Traditional Based Methods and Activity Based Costing 1

Farm Financial Standards Council Model Case Study: An Analysis ACC 501 Accounting for Decision Makers Clarence Howard Trident University

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Abstract I was required to read the Farm Financial Standards Council Managerial Accounting Case Study and the article: Throw Out Fixed and Variable Cost Thinking-Bring In Activity Based Costing for Distribution Decisions and answer three separate questions in relation to the use of Activity Based Cost principles in Managerial Accounting. The Farm Case Study is about a farm that is privately owned and operated as a soleproprietor and is located in the corn belt of the mid-west. The farm is family ran and utilizes shared equipment between the two parents and their sons farm. The farms primary crops are soybeans and corn. The long-term goal is to get a managerial accounting process in place as the two parents near retirement, with the intent to identify the differences in profitability on an annual basis between each of the two commodities, so that there will be a sound process in place to address the managerial decisions that will be faced in the future as the son takes over operations. In the second article an analysis of variable and fixed costing is done against utilizing Activity Based Costing in Decision Making. I will attempt to answer the questions presented and to identify if is indeed profitable and beneficial to utilize Activity Based Costing in this type of setting.

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In this paper, I will attempt answer questions that have been provided and explain my conclusions. The first question is as follows, do you think that the proposed solution presented in the Farm Case Study will be useful to agricultural enterprises seeking to employ management accounting techniques? Why? In the case study it stated that John and Mary Farmer were nearing retirement age. John had been observing that his son is running his portion of the farming business with a management style focused on production management rather than financial management and accounting (Farm Council Case study No. 1, 2006). John and Marys primary intent is to determine the differences in production between the farms and the differences in overall profitability between commodities (crops) produced in different years. Since this is Johns intent and there is unlikely to be major changes in the crops planted in the current or near future I think his choice of utilizing Activity Based Costing techniques is wise and would be beneficial to another agricultural enterprise seeking to employ similar management accounting techniques. Why? Activity Based Costing seeks to define the major business processes and key activities involved by linking the activities to processes, such as Johns has done in his suggested solution, where he has sought to set up a managerial accounting system with support cost centers for his equipment, shop and maintenance , and general farm. In addition, he will also have production cost centers for each of his land owners and one for each stage of production. He has also decided to establish a profit center for each commodity by year and an additional cost center for general, sales and administration and financing. By utilizing Activity Based Costing (ABC) in this manner, John has sought to identify activities and the resources associated with them as outlined above. The outcome for John and Marys farm by doing this is that the information derived will assist in making decisions about

Traditional Based Methods and Activity Based Costing 4 pricing, possible outsourcing in the future, expenditures and overall operational efficiency (Prosci, 2011). In the long-run John and Mary can utilize the information gathered from the ABC processes to identify what needs to be done and allocate their resources in a more productive manner. So what would happen if the Farm Case utilized Traditional Cost Allocation rather than Activity Based Costing? In relation to this case if John utilized the Traditional Cost Allocation data to determine demand and he planted more of one certain crops say Soybeans, based on a high demand from the previous year he might lose product if demand drops. It would be wiser to plant crops based on what crop is in demand for that year. Making decisions such as this based on Traditional Costing could cost John untold amounts of profit. By utilizing Traditional Costing Allocation one cannot view the process just the structure oriented in identifying cost which, doesnt ask what needs to be done? because the process is missing. The only question that can be asked is, what do we have at our disposal to do the job?(Emblesvag, 2000). By utilizing Traditional Costing one is unable to calculate the true cost of a product because the true cost cannot therefore be determined in order to help management make better decisions about determining a more accurate manner of costing and pricing goods and services. In saying all of this I prefer the alternative solution because it outlines the relationship between the centers for an alternative managerial accounting design and not just the support cost center that John and Mary were looking at but the alternative solution groups like items together and shows overall all profit centers from the two. In the article Throw Out Variable Cost Thinking-Bring In Activity Based Costing the author, Dr. Roger K. Harvey is not a big proponent of fixed cost/variable cost thinking. He goes so far as to say that fixed cost/variable cost thinking has no place in distribution decision making

Traditional Based Methods and Activity Based Costing 5 due to the reason of customer driven cost and I tend to agree. We all have seen that in business today cost are more likely driven by customer demands than they are by volume (Harvey, 2010). In the above instance and others ABC gives you a better idea of the cost of doing business by taking the actual activities preformed, such as ordering products or selling, delivering or manufacturing these products and the cost associated and assigns them to products or processes. The results of this are that with using ABC cost are identified and assigned not based on behavior (fixed or variable) but by actual consumption. The overall intent of decision making in a business environment whether it be farming, production or manufacturing is that strategic management decisions must be made regarding pricing, profitability and business processes. Unlike the example Dr. Harvey uses regarding the airline thinking they are making profit by selling a seat at a lower cost (fixed/variable costs), ultimately they are not because they are not focusing on customer requirements. ABC on the other hand does so by starting with customer requirements and then developing strategic management decisions based on the cost to serve those needs. The processes are redesigned to reduce costs by eliminating unnecessary tasks, streamlining operations and eliminating activities that are not efficient. So yes Activity Based Costing is better way to gather data on how cost are actually consumed in order to make better decisions on where to assign cost.

Traditional Based Methods and Activity Based Costing 6 References Case Study No. 1, (2006). Farm Financial Standards Council Retrieved from: http://cdad.tuiu.edu/Uploads/Presentations/62775John_Mary_Farm_Case_Study.pdf Prosci.com, (2010). Activity Based Costing (ABC) What is it and how can reengineering teams u use it? Retrieved from: http://www.prosci.com/abc1.htm Emblemsvag, Jan (2000). ABC Retrieved from: http://www.emblemsvag.com/abc.htm Harvey, Dr. Roger K., (2006). Throw out Fixed and Variable Cost Thinking-Bring in Activity Based Costing to Decision Making Retrieved from: http://www.e-cpa.info/White1_2010.pdf.