Product Service Organization / Company Activity-Based Costing

¶ … product service organization / company Activity-Based Costing (ABC). Then identify activities ABC cost drivers activities. Estimate application rates cost driver. If identify specific actual amounts, make a reasonable estimate apply tool data factual.

Activity-Based Costing at Ford Motor Company

Ford Motor Company is an international leader of the automobile industry, but it is now faced with escalading problems. A few years ago, the company started sensing competitive pressures from the Japanese manufacturers, who had aggressively penetrated the American market and were gaining increased market share. The outcome was possible as the firm had focused on large size and luxurious vehicles, underestimating the customer demand for small size and fuel efficient engines. Following these issues, the global economy went into recession and the automobile manufacturer was once again hit by a decreased demand for its products (Plunkett Research).

In order to overcome these challenges, Ford Motor Company is reconsidering its product palette and has come to invest more in the development of vehicles integrating fuel efficient engines. The most relevant example in this sense is represented by the Ford Fiesta, which would be hereby assessed from an accounting standpoint. The accounting methods used by the company are classified and not released to the public, but it is now assumed that the accounting specialists at Ford could be using Activity-Based Costing. This assumption is substantiated by the fact that ABC assigns costs to activities, rather than products and services, and as such creates a more accurate image (Prosci, 2001). It is believed that such an accounting approach is highly necessary at Ford Motor Company now.

In line with this assumption, the following two activities are identified:

Design of the Ford Fiesta, estimated at $1,000 per automobile

Manufacturing of the Ford Fiesta, including manufacturing of the components and assembly, estimated at $5,000

Distribution of the Ford Fiesta, including marketing, advertising and logistics, estimated at $2,000 per automobile.

The overheads associated with the production of the Ford Fiesta are of $6,000, to which another $2,500 is added in the form of labor costs, utilities and other costs not directly linked to production. The total of the overheads is as such of $8,500. In a context in which the starting price for a Ford Fiesta S (base version) is of $13,320 (U.S. News, 2011), the gross profit from the production and sell of a Ford Fiesta is of $4,820. The estimates are valid for 2011.

In this context of the figures presented above, it is important to compute and assess the application rates. The application rates are managerial tools to assessing the variances in the costs and they are computed through the division of the budgeted overhead at a specific rate of output by the budgeted activity for the rate of output (McBride). For the two activities above -- design and distribution -- the following computations are made:

a) Design

- Overheads of $1,000

- 5,000 hours worked per month

- Overhead application rate = 1,000 / 5,000 = 0.20 overhead application rate

b) Distribution

- Overheads of $5,000

- 6,000 hours worked per month

- Overhead application rate = 5,000 / 6,000 = 0.83 overhead application rate

The results of the computations reveal an overhead application rate for design which is significantly smaller than the overhead application rate for the distribution operations. This subsequently implies that distribution operations are four times more expensive than the design processes. To a degree, this outcome was expected as the distribution operations are undoubtedly more complex, but it also draws an alarm and suggests that inefficiencies and redundancies might be present in distribution operations. The final recommendation then is for Ford to assess its distribution processes and -- if necessary -- invest in their development and the increase of their efficiency levels.