Table of Contents

QUESTION 1.............................................................................................................................................2
ADVANTAGES AND DISADVANTAGES OF ABC...........................................................................3
THE BENEFITS AND DRAWBACKS OF TRADITIONAL COSTING..............................................4
QUESTION 2.............................................................................................................................................4
QUESTION 3.............................................................................................................................................7
CUSTOMER PROFITABILITY ANALYSIS.........................................................................................7
PRODUCT PROFITABILITY ANALYSIS............................................................................................9
QUESTION 4...........................................................................................................................................10
REFERENCES........................................................................................................................................14

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QUESTION 1
i) Discuss why companies are now abandoning the traditional costing method and
embarking on the application of Activity Based Costing.

Activity-based costing is more accurate and reliable at estimating product costs because it
concentrates on the cause-and-effect relationship between costs and activities in the context of
producing things. The activity-based costing method's fixing of the selling price for many items
is just and accurate since overheads are dispersed in accordance with relevant cost drivers. The
management of fixed and variable overhead costs is made possible by monitoring and controlling
activities. By making it simple to see how costs correspond to certain activities, activity-based
costing creates opportunities to cut overhead costs. It is possible to collect enough information to
form opinions about the potential of different product lines.

The activity-based cost (ABC) technique precisely connects specific products, services, and
customers to support and indirect expenses. An activity-based costing (ABC) system recognises
the relationship between costs, activities, and products and makes use of this relationship to
allocate indirect costs to goods less randomly than traditional methods. Manufacturing overhead
costs are assigned to commodities in a more logical way using activity-based costing (ABC), as
opposed to the traditional practise of merely allocating charges based on machine hours.
Activity-based costing assigns expenses to the tasks that really produce overhead in the order
that they should be prioritised. The cost of those activities is subsequently only charged to the
goods that actually need them. Tracking resource consumption and costing outputs at the
conclusion of the process are two steps in the activity based costing (ABC) method for costing
and monitoring activities. Resources are assigned to activities and activities to cost objects based
on consumption estimates.

The focus of activity-based costing (ABC) is on how activities deplete resources and cost firms
money (rather than volume alone drives costs). As a result, the companies that stand to benefit
the most from ABC are those who have a high overhead associated with a range of operations in
order to supply goods (or services) to customers whose needs change on a regular basis. In other
words, if your company has low overhead expenses, produces things that are almost same, and
calls for similar maintenance, then ABC is probably not required. When we discuss overhead, we
don't just mean production costs (O'Sullivan, 2013). Some customers can make requests for

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activities that raise selling and administrative costs. The expenses related to manufacturing and
administrative overheads, in ABC's opinion, ought to be charged to the customers and products
that create them. When there are a variety of products and consumers, it is unjust to simply
allocate the cost of all activities to all items and customers based on a single activity, such as
machining hours (some demand expensive activities while others do not). The non-machining
overhead costs shouldn't be charged to clients or products that don't need the other procedures.
The cost of the other activities should be divided among the products and customers who need
them. Once more, distributing overhead costs based on machine hours is typically sufficient if
your company has little variation in its products and clientele and the majority of its overheads
are tied to a single activity, such as machining hours. However, if you produce goods that
demand various levels of attention and labour to satisfy the consumer, you should learn more
about activity-based costing.

ii) Outline advantages and disadvantages of both traditional and activity based
costing.

ADVANTAGES AND DISADVANTAGES OF ABC

Advantages

Particularly in industries where support overheads account for a sizable fraction of total
expenses, more realistic product costs are supplied. The product can be blamed for additional
overheads. ABC considers all actions, hence it goes beyond the conventional manufacturing
floor base for product costing. It recognises that costs are caused by activities rather than things,
and that activities are consumed by products. draws attention to the true nature of cost behaviour,
which aids in cost reduction and the identification of activities that do not enhance the value of
the product. By utilising a variety of cost drivers, many of which are transaction-based rather
than dependent merely on output volume, ABC acknowledges the complexity and diversity of
modern production (Varshney, 2015). ABC offers a trustworthy indicator of long-term variable
product costs that are important to strategic decision-making. ABC is adaptable enough to link
costs to consumers, processes, managerial accountability areas, and product expenses. ABC

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offers helpful non-financial measurements and financial measures, such as cost driver rates (e.g.
transactions volume).

