Unit 1: Management Accounting
Meaning of Management Accounting
Management Accounting refers to the process of preparing financial and non-financial information that helps managers in decision-making, planning, and controlling business operations.
It combines accounting, finance, and management techniques to assist internal management in making informed business decisions.
Example: If a company wants to launch a new product, management accounting helps analyze the cost, expected profit, market trend, and budget required.
Nature of Management Accounting
The nature of management accounting can be explained through the following point.
Scope of Management Accounting
The scope of management accounting is vast. It covers several areas that support decision-making. Some key areas include
Difference Between Management Accounting and Financial Accounting
Cost Unit
A cost unit is a unit of product, service, or time in relation to which
costs are measured or expressed. In simple words: It is the standard unit
used to identify the cost of a product or service.
Examples
Cost Control
Cost control refers to the process of monitoring and regulating the
expenditure of a business to keep costs within the planned or budgeted
limits. In simple words: Keeping costs from going over budget by
controlling expenses.
Key Steps in Cost Control
- Set standards (budgets or cost limits)
- Measure actual performance
- Compare actual cost with standard cost
- Analyze variance (difference)
- Take corrective action
Objective
- Prevent unnecessary costs
- Ensure efficiency
- Improve profit margins
Cost Reduction
Cost reduction refers to the continuous process of lowering unit cost
without compromising quality or performance. In simple words: Reducing
costs permanently by finding better ways of doing things.
Methods of Cost Reduction
- Using better technology
- Reducing waste or scrap
- Streamlining processes
- Training employees
- Buying raw materials in bulk
Objective
- Achieve long-term savings
- Improve competitiveness
- Increase profitability
Key Difference Between Cost Control & Cost Reduction
Component of Total Costs
The components of total cost in business or production refer to all the expenses a company incurs to produce and sell goods or services. Total cost is usually divided into two main parts: fixed costs and variable costs, but can be further broken down for deeper understanding.
Here are the key components of Total Cost
Total cost in business refers to the sum of all costs incurred in producing goods or services. These costs can be categorized into various components. Here's a detailed breakdown of the components of total cost:
1. Fixed Costs: Fixed costs are expenses that do not change
with the level of production or output. These costs remain constant
regardless of how many units are produced or sold.
Examples
- Rent for office space or factory
- Salaries of permanent staff
- Depreciation on machinery and equipment
- Insurance premiums
- Licensing fees
Key Characteristics
- Do not vary with production level
- Must be paid even if no goods or services are produced
- Spread out over a large number of units as production increases, reducing the fixed cost per unit
2. Variable Costs: Variable costs are expenses that change
directly with the level of production or output. These costs increase
as production increases and decrease when production is lower.
Examples
- Raw materials (e.g., metals, wood, chemicals)
- Labor costs for hourly workers or production line workers
- Utilities like electricity, which increase with production volume
- Packaging materials
- Shipping costs
Key Characteristics
- Vary with the level of output
- Directly related to the production process
- Can be managed by controlling the level of production
3. Semi-Variable Costs: Semi-variable costs have both
fixed and variable components. A base cost remains constant (like
fixed costs), but there is an additional cost that varies depending on
the level of production.
Examples
- Utility bills (a basic fixed amount plus usage charges)
- Salaries of employees with a fixed component and commission-based bonuses or incentives
- Maintenance costs (fixed service charge plus costs depending on usage)
Key Characteristics
- Partly fixed and partly variable
- Often seen in contracts with variable conditions like overtime payments or service charges
4. Direct Costs: Direct costs, also known as prime costs, are
costs that can be directly traced to a specific product or service.
Examples
- Direct labor (wages of workers involved in production)
- Direct materials (raw materials used in the production of a product)
- Manufacturing supplies used directly in the production process
Key Characteristics
- Can be directly attributed to the production of a particular good or service
- Essential for calculating cost per unit of production
5. Indirect Costs: Indirect costs, also known as overheads, are
costs that cannot be directly traced to a specific product or service.
These costs are necessary for the overall functioning of the business
but are spread over several products.
Examples
- Administrative salaries
- Office supplies
- Rent for the facility
- Marketing and advertising expenses
Key Characteristics
- Not directly linked to a specific product
- Allocated across all products produced
6. Total Variable Cost: Total variable cost is the total cost
incurred due to the variable components, and it varies directly with
the production volume.
