Having recently heard about the activity-based costing the CEO of Sirtex Medical limited approached our firm the Harlequin management consultancy limited for assistance. In this regard I was appointed as the head of a team which was to evaluate the Activity based Costing system and give a report on its suitability to the firm. This report is therefore designed to give a view of the ABC model, its suitability to Sirtex as well as recommendation to the firm on the way forward. The report will thereafter be closed by a suggestion of an additional accounting tool that is also appropriate for use by tie firm and its justification.
Activity based costing is a costing system that allocates the overhead costs of manufacturing to the activities that are associated with the production process. After allocating the overhead to the activities the costs of the activities are summed to estimate the cost of making the product (Douglas, 2002). The costing system is based on the notion that products manufacturing consumes activities while the activities consume resources.
The costing system allocates the overhead costs in a more logical manner if compared to the traditional costing system. In the traditional costing system costs are simply allocated based on machine hours. In the activity-based costing system costs are first assigned to the activities which are the primary cause of the overheads, afterwards these costs are allocated to the products that had consumed the activities (Hilton, 2006).
For instance, will illustrate the activity-based costing application in a two-product manufacturing situation within a single company. Product A is a low volume product which demand some activities like special engineering, several machine set-ups and additional testing since it is ordered in small quantities. On the other hand, a similar product item B is a high-volume product which is running continuously. This product requires minimal attention and no form of special activities. Should a firm allocate overheads in this scenario using the traditional costing system it might allocate the total indirect costs based on machine hours. This way very minimal overhead will be allocated to product A since it failed to consume many machine hours (Blocher, 2006). The result will be product A will be allocated a little overhead cost than should be the case. This product even though consumed a little, machine hours, demanded lots of engineering, set-up activities and testing which the traditional costing system have ignored. On the other hand, product B will be allocated a huge amount of overhead costs due to the large amount of machine hours involved. This though fails to consider that the product demanded little overhead activity compared to product A. the outcome will be a miscalculation of both the cost of A and B. by using the activity-based costing system the company can overcome this shortcoming by assigning overheads on all the activities that the products consumed (Cokins, 2010).
The use of activity-based costing will recognise the machine set-ups, special testing, special engineering and all other activities that were involved in the products’ manufacturing since this activity led to resource consumption. Under the ABC model the firm will evaluate the costs of the resources that each activity consumed, afterwards, the cost of each activity will be allocated to the specific product that utilised the activity. In the case above product A will be allocated some of the company costs that were consumed by special engineering. Machine set-ups and special testing. Other products which might have consumed these activities will also be assigned a portion. The product B on the other hand will likely be allocated the portion of the cost that was consumed in machine hours and a small part of machine set-up.
The use of activity based costing have grown in popularity in the recent times since: the manufacturing overhead costs have increased significantly with the increase in technological advancement, the manufacturing overhead costs are becoming independent of productive machine hours and direct labour hours consumed, there have been a growth in products and consumers’ diversity and lastly some products are manufactured in large batches while others are manufactured in small batches (Kumar & Mahto, 2013).
Sirtex Medical mission and objectives
Sirtex Medical is a medical service firm which is a resident company of Australia. The firm specialises in providing radioactive treatment for inoperable liver cancer known as SIR-Spheres microspheres (Drugs.com MedNews, 2008).
The mission of Sirtex Medical is to improve the quality and longevity of patient’s lives by offering innovative and interventional encology solutions. To achieve this mission the company strives to put in place an internal working process that put the patient lives at the forefront of their priorities. The firm gives weight to respect to their clients while at the same time putting paramount importance to the safety of the clients, employees as well as other healthcare professionals.
By developing innovations, the firm strives to constantly come up with advance and new ways of offering quality healthcare services. The use of technology is a vital tool that the company relies on when it comes to advancing both the employees output as well as management performance (SIRTEX, 2018).
Sirtex Medial corporate strategies
Sirtex Medical is an Australian company which has been approved to offer cancer treatment internationally. The firm’s primary commercial product is the targeted radioactive treatment meant for liver cancer. The firm have managed to offer over 86000 doses of SIT spheres Y-90 resin microspheres to combat the liver cancer menace in over 1160 medical centres across over 40 nations. The products have been approved by the U.S food and drug administration, the EU as well as Australian Therapeutic goods administration. The Sirtex limited company currently have a manufacturing centre in the US, Germany as well as Singapore. With the massive investment in technology the firm have put in a vital strategy for continuously coming up with innovative ways to combat newly arising cases in medical care especially in the fight to combat the rapid spreading of the cancer pandemic (SIRTEX, 2018).
How ABC can be effective in achieving the company’s strategies
Based on the advancements of technology the manufacturing environment in the modern business world have become more capital intensive than the historical labour-intensive production environment. In this scenario automatic machines and computer monitored operations have replaced most of the workforce and direct labour which used to form a bigger part of the manufacturing process. In the Sirtex limited the firm’s concentration in technological innovation as a tool for offering advance medical solution have meant an increase in the costs incurred in machinery as well as maintenance expenses. As technology continue to replace the use of direct manpower the proportion overheads that are consumed in the production sector is increasingly going up as the direct labour cost reduces. Costs such as set-up, inspection labour, quality control, quality assurance, procurement, selling and marketing as well as product testing have of recent dominated the manufacturing sector of the Sirtex limited (Schulze, et al., 2012).
