Reference no: EM133165734

CASE1: MERIDIAN CO. LTD 

MERIDIAN CO. LTD is based in Melbourne and manufactures engineering components. It is the only manufacturer of these products in Australia but has recently experienced considerable competition from overseas producers. MERIDIAN CO. LTD is part of a larger group of companies and currently employs just over 100 people. Six staff are employed in its accounting function, including a financial controller who was specifically appointed to introduce ABC into the company. His previous appointment was with another Melbourne-based company which manufactured automotive components. His attempts to introduce ABC there had failed because top management was not convinced of the benefits of activity based costing.

Within the group, there had been no previous attempts to introduce ABC. MERIDIAN CO. LTD was the first company in the group to have done so successfully. Its previous costing system was a conventional costing system where overheads were allocated to products based on labour hours utilized. The company manufactured a very wide product range for a large customer base using a large variety of processes and methods ranging from highly sophisticated and automated processes to highly manual processes. Orders were typically for a small number of items produced to customers' specific requirements. A high level of flexibility and responsiveness was demanded by the marketplace.

In order to provide the required level of flexibility and responsiveness MERIDIAN CO. LTD had five years earlier made substantial investments in new manufacturing technologies including a robotics welding cell. The result of this was that the cost structure of the products manufactured by MERIDIAN CO. LTD had changed quite dramatically, with labour costs now only accounting for a proportion of what they were previously. The savings made from the technology upgrade were not passed on to the customers and eventually a clear price disadvantage emerged in the marketplace. Many of the company's buyers wanted to source from overseas; however, they preferred to stay with MERIDIAN CO. LTD. Although the company's overall profit margins were increasing, it was slowly losing many of its customers to overseas suppliers. The company was not aware of the areas, which contributed to the improved profit margins. It was clear to senior management that the existing accounting system was not adequate and appropriate decisions could not be made on pricing, etc. due to insufficient information.

Awareness about ABC came from senior executives within the group; however, they had no experience themselves about how the system worked or how to develop and implement it. They recognised that ABC would provide a solution to the problems experienced by MERIDIAN CO. LTD. Hence, the financial controller was appointed specifically to implement ABC within MERIDIAN CO. LTD. On taking up his new appointment at MERIDIAN CO. LTD, the financial controller established a small project team consisting of himself, an engineer from the manufacturing area and the cost/systems accountant to develop and implement ABC. Over a period of three months the project team held many informal discussions with other personnel in the company. Both the engineer and the financial controller worked full-time while the cost/systems accountant spent about two-thirds of his time on the ABC project.

The team established 25 cost pools for the whole of the company and spent a considerable amount of time agreeing on the cost drivers. Some of the cost drivers identified were: 

• frequency of set-ups for the new machines, this included programming the NC machines; 
• number of manufacturing orders - this was driving many activities from the original quoting stage to dispatch of the finished products; 
• number of purchase order lines - this was driving the workload in the purchasing department; 
• number of store issues to the production departments - this was driving the workload in the stores; 
• number of inspections made - sampling inspection was carried out in many areas; 
• area allocation to processes and machines; 
• service personnel costs. 

Many of the cost drivers were common to several cost pools and the project team did not experience any major difficulties in allocating cost drivers to activities. The system implemented at MERIDIAN CO. LTD is PC-based, largely consisting of spread sheets developed in-house by the financial controller. Only $1,000 was spent on purchasing software but a substantial amount of effort was made in tailoring the software for the specific needs of the company. Collecting and inputting data was also very time consuming.

The ABC system was initially piloted on a sample of 40-50 products which covered the whole range of products manufactured by the company. The level of detail reduced to 25 products once their homogeneity was established. The old costing system is still used, primarily for stock valuation, variance analysis and labour efficiencies. The ABC system can generate true costing and pricing, automatically give performance measures and product profitability and provide a variety of information for management decision-making. The current year's budget is being prepared using data and models developed from the ABC system.

Required

1. Explain four main differences between the traditional costing methods of absorbing overheads and activity based costing
2. Discuss MERIDIAN CO. LTD managements' expectation on the implementation of the activity based costing
3. State and explain problems encountered during the implementation of activity based costing
4. How has been the implementation of activity based costing in the service sector? Quote relevant studies
5. What is the future of activity based costing