Formula:
7. Total Fixed Cost: Total fixed cost remains the same regardless of the level of output. It does not change as production increases or decreases.
Formula:
8. Total Cost: Total cost is the sum of fixed costs and
variable costs at any given level of production. It is the overall
expenditure a business incurs in the production of goods and
services.
Formula:
9. Opportunity Cost: Opportunity cost refers to the
potential benefit that a company loses when it chooses one
alternative over another. While not a direct cost in accounting
terms, opportunity cost plays a critical role in decision-making.
Examples
- Choosing to invest in one project over another, where the potential return of the second project is the opportunity cost of the first.
- Time spent on one activity instead of a more profitable one.
10. Sunk Costs: Sunk costs are costs that have already been
incurred and cannot be recovered. These costs should not influence
future decisions as they cannot be altered.
Examples
- Money spent on research and development
- Investment in equipment that is now obsolete
11. Marginal Cost: Marginal cost refers to the cost of
producing one additional unit of a good or service. It helps
businesses in determining how cost-efficient their production is
at the margin.
Formula
Summary
- Fixed Costs: Do not vary with production level.
- Variable Costs: Change directly with production level.
- Semi-Variable Costs: Have both fixed and variable components.
- Direct Costs: Directly tied to a specific product or service.
- Indirect Costs: Indirectly related to the overall business operations.
- Opportunity Cost: The value of the next best alternative foregone.
- Sunk Costs: Irrecoverable costs that should not affect future decisions.
- Marginal Cost: The cost of producing one more unit.
Understanding these components helps businesses in cost
management, pricing strategies, and profitability analysis.
Cost Sheet
A cost sheet is a detailed statement that shows the breakdown
of the cost incurred in the production of goods or services.
It is used by businesses to analyze and control costs and to
determine the cost per unit of production. It also helps in
pricing decisions and profit analysis.
Cost Sheet Structure
A typical cost sheet is divided into the following sections:
1. Prime Cost (Direct Cost): Prime cost represents the
direct costs incurred in the production of goods. It includes:
- Direct Materials: The raw materials used in manufacturing.
- Direct Labor: Wages of workers directly involved in the production process.
- Direct Expenses: Any other expenses that can be directly attributed to the production of goods (e.g., royalties, special equipment for production).
Formula
2. Factory Cost (Work Cost): Factory cost includes the prime cost plus the overheads incurred in the factory, such as:
- Factory Expenses (Indirect Materials): Materials used in the production process that cannot be directly assigned to a product.
- Factory Labor (Indirect Labor): Labor costs that are not directly involved in production (e.g., supervisors, maintenance staff).
- Factory Overheads: Costs like depreciation of machinery, factory rent, utilities (electricity, water), and insurance related to the production facility.
Formula:
3. Cost of Production: The cost of production includes the factory cost plus the costs incurred during the production process outside of the factory, such as:
- Opening Work-in-Progress (WIP): The cost of partially completed goods at the start of the period.
- Closing Work-in-Progress (WIP): The cost of partially completed goods at the end of the period.
- Other factory-related expenses.
Formula:
4. Cost of Sales: Cost of sales includes the cost of production along with other expenses incurred after the production phase, such as:
- Opening Stock of Finished Goods: The cost of finished goods at the beginning of the period.
- Closing Stock of Finished Goods: The cost of finished goods at the end of the period.
- Selling and Distribution Expenses: Costs related to the marketing and distribution of products (e.g., transport costs, advertising).
Formula:
5. Total Cost (Final Cost): The total cost is the final sum of all costs incurred during production, including the cost of sales and the administrative expenses.
Formula:
Classification of Costs
Costs are classified into different categories based on their nature,
function, and behavior. Here are the main classifications:
1. Based on Behavior (Cost Function)
- Fixed Costs: These costs remain constant regardless of the level of production or business activity. Examples: Rent, salaries of permanent employees.
- Variable Costs: These costs change directly with the level of production. Examples: Raw materials, labor costs for hourly workers.
- Semi-Variable Costs: These costs have both fixed and variable components. Example: Electricity charges (fixed base charge plus usage).
2. Based on Traceability to Product
- Direct Costs: Costs that can be directly attributed to a specific product. Examples: Direct materials, direct labor.
- Indirect Costs: Costs that cannot be directly attributed to a specific product. Examples: Factory overheads, administrative expenses.
3. Based on Cost Function
- Production Costs: Costs incurred in the manufacturing process. Examples: Direct materials, direct labor, factory overheads.