Disadvantages

The following criticisms are levelled with ABC despite the fact that it mostly eliminates the
issues with conventional absorption approaches. the decision of cost factors. The notion that a
selected cost driver serves as a suitable summary indicator for complicated processes is
oversimplified. the idea that there is a direct, linear link between using a cost driver and how
much overhead there is. Very few costs, whether they be short-term or long-term, are actually
truly changeable in this sense. the issue of shared costs. It can be challenging to assign costs to
specific activities because certain costs support a number of them.

THE BENEFITS AND DRAWBACKS OF TRADITIONAL

COSTING
Advantages

The significance of fixed expenses in production is acknowledged. Since the stock is not
undervalued, Inland Revenue accepts this strategy. Financial accounts are always prepared using
this technique. Absorption costing will show less variation in net profit when production is
constant but sales are variable. In contrast to marginal costing, when fixed expenses are accepted
to turn into variable costs, it costs into the stock value therefore distorting stock valuation.

Disadvantages

disregards the fact that various products have various demands placed on factory support
services. Absorption costing focused on total cost, including variable and fixed costs, thus
management could not use it effectively for decision-making, planning, or control. The manager
ignores the relationship between cost volume and profit because they focus more on total cost.
The manager must make the choice using his gut feeling.

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QUESTION 2
i) Prepare the cash budget for ABX Limited for the periods of Jan, Feb,
Mar and Apr.

The cash budget for ABX Limited

Details JAN (K) FEB (K) MAR (K) APR (K)

15,000. 49,500.0 59,000.0 67,500.0
Opening cash in hand 00 0 0 0
20,000. 20,000.0 20,000.0 20,000.0
Sales 00 0 0 0
15,000.
Cash in hand 00      
12,000.
Debtor outstanding paid 00      
(2,000. (2,000.0
Grader for hire 00) 0)    
(3,000.0 (3,000.
Electricity     0) 00)
(3,500. (3,500.0 (3,500.0 (3,500.
Wages and salaries 00) 0) 0) 00)
(1,500. (2,500.0 (2,500.0
Stationery 00) 0) 0)  
(2,500. (2,500.0 (2,500.0 (2,500.
Transport and fuel 00) 0) 0) 00)
(3,000.
Repairs and maintenance 00)      
49,500. 59,000.0 67,500.0 78,500.0
Closing cash in hand 00 0 0 0

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 ii) Discuss problems associated with preparing cash budgets.

Realistic results

A budget is based on a set of assumptions that are frequently quite close to the operating
circumstances under which it was developed. In response to any significant changes in the
business environment, the company's revenues or cost structure may alter so drastically that
actual results may differ significantly from those forecasted in the budget. This situation is
particularly problematic when there is a sudden economic downturn since the budget authorises a
certain level of spending that is no longer possible given the sharp decline in revenue. Unless
management takes prompt action to override the budget, managers will continue to spend within
their initial budgetary authorizations, eliminating any prospect of turning a profit. Additionally,
variations in interest rates, currency exchange rates, and commodity prices could cause outcomes
to abruptly diverge from the budget's predictions.

Strict Decision-Making

The management team's attention to strategy only enters the budgeting process during the phase
of budget formulation, which is near to the end of the fiscal year. The remainder of the year's
approach won't be changed formally. A corporation is at a disadvantage to its more nimble
competitors since there is no framework in place to properly analyse the situation and make
changes if a fundamental shift in the market occurs quickly after a budget has been created.

