Activity Based Costing system

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Question 1

Describe the changes in cost structure that are likely to have occurred at Santa Cakes Pty Ltd over the last twenty years and explain their causes.


Refer to this case which the company is named Santa Cakes Pty Ltd manufactures a wide range of delicious cakes and pastries. Previously, they just have three product lines and using very simple machinery and a lot of hard work. As time goes by, the customer demands are changing, some specific products become more and more popular. But these products can not be produced in large volume. In order to produce a wide range of low volume lines as well as make and sell a lot of pies and lamingtons, they want to develop their production lines, which involve a lot of extra machinery set ups and material handling. These changes would directly lead to the changes in cost structure of the company.

In the past, the cost structure of company seems very simple; absorption costing system is easy applied to this structure. It is an inventory valuation and costing model that includes all manufacturing costs. For example, one is the direct material, those materials that become an integral part of a finished product and can be conveniently traced into it. Another is direct labor, those company labor costs that can be easily traced to individual units of product which are all kinds of cakes. The other is both variable and fixed manufacturing overheads, something like rent, insurance, power and utilities of the Santa Cakes Pty Ltd.

Currently, the company’s new cost structure is more complex than before, the traditional costing system is no longer suitable for current complicated conditions. So it is the time to adopt new costing system which is the Activity Based Costing system. This method computes the overall product cost taking into account the cost involved in the intermediate activities leading to delivery of the final product. ABC refines costing systems by focusing on individual activities as the fundamental cost object. It assigns costs to cost objects based on the activities undertaken to produce each product or service. This entails classifying the costs into one of four categories. These categories are unit level, batch level, product level, and product sustaining. Under this costing system, the company’s cost structure is more reliable.

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Question 2

Do you think the existing cost system understates or overstates the cost of a lamington and a Danish pastry? Explain.


The existing cost system used by Santa Cakes Pty Ltd is absorption costing system. If Santa Cakes Pty Ltd only manufactures some similar products like pies, finger buns, and lamingtons, absorption costing system is suitable because absorption costing tries to share overhead costs between products as fairly as possible, and these products can be produced in large volumes, ...

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