This increase in overhead have brought complexities in allocating the costs to a given product being that most of the overheads are frequently shared by several products and cannot be identified to a single item with ease. In the traditional overhead allocation process, this cost was generally assigned using the production volume or direct labour consumed as the bases. This allocation base is no longer relevant as they do not address the origin of the overhead in the advancing manufacturing environment. Applying the traditional costing system to allocate costs will mean the management of the Sirtex limited will come up with distorted costs that do not address the real volume of resources consumed while producing the units or offering the services. In cases where the overhead costs were small like in the traditional labour-intensive production set ups the distortion was minimal and could be ignored. Of late the growth in the manufacturing overhead meant its now a major component of product cost and Sirtex cannot accommodate irrelevant estimations.
This calls for modern coting systems to assist solve the loophole left by the traditional cost allocation system. The use of activity-based costing has been approved by various researchers to offer the best solution to the issue. The Sirtex medical through efficient allocation of costs using the ABC model can come up with more accurate and reliable manufacturing costs than before.
After an intensive evaluation of the structure, strategies and objectives of the Sirtex Medical Limited in addition to the features of the activity-based costing, its recommended that the hospital management should consider putting the system in place. Accepting the use of the ABC costing model will enable the company to significantly improve on its costing system with this there is an assurance of making informed strategic steps. To incorporate the system effectively the Sirtex management team need to do the following:
Other than considering the implementation of the activity-based costing system the management of Sirtex Medical should consider putting in place a balance scorecard. This is a strategic management performance evaluation tool that makes use of semi standard structured reports to assist the manages keep track of the activities’ execution by the employees. Through its use the management team can evaluate the business performance and take a corrective measure where necessary. The primary features of the balance scorecard model involve:
The use of balanced scorecard can be a big improvement to the managers of Sirtex limited if integrated in the firm. The management tool will give the managers a view of the future financial viability by evaluating all the areas that are relevant to the positive performance of the firm. This includes: consumer perspectives, financial perspectives, internal business operations perspectives as well as technical knowhow perspectives. Stressing in the use of balance scorecard will remedy the company from the limitations of traditional performance measurements tools which only focuses on the financial aspects and therefore ignore all the other vital areas. Sirtex limited is an organization that build its operations around technical innovation. This is an area that is continuously changing and need a lot of focus to estimate appropriate strategic plans. This way the use of balance scorecard will perfectly fit in the company’s strategic performance measurement.
Conclusion
Costing is the first stage to product and service pricing. On the other hand, the pricing of products and services will define how the company delivers its corporate objectives profitability being a core part. The use of traditional costing systems has been bypassed by events and the advanced manufacturing set-up of Sitex limited cannot incorporate the traditional costing system efficiently. For the company to remain relevant it is vital for the firm to accept the use of activity-based costing to accurately price its products and formulate relevant strategic plans.
The managers of the Sirtex limited by applying the use of the ABC costing system will be able to accurately allocate the overhead costs incurred in the manufacturing process through evaluation of activities taking place in the firm.
In addition, the organisation by using ABC model will be in a good position to minitour activities consuming the company resources and are therefore able to regulate those which are non-profitable but consumes a lot of resources.
References
Blocher, E., 2006. Cost Management: A Strategic Approach. 5th ed. New York: McGrawHill Hill.
Cokins, G., 2010. Implementing Activity-Based Costing, New Jersey: Institute of Management Accountants.
Douglas, T. H., 2002. Activity-Based Costing: Making It Work for Small and Mid-Sized Companies. New York: John Wiley & Sons.
Drugs.com MedNews, 2008. SIR-Spheres Microspheres Featured at the 2008 Society of Nuclear Medicine Annual Meeting. [Online]
Available at: https://www.drugs.com/clinical_trials/sir-spheres-microspheres-featured-2008-society-nuclear-medicine-annual-meeting-4802.html
[Accessed 27 May 2018].
Hilton, R. W., 2006. Cost Management: Strategies for Business Decisions. 3rd ed. New York, : McGraw-Hill.
Kumar, N. & Mahto, D., 2013. A Comparative Analysis and Implementation of Activity Based Costing (ABC) and Traditional Cost Accounting (TCA) Methods in an Automobile Parts Manufacturing Company: A Case Study. Global Journal of Management and Business Research Accounting and Auditing, 13(4), pp. 1-11.
Schulze, M., Seuring, S. & Ewering, C., 2012. Applying activity-based costing in a supply chain environment. nt. J. Production Economics , Volume 135, pp. 715-125.
SIRTEX, 2018. Company Overview. [Online]
Available at: https://www.sirtex.com/us/investors/company-overview/
[Accessed 27 May 2018].
SIRTEX, 2018. Mission and Values. [Online]
Available at: https://www.sirtex.com/us/investors/company-overview/mission-and-values/
[Accessed 27 May 2018]
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