Time Required to Complete the Budget

It could take a while to create a budget, especially in disorganised conditions where it might
require numerous adjustments. The time required is decreased if a well-designed budgeting
strategy is in place, staff employees are comfortable with the process, and the company uses
budgeting software. The needed work could be greater if business conditions are constantly
changing and the budget model needs to be updated on a regular basis.

Abuse of the System

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An experienced manager could aim to introduce budgetary slack by purposely increasing
spending forecasts while lowering revenue estimates in order to swiftly generate favourable
variances from the budget. This might be a significant problem, and identifying and resolving it
requires extensive oversight. Additionally, using gaming effectively encourages unethical
behaviour, which can lead to more issues with fraud.

Budgetary Allocations

The methods used to distribute the mandated amounts of overhead costs among the various
departments in the budget may not be acceptable to the managers of those departments. This
presents a unique difficulty when departments are not permitted to substitute lower-cost services
from other sources for those delivered by the business.

Utilize it or lose it The department manager may, at the last minute, approve excessive spending
on the grounds that, if he does not use all of the authorised funds, his budget for the following
period will be reduced. This happens when a department is given a certain amount of spending
authority but it does not appear that the department will use all of the funds during the budget
period. Managers frequently believe they are entitled to a certain amount of finance each year
when they are not, regardless of their actual need for the money.

Only considers financial outcomes

Customers aren't concerned with a business's bottom line; they'll only use it if they get friendly
service and high-quality goods at reasonable prices. The budget tends to direct management
attention toward the quantitative features of a firm because it is numerical in nature; often, this
entails an intention emphasis on increasing or sustaining profitability. Sadly, it can be difficult to
include these ideas in a budget because of their qualitative nature. The budgeting concept may
therefore not always support customer needs.

QUESTION 3
Provide an in-depth analysis and giving examples of both product and customer
profitability analyses.

CUSTOMER PROFITABILITY ANALYSIS

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Companies can estimate the overall revenue a customer generates using CPA, a managerial
accounting technique. A customer is said to be profitable if they generate more revenue than it
costs to find, sell to, and satisfy them. The CPA is calculated by businesses either for each
specific consumer or for the entire client base. When businesses are more focused on their
divisions, products, and office locations, they commonly tend to lose sight of the clients. Because
of this, organisations can incur costs associated with maintaining unprofitable customers, which
hurts their bottom line (O'Sullivan, 2013). Businesses can evaluate their clientele using CPA and
decide whether it would be beneficial to maintain them. Based on this value, they may determine
how much it will cost to serve them or even whether to keep or fire them. Which customers
belong into the profitable category can be determined by analysing customer profitability.
Market share, value, and customer satisfaction are all factors that help businesses improve
(Varshney, 2015). Customer profitability helps to spot potential trends so that businesses can
move in that direction. Additionally, you can choose more beneficial pricing options for the
business. If done properly, customer profitability analysis allows for the matching of lower-
performing customers with lower-performing customers to gain insights and give customised
content.

Monitoring product performance, customer product usage time, product features, and all costs,
both internal and external, can improve the customer profitability analysis. The first step in
determining customer profitability is to identify all of the costs involved in supplying a certain
client or market group. For instance, a solar panel company serves both small and medium-sized
enterprises and people (SMEs). In order to attract, keep, and retain its customers, the company
must fulfil orders for sales as well as consulting and service visits. Customers only need to view
the website once before placing an order. Because they have multiple locations and require after-
sale maintenance as part of their bulk purchases, SMEs need to be visited more regularly.

INDIVIDUAL
S SMES
Customer behavior    
Annual sales (units) 4 12
Visits per year 1 10
Orders per year 1 8

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Customer costs    
Annual sales 1000 3000
Visits per year -150 -1500
Orders per year -100 -800
Customer Profitability 750 700
The above example shows that the SME segment's customer profitability is lower than the
Individual segment's. The company can then utilise this information to guide its strategic
decisions. It might refocus its efforts to entice and retain more customers from the more
profitable Individual segment. As an alternative, it might look into ways to save money for its
SME sector. To reduce the number of trips or orders, it can attempt to alter its purchasing
process. If not, it can try to charge the consumer for further service visits in an effort to shift the
cost from the company to them.

