Esprit holdings were founded in 1968 by Dong Tompkins, Susie and J. Tise, the company produces fashion wear and currently has 13 production lines. The company has various departments and uses process costing methods in allocating overhead costs, other cost includes direct labor cost and direct material costs. The departments include the administration department, the marketing and sales department and the manufacturing department.
Esprit holdings has various divisions which are determined depending on the products they produce, these divisions include the collection wear division, the lifestyle and home division, causal wear division and the sports wear division. We consider the lifestyle and home division to analyze the costing method that is used in this division. This division produces such products as jewels, eye wear, umbrellas, baby carriage, toys and stationery.
The most appropriate costing method used in this division is the job costing method, this is due to the fact that each of the above named products produced undergo different activities to achieve the quality and product desired. For example the activities involved in making of jewels are different from the activities involved in the making of toys, for this reason therefore the most appropriate method is the job order costing method that allocates appropriate overheads to the products produced.
Production and support departments:
In the production of lifestyle and home products a number of department are involved, these include the production departments and the support departments. Production departments include the manufacturing department and the quality control department. Support departments include the human resource department, the administration department and the marketing and sales department. These entire departments are important in the smooth running of the company.
All companies have costs that are incurred in the production of products, the lifestyle and home division has these costs which include the variable and overhead costs. Some of the major costs include electricity and power costs which are incurred through lighting and the running of machinery in the manufacturing department. The other cost is labor cost which includes direct and indirect labor costs; the production process requires labor while indirect labor costs are evident from the administration and human resource department.
Material cost is also a cost incurred by the division and the material costs depend on the product being produced, example material used to make jewels are more expensive than he materials used to make umbrellas. The other major cost is transport costs, these are costs incurred in the transportation of final products and also in the transportation of raw materials to the manufacturing department. Rent is also a cost that is incurred and this is evident from the
stores that are directly managed by the company. Other costs include machine repair costs, marketing costs and insurance costs.
Cost pools and cost allocation base:
The above costs are allocated to each unit of production, there are various cost drivers which include labor hours, machine hours and the area in meters, and the following diagram shows the cost allocation process:
The diagram below shows the allocation of the costs involved in the production of this products, direct labor and direct materials can be directly located and therefore are charged directly to the product, the electricity and machine repair costs cannot be directly traced to the proidcut and they are the machine costs which will be allocated on the basis of machine hours, the other costs include rent and insurance costs which are referred to as occupancy costs, these costs will be allocated on the basis of the area occupied, finally the marketing and transport costs will be allocated on the basis of labor hours.
The above diagram simplifies the allocation of overhead costs in the division, the allocation basis of the occupancy, selling costs and machine costs depend on the most likely factor that drives the costs. Direct costs are allocated on the product and then the indirect costs are allocated depending on the most appropriate rate that is charged.
For the machine cost the allocation basis is machine hours, the number of machine hours that are spent in making a product will determine the machine costs that include the electricity costs and the machine repair cost. For the occupancy cost which includes rent and insurance will be allocated using the area occupied, this means that these costs will be allocated depending on the area in meters squared occupied by the departments. Finally the selling costs which include transport costs and the marketing costs will also be allocated to the product; this cost will be
allocated based on the labor hours.
We choose the machine hours as the allocation base for machine cost because the machine hours will determine the amount of electricity consumed, it also determines the number of repairs that will be involved, more machine hours means that the machines will incur more expenses in terms of repair and servicing.
For the occupancy cost we use the area to allocate these costs, this is becaosue the rent incurred by a department will depend on the area in meters squared, it appropriate because a larger area will incur more costs than smaller areas. Also the insurance costs are referred to as occupancy costs because the building and the assets contained then the higher the cost of insurance, the machines are insured and the number of machines used depend ion the area available.
The selling costs include the cost of transport of final goods and also the cost of marketing these goods which include advertising. The appropriate allocation basis for this cost is labor hours, the number of labor hours will determine the amount of products produced and for this reason the more the products produced then the higher the transport costs and also marketing costs, therefore we use labor hours to allocate the selling costs.
The two stage allocation process:
From the diagram above the overhead costs are allocated by the departments both the support and the production departments, the overhead costs are first identified, the next step is that the
departments allocate these costs to the product and the second step shows the addition of the overhead costs into the product costs, the support department which include the marketing, human resource and the administration department will allocate the costs and these costs are added up in the production departments which include the quality control and the manufacturing department, the cost is then added to the product as shown by the diagram in stage two.
The human resource department will allocate the overhead costs on the basis of labor hours used in producing a product; this is because the overhead costs incurred by the human resource department are labor related. This human resource department may also allocate these costs depend on the number of activities involved in the production of a product, therefore this department will use either the labor hours of the number of activities involved in the production of a product.
The marketing and sales department will allocate the overhead costs using either labor hours or the machine hours; this is because the higher the labor or machine hours means that the sales department will spend more due to increased production.
The manufacturing department and the quality control department will allocate the costs based on the number of machine hours, the higher the number of machine hours then the higher are the overhead costs, the other allocation base would be the number of processes involved in the production of a product, the more the processes then the higher will be the overheads and therefore it would be an appropriate allocation base.
Activity based costing:
The activity based costing method is appropriate for this division; this costing method involves assigning costs to activities involved in production based on the resources used. This type of costing is appropriate in that it helps in accurate estimation of costs incurred in production of a
This costing method assesses the individual activities based on the resources used ad therefore activities are assigned costs accurately, this method could also be used to identify high and low cost production in the division, it can also be used to identify the causes of the low and high costs and therefore is appropriate in identifying problem areas in the production process which may help increase efficiency.
This costing method is appropriate in the division in that it helps in decision making regarding the areas that require improvements, the problems are identified and therefore depending on the cost level decision are made to improve the process. Finally this costing method is appropriate in that it helps in making more accurate planning and budgeting in that it gives accurate costs associated with activities, therefore the division can create more accurate budgeting regarding prices and future expenditure.
Activity based allocation option:
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