Case study-1500+10% word report and analysis

Introduction

Background of the cost system used by Optic vision for overhead allocation:
Optic Vision Pty Ltd uses a job costing system and manufacturing overhead is applied based on machine-hours using a predetermined overhead rate. The job order costing method is one of the methods which is used by many businesses for allocation of cost.
Job order costing method analysis:
The job order costing method is appropriate to be used when the company is producing unique products as per the requirement of the customers where each order from the customer is considered to be different from the other customer. Like in the case of legal firms, the case of each customer is different and so will be the time spend on each case.
(Banker, Chang, Ou and Wu, 2000)
Calculation of manufacturing overhead rate per machine hour:

Overhead rate will be calculated as below:
Estimated manufacturing overhead / Estimated machine hours
= $36,00,000 / 80,000
= $45
Manufacturing overhead applied to jobs to 30 November by Optic Vision:
In the job costing method, the pre-allocated manufacturing overhead rate is applied to all the jobs based on the actual utilization of the overhead allocation base. In this case, the base is machine hours.

(As calculated above)
 Therefore, the overhead application will be
Actual Machine Hours till 30th Nov X Predetermined manufacturing overhead rate
= 73,000 X $45
= $3,285,000
Manufacturing overhead during December:

Total Manufacturing overhead application in December is $270,000
Determination of the amount by which the manufacturing overhead is overapplied or underapplied as at 31 December:
In the job costing method, since a predetermined allocation rate is used, so in most cases, there is a mismatch between the actual overheads incurred and the allocated overheads which leads to either over applied overheads or under applied overheads.

(Job Order Costing – Guide of How to Calculate Job Order Costs)
Determination of the balance of finished goods inventory account on 31 December:
All the completed jobs except job number N11-013 had been turned over to customers by the close of business on 31 December. So, the finished goods Inventory will be only for job number N11-013

Schedule of cost of goods manufactured for Optic Vision for the year:
For the cost of goods manufactured, we need to first calculate the direct raw material used and the closing inventory of work in process.

Since the raw material purchases and raw material, inventory includes both direct and indirect materials, so from the raw material purchases, we will have to reduce the amount of indirect materials to arrive at raw material used, the reason being that the indirect material is being charged to the jobs through overhead allocation.

The closing work in process needs to be considered only for the jobs which were not completed till the end of December. Since Job numbers T11-007, N11-013 and N11-015 were completed during December, so we need to consider only the balance jobs which are still in work in process.
Computation of total cost of completed jobs T11-007, N11-013 and N11-015:
Only three jobs were completed till December so the total cost will be direct cost and overhead allocation of December as the opening work in process includes direct and allocation till November.

(What is job order costing – Accounting for Management)
Application of Activity Based Costing (ABC) method to Optic Vision instead of job order costing.
Activity-based costing (ABC) is a method that allocates the cost based on the volume of activity. Activity-based costing is a concept where overheads are allocated among various products or services for determination of the cost accurately and in this process, there is no elimination of any overhead cost. In the activity-based costing method, the cost of all activities and overhead is traced to a particular product or service rather than blanket use across all product lines or services by using a single overhead rate. This enables businesses to allocate overhead costs more accurately to the product and the services that consume them. The different types of activities that can be there in the ABC method are product level, batch level, unit level, customer level, etc. The drivers for cost assignment in the ABC method are activity drivers and resource drivers. ABC method should be used when the overheads are high, there is a product or customer or service diversity, and also when there is a tough competition in the market
(Activity-based costing (ABC), 2013)
(Park, 2019)
Activity-based costing provides many benefits to the organization. Some of the key advantages of using the ABC concept to allocate overhead cost are summarized below:

• The first and the most important benefit of using the activity-based costing method is that it allocates cost based on the use of resources and does not do allocation based on a pre-determined rate like in the case of job order costing where the total overheads and total allocation basis is used and applied for all the jobs
• To determine the selling price of any product, the accurate cost of the product must be first determined. The use of an activity-based costing method ensures that accurate cost is allocated and thus helps in the determination of correct cost of the product. It also helps in planning and forecasting of cost of the product which is required to prepare finance budgets.
• ABC method also helps to identify where high (and low) costs are being incurred and the cause which indirectly helps managers to take cost control measures and thereby reduce overheads.
• ABC method helps in the identification of inefficient products, allocation of more resources to profitable products, and helps in cost control at an individual level, which helps in tracking unnecessary costs.

(Durana, 2019)
Based on the above discussion on the use of ABC and its advantages, it will be appropriate for Optic vision to use the ABC method rather than the job costing method.
Conclusion:
Analytical review of the job order costing method and the ABC method and also looking at the business in which these methods will be more appropriate, it can be concluded that Optic vision should change from job costing to the ABC method.
References:
Banker, R., Chang, H., Ou, C. and Wu, A., 2000. Job Costing and Pricing: Empirical Evidence from a Printing Company. [online] Available at: <https://www.researchgate.net/publication/2383350_Job_Costing_and_Pricing_Empirical_Evidence_from_a_Printing_Company>.
Corporate Finance Institute. Job Order Costing – Guide Of How To Calculate Job Order Costs. [online] Available at: <https://corporatefinanceinstitute.com/resources/knowledge/accounting/job-order-costing-guide/>.
Accounting for Management. What Is Job Order Costing – Accounting For Management. [online] Available at: <https://www.accountingformanagement.org/what-is-job-order-costing/>.
Durana, M., 2019. Research Review on Activity-Based Costing System (ABC): ABC’s Development, Applications, Challenges, and Benefits. SSRN Electronic Journal,.
Park, C., 2019. Activity-Based Costing system in the service sector. Korean Journal of Hospitality & Tourism, 28(6), pp.195-209.
CGMA. 2013. Activity-Based Costing (ABC). [online] Available at: <https://www.cgma.org/resources/tools/essential-tools/activity-based-costing.html>.