The fundamental criticism of customer profitability analysis is the use of a limited time frame
and segmentation rules. Using novel methods that consider a customer's lifetime worth rather
than just the sales during a certain time frame, Big Data has made it possible to analyse customer
profitability. Furthermore, by identifying drivers in behavioural patterns, segmentation using
predictive analytics will be able to determine the value of individual consumers rather than
merely the value of the typical customer in a specific category.

PRODUCT PROFITABILITY ANALYSIS

Investigating a company's product profitability in addition to its gross earnings will help you get
a more complete picture of its revenue. A company can utilise product profitability analysis to
boost sales by monitoring the profitability, production costs, cash flow, and price for each unique
product. In this article, we discuss product profitability analysis, including its definition, business
uses, and analytical methods. One of a company's main objectives when it first starts out is to
make money. Basically, the goal of every business owner is to have a profitable firm. Therefore,
it should go without saying that a thorough analysis of earnings is necessary to determine how
well your firm is doing (Geijsbeek, 2018). The nuances that obscure various financial indicators
will, however, reveal your company's genuine prosperity. By examining the earnings, which are

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essentially the funds left over from the capital after deducting all operating costs, you may keep
tabs on the performance of your business. Profitability analysis for businesses enables profit
maximisation. As a result, companies may make the most of their opportunities to profit from
them in order to keep growing in a market that is extremely dynamic, competitive, and active.
Profitability research helps businesses identify growth opportunities, inventory items with high
or low turnover, market trends, and more, ultimately providing decision-makers with a clearer
picture of the firm as a whole.

Margins in Ratio

To understand your financial status over a specific time period, it is essential to understand your
company's ability to convert revenues into profits. Margin ratio is equivalent to that at various
levels of measurement. Operational profit margin, net profit margin, cash flow margin, operating
expense ratio, and overhead ratio are a few examples. The operating profit margin, net profit
margin, gross profit margin, and cash flow margin are other examples.

Return Ratios

The phrase "return ratio" refers to a company's capacity to generate returns for its owners. The
cash return on assets, return on equity, return on debt, return on retained earnings, return on
sales, risk-adjusted return, return on invested capital, and return on capital used are a few
examples.

QUESTION 4
a) Illustrate and give examples of how variances operate in an organisation and why
management must always endeavour to have them determined

Businesses employ variance analysis in a variety of ways. The first step is to select the
benchmarks to compare actual performance to. The management that is in charge of the
variances must provide an explanation for any deviations that are outside of a predetermined
range, according to the variance reports that many organisations produce. Many businesses

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require explanations for both positive and negative deviations, whereas some just want
explanations for negative variances. When managers are asked to pinpoint the causes of
unfavourable variations, they are compelled to look into potential problem areas or determine
whether the deviation was an isolated incident. By demanding an explanation, managers can
decide whether a favourable variance is sustainable. Knowing what caused the favourable
variation will help management plan for it in the future, whether it was a one-time occurrence or
a regular one.

Another option is that the standards may already have taken the positive variance into account.
For instance, management may overestimate labour rates, material costs, labour costs per unit, or
material quantities. The standards allow for this kind of budget slack, often known as
overestimation, so management may preserve a positive reputation even if spending end up being
higher than expected. In any case, managers may be able to help other managers and the
company as a whole by pointing out specific problem areas or exchanging knowledge that
lessens differences. Management frequently manages "to the variances," which refers to
measures that may not be in the organization's best interest over the long term, in order to meet
the variance report threshold limits. This may occur when standards are developed wrongly,
resulting in significant differences between actual and standard figures.