- Non-Production Costs: Costs not directly related to the manufacturing process. Examples: Selling, distribution, and administrative expenses.
4. Based on Time Period
- Historical Costs: Costs that have already been incurred in the past. These are used to analyze the past performance of the business.
- Imputed Costs: Notional costs that are estimated but not actually incurred. Examples: Opportunity cost, imputed rent.
- Forecast Costs: Costs that are estimated or budgeted for a future period.
5. Based on Function
- Manufacturing Costs (Product Costs): Costs incurred in the process of producing goods. Includes direct materials, direct labor, and factory overheads.
- Administrative Costs (Period Costs): Costs associated with the general management and administration of the business. Examples: Office salaries, rent of office space.
- Selling and Distribution Costs: Costs related to the marketing and distribution of products. Examples: Advertising, shipping, and sales commissions.
6. Based on Decision-Making
- Relevant Costs: Costs that will be affected by a specific decision and should be considered in decision-making. Example: The cost of raw materials when deciding whether to make or buy a product.
- Irrelevant Costs: Costs that are unaffected by a specific decision and should not be considered. Example: Sunk costs.
7. Based on Controllability
- Controllable Costs: Costs that can be controlled or influenced by a manager. Example: Direct labor costs, direct materials costs.
- Uncontrollable Costs: Costs that cannot be easily controlled or influenced by a manager. Example: Rent, insurance premiums.
Costing
Costing is the process of determining the cost of a product, service,
or project, which helps businesses understand their expenses, set
pricing strategies, and improve profitability. There are various types
of costing and methods of costing, each suited for different types of
industries, production processes, and organizational needs.
Types of Costing
1. Absorption Costing (Full Costing): Absorption costing is a
method where all manufacturing costs (both fixed and variable) are
absorbed into the cost of the product.
Features
- Includes direct materials, direct labor, and both variable and fixed factory overheads.
- Used for financial accounting and preparing financial statements.
- Applicable for: Companies that produce tangible products in large volumes.
2. Marginal Costing (Variable Costing) : Marginal costing
is a method where only variable costs are included in the cost of the
product. Fixed costs are treated as period costs and are not included
in the product cost.
Features
- Focuses on the cost incurred for producing one additional unit (marginal unit).
- Helps in decision-making (like pricing and production decisions).
- Applicable for: Decision-making and short-term financial analysis.
3. Job Costing: Job costing involves calculating the cost of
specific jobs or projects. Each job is treated as a unique unit of
production, and costs are assigned to it individually.
Features
- Common in industries where each product or job is custom-made (e.g., construction, custom manufacturing).
- Costs are accumulated for each job (direct materials, direct labor, and overheads).
- Applicable for: Industries like construction, shipbuilding, and advertising agencies.
4. Process Costing: Process costing is used for industries
where production is continuous and products are identical or nearly
identical. Costs are averaged over all units produced.
Features
- Used in mass production where products cannot be distinguished from one another.
- Costs are assigned to processes or departments rather than individual products.
- Applicable for: Industries such as chemicals, food production, oil refining, and cement manufacturing.
5. Contract Costing: Contract costing is used when the
production process takes a long time to complete and is specific to a
contract or project.
Features
- The costs are assigned to a contract and are monitored over time until the contract is completed.
- It includes direct costs (materials, labor) and indirect costs allocated to the project.
- Applicable for: Construction companies, large infrastructure projects, and long-term service contracts.
6. Batch Costing: Batch costing is similar to job costing, but
the costs are assigned to a batch of products, rather than individual
units or jobs.
Features
- Common in industries where products are manufactured in batches (e.g., pharmaceutical, clothing, food production).
- Helps in cost determination for a group of similar items produced together.
- Applicable for: Pharmaceuticals, food processing, and printing.
7. Operating Costing: Operating costing is used by service
industries that offer services rather than physical goods. It helps
determine the cost of delivering a service.
Features:
- Focuses on the cost of operation rather than manufacturing.
- Costs such as labor, maintenance, and utilities are analyzed and allocated.
- Applicable for: Transport companies, hospitals, and utility providers.
8. Activity-Based Costing (ABC): Activity-based costing assigns
overhead costs to products based on the activities that drive those
costs, rather than allocating overhead uniformly.
Features
- More accurate way of allocating costs, especially in complex or multi-product environments.
- Identifies the true cost of production by linking overhead costs to specific activities.
