Introduction Activity Based Costing (ABC) addresses internal operating concerns and is an augmentation to the traditional cost management system. It is not a replacement for traditional accounting, but makes use of the source documents provided from standard job costing systems. ABC looks at a business unit^aEURTMs events as cost drivers and assigns all company resources and accumulated costs against those events in a time-phased sequence. Revenue tracking provides management with a different point of view on the profitability of products and services, providing insight into pricing. Middle management and technical performing organizations are involved in the line item reporting provided within the ABC system, enabling management to achieve more responsibility of reported information throughout all levels of the organization. ABC is being ostensible by the accounting industry as the wave of the future and is gaining broad acceptance within larger organizations.
This system is intended to provide performing entities and management alike. History of ABC Activity Based Costing (ABC) is an approach to costing that considers the resources consumed by activities in order to create and deliver a product or service. It evolved in the mid-1980 s to improve the allocation of manufacturing overhead costs to products, but it soon became apparent that activity-based costing systems could be expanded to include non-manufacturing costs (Lang field-Smith, Thorne & Hilton, 2004). Review of ABC Whereas the underlying assumption of a conventional costing system is simply that products cause costs, an activity based costing system assumes that cost objects (e. g. juice) creates the demand for activities (e.
g. manufacturing), which in turn causes resources to be consumed (e. g. manufacturing time, outlet space, etc. ) and causes costs. Cost objects are the reason for performing activities, and activities are the processes or procedures that cause work and create costs.
ABC analyses costs from the perception of the how much a particular activity costs, and the amount of resources consumed by the end product of the activity. Using activity based costing differs from traditional cost accounting in that the focus is on the activities that are required to produce an end product, rather than assuming that the volume of the end product is the only driver of costs. A cost driver is a term used in activity-based costing. It simply refers to any activity that causes a cost. It can be anything from machine hours, labor hours, number of machine setups, or the number of parts in a product. By understanding how resources are transformed into products or services, and by focusing on the cost of activities, ABC helps an organisation to obtain a greater understanding of how costs behave in their organisation and which activities create significant amounts of cost.
Organisations can then begin to control their costs based on tangible activities rather than relatively uninformative general ledger or cost centre reports. ABC is the assignment of costs from resources to activities and then from activities to cost objects: ABC identifies the processes and activities involved in producing the cost object (e. g. fruit juice) and then cost these activities. The activities are cost by taking the traditional general ledger cost reports and determining an appropriate resource driver to assign the resource costs to the various activities.
This involves accumulating costs that behave in a similar way into ^aEUR~cost pools^aEURTM (e. g. salary costs, machinery costs), and then identifying appropriate resource drivers to assign the costs from the cost pools to the activities (e. g. % of manufacturing time, factory space, etc). The next step in ABC is to assign the activity costs to products or services.
This involves identifying activity drivers to assign the cost of these activities to the final cost objects, typically a product or service. Advantages of AB CAn advantage of activity-based costing is that overhead costs are broken down into activities that cause the costs. These activities can then be changed to reduce costs. If management implemented an activity based costing system it should be provided with a more thorough understanding of product costs.
By breaking down costs into cost drivers, i. e. , those activities that drive the costs, management should be able to see the relationship between product complexity, product volume and product cost. This would be vital information for pricing decisions and profitability strategies. Management should also be able to streamline the production process by reducing those non-value adding activities such as setups and travel time between activity centers or departments. Another benefit from ABC is activity-based overhead is more accurate.
It allocates the individual components of our overhead to our products based upon the products use of that overhead component. With the more accurate product costs, we should begin to concentrate our efforts upon reducing the costs of our more expensive overhead operations Problems with ABC While activity-based costing may yield more detailed product cost estimates, it must pass a cost benefit test before being implemented. Activity-based costing requires a much more detailed breakdown of costs into activities that cause costs. This can be a complex task involving the teamwork of management, production, accounting, purchasing, marketing and many others.
A company should implement ABC only if it thinks the benefit from improved management decisions will outweigh the cost of establishing and maintaining the new cost system. Furthermore, there might be underestimation of the task of collecting activity driver data, and the implementation of this system may be considered a financial management which might cause insufficient commitment from operational managers. We should use activity-based costing if we find the benefits from the new system exceed its costs. REFERENCE 1.
Innes, J & Mitchell, F. (1991), ^aEURoeActivity Based Cost Management^aEUR.