Abc Costing System Advantages and Disadvantages

BREAK EVEN ANALYSIS

Breakeven analysis is a powerful management tool, and one that is critical in planning, decision-making, and expense control. Breakeven analysis can be invaluable in determining whether to buy or lease, expand into a new area, build a new plant, and many other such considerations. Breakeven analysis can also show the impact on your business of changing your price structure. As the price goes down (and so your gross margin goes down), breakeven shoots up - usually very rapidly. Breakeven analysis will not force a decision, of course, but it will provide you with additional insights into the effects of important business decisions on your bottom line.

Break-even analysis will provide a sales objective that can be expressed in either dollars or units of production or sales, or whatever else is relevant. If the breakeven

point is known, it can be a definite target to be reached and exceeded by carefully reasoned steps.

Once you know the level of sales you have to reach before making a profit, you can evaluate the reasonableness of this target. What are the odds of reaching this breakeven sales level? One way to test this is to convert the gross pound sales needed for breakeven into some other unit which can then be compared against the capacity of the business or the size of the market. If the breakeven occurs at or near the capacity of the business, or if your analysis shows that you must capture all (or more than all) of the available target market, the feasibility of your concept is suspect, and the odds of business success are loaded against you.

Another way to use breakeven analysis is to change the variables in the equation. If fixed or variable expenses can be reduced, the breakeven point will go down. If prices can be increased without hurting sales (and without increasing costs), the breakeven point will go down. This is an excellent way to experiment with different alternatives. Clearly, this is a subjective process - but then, so is the rest of business analysis. The purpose is to make your business decision making as reasonable as possible.

Costing Systems and techniques for engineering companies

There are three major types of costing they include;

1 Absorption Costing

2 Marginal Costing

3 Activity based costing

Absorption Costing;

In product/service costing, an absorption costing system allocates or apportions a share of all costs incurred by a business to each of its products/services. In this way, it can be established whether, in the long run, each product/service makes a profit. This can only be a guide. Arbitrary assumptions have to be made about the apportionment of many of the costs which, given that some costs will tend to remain fixed during a period, will also be dependent on the level of activity.

An absorption costing system traditionally classifies costs by function. Sales less production costs (of sales) measures the gross profit (manufacturing profit) earned. Gross profit less costs incurred in other business functions establishes the net profit (operating profit) earned.

Using an absorption costing system, the profit reported for a manufacturing business for a period will be influenced by the level of production as well as by the level of sales. This is because of the absorption of fixed manufacturing overheads into the value of work-in-progress and finished goods stocks. If stocks remain at the end of an accounting period, then the fixed manufacturing overhead costs included within the stock valuation will be transferred to the following period

One method of determining the total cost of a given product or service is that of adding the costs of overheads to the direct costs by a process of allocation, appointment and absorption. Since overheads (or indirect costs) can be allocated as whole items to production departments, it is possible to arrive at a normal amount that must be added to the cost of each product in order to cover the production overheads.

Advantages

1 We cannot realistically produce unless fixed.

2 Costs are paid; therefore, they should be included in the production costs. Selling can be set.

3 Prices are based on total costs and in times of uncertain demand, it is better to consider final profit and not just contribution.

Disadvantages of Absorption Costing

The following are the criticisms against absorption costing:

1 You