- Applicable for: Companies with diverse products or services and high overhead costs.
Methods of Costing
Costing methods refer to the various techniques used to calculate and
allocate costs in the production process. The most commonly used
methods are:
1. Standard Costing: Standard costing involves estimating the expected costs of production (standard costs) for materials, labor, and overheads. Actual costs are then compared to these standard costs to measure performance.
Features
- Used for performance evaluation and cost control.
- Variance analysis is conducted to understand discrepancies between expected and actual costs.
- Applicable for: Manufacturing companies with repetitive production processes.
2. Direct Costing: Direct costing involves calculating only the
direct costs (direct materials and direct labor) for producing a
product. Indirect costs (overheads) are not included in the cost of
production.
Features
- Simplified method, often used for decision-making, like pricing or profitability analysis.
- Overheads are treated separately and are not part of product cost.
- Applicable for: Short-term decisions or businesses with fluctuating overhead costs.
3. Variable Costing: Variable costing (also known as marginal
costing) includes only the variable costs (direct materials, direct
labor, and variable overheads) in the cost of the product. Fixed costs
are treated as period expenses.
Features
- Used to calculate contribution margin (sales minus variable costs).
- Helpful in break-even analysis, pricing decisions, and contribution margin analysis.
- Applicable for: Decision-making, especially in businesses where the production volume can vary.
4. Absorption Costing: Absorption costing allocates both fixed
and variable overheads to products. This method is used for external
financial reporting and tax purposes.
Features
- Provides a more complete picture of the cost of a product by including all production costs (fixed and variable).
- Required by Generally Accepted Accounting Principles (GAAP).
- Applicable for: Businesses preparing external financial statements.
5. Marginal Costing: Marginal costing calculates the additional
cost of producing one more unit of output. It includes only variable
costs, and fixed costs are treated separately.
Features
- Focuses on the cost incurred for producing one more unit of a product.
- Helps in break-even analysis, pricing decisions, and determining the effect of changes in production volume on profitability.
- Applicable for: Short-term decisions, particularly in situations where fixed costs remain constant.
6. Throughput Accounting: Throughput accounting is a cost
management method used primarily in the Theory of Constraints (TOC).
It focuses on maximizing the throughput (the rate at which the system
generates money through sales) while minimizing inventory and
operational expenses.
Features
- Focuses on increasing the throughput (sales minus direct costs) rather than just cutting costs.
- Used to identify bottlenecks in production and optimize resource utilization.
- Applicable for: Companies using the Theory of Constraints, manufacturing industries with bottleneck operations.
Comparison of Costing Methods
The choice of costing method depends on the nature of the business, the type of production process, and the decision-making needs of the organization. Each costing method provides valuable insights that help businesses in budgeting, pricing, cost control, and profitability analysis. Selecting the right method allows for better cost management and informed strategic decisions.
Inventory Management
Inventory management involves the process of overseeing and controlling
the ordering, storage, and use of materials and products in a business.
It is crucial for maintaining a balance between having enough stock to
meet customer demands and avoiding overstocking, which can lead to
excess costs.
Objectives of Inventory Management
- Ensure Uninterrupted Production: Inventory management helps maintain sufficient stock levels to ensure that production doesn’t stop due to shortages.
- Minimize Costs: It aims to minimize the costs of holding inventory, such as storage, insurance, and depreciation.
- Meet Customer Demand: Proper inventory management ensures that products are available to meet customer demand without delays.
- Improve Cash Flow: By avoiding excessive inventory, businesses can improve their liquidity and reduce unnecessary investment in stock.
Types of Inventory
- Raw Materials: Materials that are used in the production process but haven’t yet been processed.
- Work-in-Progress (WIP): Goods that are in the process of being manufactured but are not yet completed.
- Finished Goods: Completed products that are ready for sale.
- Maintenance, Repair, and Operating Supplies (MRO): Items used for maintenance and repairs in the production process, such as lubricants, tools, etc.
Inventory Management Techniques
- Just-in-Time (JIT): A strategy where inventory is kept to a minimum and goods are only produced or ordered when needed. This reduces holding costs and minimizes waste.
- Economic Order Quantity (EOQ): EOQ helps determine the optimal order size that minimizes the total cost of ordering and holding inventory. The formula is:
- ABC Analysis: This technique categorizes inventory items into three groups:
- A: High-value items with low frequency of use.
- B: Moderate value and frequency of use.
