000 respectively. However, the company spends more on the standard one in machining and assembly. In quality control, the standard one takes up 60,000 while the deluxe one costs 160,000. The total cost of the standard one is 3,041,431 whereas the deluxe one is 1,948,568. Overall, the standard one is over-recovered of about 17% whilst the deluxe one is under-recovered of nearly 46%.
Based on the calculations, it is recommended to use Activity-based costing method. Activity-based costing has more cost pools and cost drivers which makes the result more accurate. Besides, it has a observable link between products and activities. Also, the cause and effect relationship between products, activities and cost is maintained in the ABC system. Although it is undeniable that activity-based costing has disadvantages as well, for instance, it is very complex. Also, it is difficult and time-consuming to implement and maintain, not only it is very costly, but also the cost-benefit analysis is important. Nevertheless, activity-based costing reflects complexity of activity and their consumption. In Corgan Ltd. ‘s case, there are lots of cost drivers and cost pools, in order to increase the accuracy of the data, it would be the best if activity-based costing is applied. Accurate product cost is important as it is a basis for deciding selling price and identifying profitable products. In Corgan’s company, they manufacture two types of different products which means many costs will also be incurred. It is essential for any company to control the costs as increasing profit is the main goal for every company. Costs of activities consumed can be identified for product cost control purposes, which Activity-based costing can also help with.
Activity-based costing allows people better allocate overhead costs and, as an added bonus, also often provides people unique insights into what "drives" the overhead costs. In Corgan, with this information in hand, the company can make better decisions about their products and service lines, and sometimes they can even change their business operations in a way that reduces costs. There is a number of overheads incurred in Corgan’s company, like administration, marketing, management, purchasing, machine set-ups, machining, assembly and quality control, Activity-based costing is most useful when the company have lots of overhead and different products, it delivers insight to the company.
An Activity-Based Costing system allocates indirect costs based on a product’s cost driver, or the factor that creates the cost. As costs are allocated per product, it gives the manager ideals of which business processes are performing well and which ones need to be improved. Plus, Activity-Based Costing can be used to
