Introduction to activity based costing. Introduction to Activity Based Costing 2022-10-23
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Activity-based costing (ABC) is a method of calculating the cost of a product or service that considers the cost of the resources consumed in each specific activity that goes into producing it. This approach is different from traditional costing methods, which typically assign overhead costs to products or services based on a single cost driver, such as direct labor hours or machine hours.
ABC was developed in response to the limitations of traditional costing methods, which often resulted in inaccurate product costs. For example, a product that required a lot of machine hours may have appeared to be more expensive to produce than a similar product that required less machine time, even if the latter required more expensive materials or more labor hours. This type of pricing distortion can lead to incorrect decisions about pricing, production levels, and resource allocation.
To use ABC, a company first identifies the activities that go into producing a product or service and the resources consumed by each activity. These activities and resources are then grouped into cost pools, with each pool representing a specific type of cost. For example, a cost pool may include the materials and labor required to produce a product, or the energy and maintenance costs associated with operating a machine.
The company then calculates the cost of each cost pool by dividing the total cost of the resources consumed by the number of units produced. This results in a per-unit cost for each cost pool, which can be used to calculate the total cost of a product or service.
One advantage of ABC is that it provides a more accurate representation of the true cost of a product or service. By considering the cost of each activity that goes into production, ABC can more accurately reflect the true cost of each product or service, rather than just the cost of direct labor or materials. This allows companies to make more informed decisions about pricing and resource allocation, which can improve profitability and efficiency.
Another advantage of ABC is that it helps companies identify areas where they can reduce costs. By breaking down the cost of each activity, companies can identify activities that are less efficient and take steps to streamline them or eliminate them altogether. This can help companies become more competitive and improve their bottom line.
Overall, activity-based costing is a valuable tool for companies that want to better understand the true cost of their products and services and make more informed decisions about pricing, production, and resource allocation.
Introduction to Activity
Calculate the total overhead of each cost pool. In fact, outsourcing might actually be more expensive. It is widely known that the traditional costing system uses a single, volume based cost driver. · Assign each cost pool activity cost drivers, such as hours or units. The collected data were analyzed using the ordinary least square regression method. We have consciously combined the best elements from practice and have added some innovations of our own.
Activity Based Costing allocates the overheads to the cost pools before absorbing them into units using cost drivers. Here we discuss the definition and how activity-based costing works along with its advantages and disadvantages. . Cost pool and cost drivers are taken care of in this method. To address this problem, activities- based - cost accounting method was developed to provide a means of creating a more accurate representation of how activities performed in the creation of a product or service actually impact costs. Inspecting, and Production Set up.
(DOC) SUMMARY OF " INTRODUCTION TO ACTIVITY BASED COSTING "
A cost pool is an activity that consumes the resources for which the overheads are identified and then allocated. This results in over- and under-allocation of some products and customers, which can distort the profitability of products and customers. Process costing is best suited for costing standardized products in continuous operation, high production. Properly assigning indirect costs is extremely important for management, especially in the case of downsizing or outsourcing. Traditional cost accounting method, which allocates overhead costs on the basis of one driver, that is, overhead absorption base e. Since cost drivers are required to be found out, it is mainly used in the service sector, where cost allocation becomes a challenge. According to Walther 2009 , job order costing is best suited where products are produced upon receipt of a customer order according to customer specification such as ship builder and aircraft manufacturer.
It helps to formulate the appropriate marketing and corporate strategy. Introduction Activity-based costing differs from traditional costing systems in a number of ways. Activity Based Costing helps in the decision making of the management. To compound the problems, once the profitable branch is closed the only remaining branches are the unprofitable ones. Traditional cost accounting spreads out overhead and indirect costs over product cost, based on a random and inaccurate driver such as manufacturing cost, labor hours, units sold, revenue, etc. Introduction to Activity Based Costing Page 2……………………………………. This section explores these variables and thus provides a critical assessment of the roles and uses of the techniques.
In practice activity-based costing comes in many variations. Closes with the admonition to balance the benefits from more accurate cost estimates with the cost of developing an appropriate activity-based cost system. This can lead to misinformed management, and decisions to prioritize certain products or customers can have disastrous outcomes because of it. And, some manufacturing costs—including the costs of idle capacity—may be excluded from product costs. I will also be looking to find companies that use a variety of different costing techniques and methods. The differences are in the precision and density of the two methods. It has been developed and adopted by the industry to overcome the limitations of the traditional costing method.
It helps to divide the true overheads into the proper place, thus making the costing system more accurate. It captures the cost at each process or stage of manufacture where output of each process becomes the input for next process until final product. The same scenario is true for outsourcing. Finally they signpost some further. They include a basic definition, a brief overview and a fuller explanation of practical application. In activity- based costing, nonmanufacturing as well as manufacturing costs may be assigned to products.
Management may estimate outsourcing to be a cheaper option because costs have not been allocated properly. It is used mostly in complex situations where the cost allocation requires some expertise. It identifies the activities in the organization, such as the purchase of material is an activity of purchase requisition, and follow up from the suppliers of the product delivery is also an activity. Understanding the methodology of costing and its behavior of what costing method is best suited for the products will support managers to make better decision on pricing and improve profitability for the business. Therefore, all overhead costs are assigned to costs of production for specific products. This is why the traditional product costing system alters the cost of products. In the traditional costing method, the overheads were allocated arbitrarily; sometimes, the allocation was done based on the production volume, which is not a correct method of giving the cost.
These individual activities are grouped together with similar processes into a cost pool that relates to single activity cost driver. Spss program was used in the analysis. Example of Activity Based Costing Otis worldwide corp is a company that produces 2 items A and B. Explanation Activity Based Costing is being introduced to solve the costing problems associated with the traditional costing method. Also I will be explaining when a Company would use job costing, process costing, marginal and activity based costing. He has given an example of a single and a diversified pen factory manufacturing one million pens and Multifactory manufacturing same quantity of pens but of different colors, size and varieties.
The study concluded with some results. · Divide the activities into cost pools, which include all the individual costs related to an activity—such as manufacturing. Application of Activity Based Costing It is applied mostly in big companies where the overheads are too much and cannot be allocated in a single overhead activity. This treatment follows recommendations by Cooper and Kaplan and others. Contents Introduction 1 Task 2 Appendix 1 Activity Based Costing - Essay 4 Topic Gateway Series Activity Based Costing Activity Based Costing Topic Gateway Series No.