- C: Low-value items with high frequency of use.
- The goal is to focus more on managing high-value items (A) and less on low-value items (C).
- Reorder Point (ROP): The inventory level at which a new order should be placed to replenish stock before it runs out. The formula is:
- Safety Stock: Extra inventory held as a buffer against uncertainties in demand or supply delays.
Inventory Control Methods
- Perpetual Inventory System: Continuously tracks inventory levels in real time. This is ideal for businesses that need to manage inventory closely and have a high volume of transactions.
- Periodic Inventory System: Inventory is counted at regular intervals, typically at the end of a financial period, to assess stock levels.
Labour Cost
Labour cost refers to the total compensation paid to employees for their
work, including wages, salaries, benefits, and other employment-related
expenses. It is a crucial component of a company’s cost structure and can
significantly impact profitability.
Components of Labour Cost
- Direct Labour Costs: These are wages and benefits paid to employees who directly contribute to the production of goods or services. Example: Wages of assembly line workers or service staff.
- Indirect Labour Costs: These are wages and benefits paid to employees who are not directly involved in the production process but are necessary for operations. Example: Wages of supervisors, maintenance workers, or administrative staff.
- Employee Benefits: This includes health insurance, pensions, paid vacations, and other non-wage compensation paid to employees.
- Overtime Payments: Extra wages paid to employees who work beyond their standard working hours.
- Payroll Taxes: Taxes that the employer must pay on behalf of the employees, such as social security or unemployment insurance.
- Bonus and Incentive Payments: Additional compensation paid to employees based on performance or company profits.
- Training Costs: Expenses related to training employees, which could also be considered part of labor cost in certain cases.
Methods for Calculating Labour Cost
1. Labour Cost per Unit of Production: This is calculated by
dividing the total labour cost by the number of units produced. It helps
determine the labour cost involved in producing a single unit.
Impact of Labour Cost on Business
- Cost Control: Labour costs are often one of the largest expenses for companies, especially in service and manufacturing sectors. Proper management and control can improve profitability.
- Productivity and Efficiency: Reducing labour costs can improve profitability, but it must be done without negatively affecting productivity. Investing in employee training and maintaining a motivated workforce is key to long-term success.
- Wage Policies: The level of wages and benefits paid to employees affects recruitment and retention. Competitive wages and benefits are necessary to attract and retain skilled employees.
- Automation and Technology: In some industries, companies may reduce labour costs by investing in automation or new technology that improves efficiency and reduces the need for manual labor.
Labour Cost Control Strategies
- Job Design and Work Simplification: By designing jobs more efficiently, businesses can reduce the time and effort needed to complete tasks.
- Performance-based Incentives: Linking part of the pay to performance can motivate employees to work more efficiently and reduce overall labor costs.
- Outsourcing: Some businesses outsource non-core activities to reduce labor costs (e.g., customer support, cleaning services).
- Automation: Investing in technology to automate repetitive tasks can reduce the need for manual labor and lower costs.
In Short, Both inventory management and labour cost management are vital
for maintaining profitability in a business. Proper inventory management
ensures that businesses can meet customer demand without tying up too
much capital in stock, while effective labour cost management ensures
that the workforce remains efficient and motivated, contributing to
higher productivity and lower operational costs. Efficiently managing
both can lead to improved cash flow, profitability, and long-term
sustainability.
Overheads
Overheads are the ongoing expenses of operating a business that are not
directly tied to specific products or services. They are costs that
support the production process but do not directly contribute to the
creation of a product or service. Overheads are necessary for the
business to operate but cannot be directly traced to any specific unit
of production.
Types of Overheads
1. Fixed Overheads: These costs remain constant, regardless of
the level of production or business activity. They do not change with
the volume of goods or services produced.
Examples:
- Rent for factory or office space
- Salaries of permanent staff
- Depreciation of machinery
- Insurance premiums
2. Variable Overheads: These costs vary in direct proportion to
the level of production or business activity. As production increases,
variable costs increase, and as production decreases, variable costs
decrease.
Examples:
- Utility bills (electricity, water) that fluctuate with usage
- Direct materials handling costs
- Maintenance costs for equipment depending on usage
3. Semi-variable Overheads: These costs have both a fixed and a
variable component. A portion remains fixed regardless of production
levels, while another portion varies with the level of activity.