Variance analysis is a useful technique that an organisation can use to attain its long-term goals.
The crucial function accounting plays in recording a company's financial results and the potential
effects of responding to a deviation on management's behaviour in accomplishing goals are both
concepts that must be understood by businesses. This is especially true when a variation is
discovered by its accounting system. 1 Many managers don't look at the reasons of the variance
from a long-term perspective; instead, they only utilise variance analysis to forecast a short-term
response. A longer-term analysis of variations enables an approach called "responsibility
accounting," in which power and accountability for tasks are delegated downward to those
managers with the most impact and control over them. Managers should use a longer-term view
than merely the immediate term when analysing the reported changes.

Managers occasionally only care about generating results for the near future. For instance, a
management may decide to forego reaching the company's long-term goals in order to appear

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lucrative in the near term with a manufacturing division's performance. A recognisable cost
variance could be an increase in repair costs as a percentage of sales on an ongoing basis. This
discrepancy can indicate underperforming equipment, which would drive up overall cost.
However, the cost of installing new, more efficient equipment may be greater than the cost of
maintaining the current equipment. Although replacing the outdated equipment might be more
affordable in the short run, the company would be better served in the long run by investing in
more up-to-date machinery. If the mechanism employed for cost control is not linked to reinforce
management of the firm with a long-term view, the manager has no organisational incentive to
be concerned with significant issues unrelated to anything other than the immediate costs3 tied to
the variation. A management must be aware of the goals of their organisation while making
judgments based on variance analysis.

b) Discuss the significance of both favourable and adverse variances how they assist
management in reversing decisions.

An unfavourable variance occurs when real income or expenses fall short of or exceed the
budget. This is the same as having a deficit, where spending exceeds income. An unfavourable
variance exists when the cost of production is higher than expected. Unfavorable variations are
expressed by positive numbers. Remember that the luxurious blend of acrylic and polyester used
to make your custom blankets keeps them supple for years. However, it is challenging to find the
material. You make a large number of purchases, but three months later, an unexpectedly large
price increase occurs. Because of this pricing mismatch, you are spending more money on
materials than you had planned. Your financial accounts now show a negative variance.

A beneficial variance occurs when real revenue or expenditures surpass or fall short of the
budget. This is comparable to a surplus where income exceeds expenses. The management of a
business can infer from a positive variance that things are running well and financially. A
company may find ways to produce more as it grows without having to raise costs, creating a
higher revenue stream (O'Sullivan, 2013). However, a positive variance may indicate that the
initial output projections were inaccurate, which is more likely if the business is new. Let's
imagine you run a business that makes custom-made, handcrafted blankets. The company has

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only been in business for about six months, but because of the customising process and the
premium fabric you use, it has become well-known throughout the world. The initial cost of
materials, labour, and production supplies was included in your budget. You anticipated that it
would take twenty hours to make one blanket, but it actually takes an average of fifteen, thus
there is a five-hour difference between the two in terms of direct labour costs. The decrease in
labour costs has resulted in a positive variance.

When analysing the causes of a favourable or unfavourable variation, one must consider whether
the budget variances were actually under one's control. Line-by-line budget consultation is
necessary for this. If the variance was "controllable," it means that management had some degree
of control over the beginning expenses (Geijsbeek, 2018). This could be the hourly pay for the
workforce or commissions for the sales group. When a factor is described as "uncontrollable," it
signifies that management has no control over it. The cost of materials is one illustration of this.
Management might be able to move quickly to address the problem if a budget change is
unfavourable but judged to be controllable. If management does not have direct control over the
budget item, they might need help coming up with a fresh business plan to grow and prosper.

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REFERENCES
1) O'Sullivan, Arthur; (2013). Economics: Principles in Action. Upper Saddle River, New
Jersey 07458: Pearson Prentice Hall. pp. 375

2) Geijsbeek, William R. Jr. (2018). "Survey and Analysis of Capital Budgeting

Methods". The Journal of Finance. 33 (1): 281–287.

3) Varshney, R.L (2015). Managerial Economics. 23 Daryaganj, New Delhi 110002: Sultan

Chand & Sons. p. 881.

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