Finance

Absorption costing in a modern production environment.

In the modern production environment, absorption costing is an accounting method where all fixed and variable costs incurred in production process are absorbed by cost centers. Variable costs in absorption costing also known as marginal costs are incurred or charged during the process of manufacturing and selling of products or services. Fixed costs on the other hand are costs charged direct to income statement.

The production process includes direct materials and direct labor. Direct materials include all materials that become part of finished products and they can be traced in finished product. Direct labor involves labor costs that a factory incurs during the time of manufacturing. The evolution of costing in the nineteenth century has led to treatment of costs being absorbed as part of overheads. This has led to charging products at a price that covers overheads. Many accountants opt to use absorption cost method to prepare financial statements. The method is high appreciated in modern production because overheads are considered to bring stocks at their present conditions (Kip, 2007, p.36). Absorption costing is a major achievement of accountants.

2. Compare and contrast absorption costing and activity based costing
In absorption costing, indirect production costs are allocated to products on the basis of volume produced. Activity based costing (ABC) method of inventory valuation applies both production and non-production related bases. Absorption costing is a method of inventory valuation that acknowledges allocation or apportionment of overheads to different production departments while ABC allocates overheads to cost pools (Williams, 1995, p.8). Allocation of overheads in production departments means that each department has particular target that must be met. Cost pools as is used in Activity Based Costing means distribution of overhead costs as a group such as machine hours and direct labor (Heyman, Bloom, 1990, p.12).
 
Activity Based Accounting is used to give out efficient results as compared to absorption costing. This is because costs incurred during production are traced trough activities. This will help to monitor the usage of resources since activities are applied to use resources and products consume activities. Manufacturing, selling, and administrative costs are associated to products in ABC method while absorption costing recognizes these costs during preparation of financial statements. Absorption costing applies rates based on volume absorption while Activity Based Accounting applies cost driver rates (Cheatham, 1993, p.44).

3. Compare and contrast absorption costing and marginal costing
Marginal costing also known as variable costing includes manufacturing costs such as direct labor, material and overheads in the process of determining cost per unit of producing a product. Absorption overhead on the other hand involves manufacturing costs such as direct labor, direct materials and variable and fixed overheads while evaluating cost per unit of a product.

Marginal costing does not recognize importance of working to full capacity and it uses cost plus pricing method (Pohlem, 1999, p.74). Absorption costing on its part avoids fluctuations in profit due to market demand in sales while production is constant. In marginal costing, selling price does not guarantee that all fixed costs will be covered. Absorption costing recognizes variable costs in the long run thus this argument favors absorption costing. Other arguments that favor marginal costing are that it shows the cash flows of an organization and how profits are affected by change in sale volume. This is true because profit is proportional to the volume of units sold. Absorption costing allows profits to be manipulated through setting of a production level that is met through market demand of sales (Mohsen, 2000, p.37).

Compare and contrast absorption costing and standard (opportunity) costing
Standard costing also known as opportunity costing is an accounting system that acknowledges application of manufacturing costs to inventory by using standard prices. This is different from absorption costing that allows the use of volume based absorption prices. Opportunity cost is benefit of best foregone option. It is the benefit which ha been given up at the expense of choosing another option (Lewis, 1993, p.21). In standard costing, resources are valued at their opportunity cost other than the actual cost incurred to acquire the resources.

The  advantage of standard  costing as compared to absorption costing is  that management  can easily  monitor how  resources are used and to develop new  policies on how to utilize resources effectively. However, one major draw back of standard costing is that it is not easy for manager to identify accurate opportunity cost. In case there is no another way in which resources can be used or when the resources are not limited, opportunity cost becomes zero. The use of standard costing in business is a way of comparing costs and revenues with the actual results so as to obtain variances (Brimson, Antos, 1999, p.19). Variance is used to stimulate performance in production process.

Pricing approach and relevant factors considered by company launching a new product.

The price of a product is determined by several factors such as cost incurred, variable and fixed overheads, and inventory method used. The approach of absorption cost is used to allocate unit products. It is a guide to products price that cover overheads. Direct materials, labor and overheads are aspect of manufacturing costs that determine the price of a product. The price of the product must be set such that it covers all manufacturing costs and the some profit is recognized (Tsuji, Garner, 1999, p.25) Contribution approach is another pricing approach that many companys advocate to use.

Managers of a company must consider some factors when launching a new product in the market. Such factors include target customers, competition in the market, demand and supply forces in the market, and advertisement costs. Positioning and location are the best strategies that must be used to launch a product successfully in the market. Promotion is another factor that managers should put into consideration. This will help to draw the attention of buyers from their normal taste to that of new product. Discount policy is a major factor that must be put in consideration by managers.

Analyze why budgets may cause budget padding and dysfunctional behavior by employees.

Budgeting in production process helps the company to utilize its resources in an effective manner. It is a way of helping employees to allocate resources in specific areas needed for production. Budgets however, may create budget padding because some head of departments may fail to come up with the list of items needed during manufacturing process. The additional items later in the budget may cause dysfunctional behavior of employees. Employees will fail to work due to lack of basic resources or equipments (Razek, 2002, p.160). On the other hand, employees try to include items that are not of essence during production process and use them for their own benefits. It is therefore, important for managers to budget well for all their needs and resources to avoid weird behaviors by employees.