Examples:
- Telephone bills (a fixed monthly charge plus charges based on usage)
- Salaries of supervisory staff (fixed component plus overtime or bonus depending on production)
4. Administrative Overheads: These are overhead costs that relate
to the general administration of the business, not directly linked to
the production process.
Examples:
- Salaries of office staff
- Office supplies
- Legal and audit fees
5. Selling and Distribution Overheads: Costs incurred in the
marketing, selling, and distribution of goods or services.
Examples:
- Advertising cost
- Sales commissions
- Shipping and delivery costs
Allocation of Overheads
Overheads are allocated to products or services in different ways, based
on the method being used. Common allocation methods include:
1. Pre-determined Overhead Rate: The overhead rate is calculated based on an estimate of total overhead costs and the estimated activity level (e.g., labor hours, machine hours).
Formula:
2. Activity-Based Allocation: Overheads are allocated based on specific activities that drive costs (discussed below in Activity-Based Costing).
Activity-Based Costing (ABC)
Activity-Based Costing (ABC) is an accounting method that assigns overhead
costs to products or services based on the activities that drive those
costs. Instead of allocating overheads arbitrarily, ABC identifies the
various activities in the production process and assigns overheads based
on the resources each activity consumes.
Why Use Activity-Based Costing?
Accuracy in Cost Allocation: ABC provides a more accurate way of assigning
overheads to products by focusing on the activities that drive costs. It
eliminates the distortions caused by traditional methods that might
allocate overheads based solely on labor or machine hours.
- Cost Transparency: It gives a better understanding of the true costs of production and helps businesses identify areas of inefficiency.
- Helps in Decision-Making: ABC provides more detailed information for pricing, budgeting, and profitability analysis, especially when multiple products are involved.
- Improved Profitability: By understanding the cost drivers, businesses can better control costs and improve profitability.
Steps in Activity-Based Costing
- Identify Activities: Identify the activities involved in the production or service process that incur costs. Examples: Machine setup, order processing, inspections, packaging, etc.
- Determine the Cost Drivers: A cost driver is a factor that influences the cost of an activity. For example, the number of machine hours used could be the cost driver for machine maintenance. Examples: Machine hours, labor hours, number of setups, number of inspections.
- Calculate the Cost of Each Activity: Assign a cost to each activity based on the resources used by that activity. This can include direct costs (like wages) and allocated overheads. Example: If the cost of maintaining machinery is $10,000 annually and machine maintenance takes 1,000 hours, the cost per machine hour is $10.
- Assign Costs to Products or Services: Once the activity costs are identified, allocate the costs to products or services based on their use of each activity. Example: If a product requires 5 machine hours for setup, and the machine setup cost is $10 per hour, then the product will be allocated $50 of the machine setup cost.
Advantages of ABC
- More Accurate Costing: Provides a more precise way of assigning overheads, which helps companies understand the true cost of their products or services.
- Better Cost Control: By identifying the activities that drive costs, businesses can focus on eliminating waste and improving efficiency.
- Helps in Pricing Decisions: Businesses can price their products more accurately by understanding the actual cost involved in producing each product or service.
- Improved Profitability Analysis: Helps to identify unprofitable products or services by revealing the true costs, leading to more informed decision-making.
- Supports Strategic Planning: ABC can provide detailed insights that support long-term planning, such as evaluating the profitability of different product lines or customer segments.
Disadvantages of ABC
- Complex and Time-Consuming: Implementing ABC can be complex and time-consuming, especially for companies with many products and activities.
- Expensive to Implement: Setting up an ABC system may require significant investment in software, training, and resources.
- Requires Regular Updating: As business activities and production processes change, ABC systems need to be regularly updated to maintain accuracy.
ABC vs Traditional Costing Methods
| Aspect | Traditional Costing | Activity-Based Costing (ABC) |
|---|---|---|
| Cost Allocation | Overhead allocated based on a single cost driver (e.g., labor hours or machine hours). | Overhead allocated based on multiple cost drivers (e.g., machine setup, inspection time). |
| Accuracy | Can result in over or under-costing of products due to broad allocation of overheads. | More accurate, as it assigns costs based on actual activities that drive costs. |
| Complexity | Simpler to implement and manage. |
More complex and time-consuming to implement. |
| Cost Transparency | Limited transparency into the cost structure. |
High transparency, identifies cost drivers for better
decision-making. |
| Decision-Making Support | May not provide detailed insights for strategic decisions. | Provides better insights for pricing, cost control, and profitability analysis. |