WHAT IS THE DEFINITION OF ACTIVITY BASED COSTING

Activity based costing ( ABC ) involves the designation of the factors which cause the costs of an administration ‘s major activities. Support operating expenses are charged to merchandises on the footing of their use of the factor doing the operating expenses ( Drury, C.2008 ) . Allen, M.W & A ; Myddelton, D.r ( 1992 ) states “ Activity based costing system ( ABC ) relates overhead costs to merchandises via cost drivers ” . In add-on, the activity based costing system is globally recognised as a of import tool for developing the behavioural, concern and accounting patterns in companies ( Anderson,1995 ; Cooper and ZmUD,1990 ; Foster and Swenson,1997 ; Mcgowan and Klammer,1997 ; Shields,1995 ) cited by Maiga, S.A & A ; Jacobs, A.F ( 2003 ) .

DETAILS OF THE DEVELOPMENT OF THE TECHNIQUE AND THE UNDERLYING CONCEPT:

During the 1980s the ABC method was designed in the USA because of traditional systems unable to find accurately production and service costs or to supply to the full utile information to back up operational determination devising ( Cooper and Kaplan, 1988 ) . ABC favours better cost allotment utilizing smaller cost pools called activities. Using cost drivers, the costs of these activities are the footing for delegating costs to other cost objects such as merchandises or service Activity -based costing ( ABC ) was developed to turn to the lacks of traditional costing system in the modern concern environment. It helps director understand the merchandise and client profitableness and place major countries for procedure betterment ( Kirche, E & A ; Srivastava, R. 2005 ) . Many companies have found that by implementing ABC bing system best public presentation can be achieved ( Compton, 1996 ) .The basic rule of this costing is that cost units should bear the costs of an administration ‘s major activities which they cause and all costs are driven by activities which take topographic point in the concern environment. ( Gowthorepe, C.2003 ) .

Traditional bing versus activity based costing:

Atrill, P & A ; Mclaney, E.p.294 ( 2008 ) states that the traditional costing versus ABC costing.

Traditional attack:

Operating expenses are first assigned operating expenses are so allocated to be units

To merchandise cost Centres utilizing an overhead recovery rate

Entire

Operating expenses

Merchandises

A B C D

Cost Centres overhead

Recovery rate 1

Merchandise cost

Centre 1

Merchandise cost

Centre 2

Cost Centres overhead

Recovery rate 2

Cost Centres overhead

Recovery rate 3

Merchandise cost

Centre 3

ABC APPROACH:

Operating expenses are first assigned operating expenses are so allocated to be units

To merchandise cost pools utilizing cost driver rates

Merchandises

A B C D

Entire

Operating expenses

Activity cost driver rate 1

Activity cost pool

1

Activity cost driver rate 2

Activity cost pool

2

Activity cost driver rate 3

Activity cost pool

3

Activity cost pool

4

Activity cost driver rate 4

In traditional attack, overhead are foremost assigned to merchandise cost Centres and so overhead are absorbed by cost units based on the overhead recovery rate for each section. On the other manus in activity based bing system operating expense is assigned to be pools and so be units are charged with operating expenses to the extent that they drive the costs in to assorted pools.

Cost pool: A cost pool is like a cost Centre in traditional soaking up costing. The costs of an activity are collected into cost pools ( Atrill, P & A ; Mclaney, E.2008 ) .

Cost driver: A cost driver is the factor which the costs of an activity ( Atrill, P & A ; Mclaney, E.2008 ) .

An ABC system operates as follows:

Measure 1: Identify chief activities of an organisation.

Measure 2: Roll up the costs of each activity into cost pools.

Measure 3: Identify the cost driver for each chief activity/cause.

Measure 4: Charge support operating expenses to merchandises on the footing of their use of the activity.

( Drury, C.2008 )

Example: ABC

Suppose that Cooplan LTD manufactures four merchandises, W, X, YAND Z. Output and cost informations for the period merely ended are as follows:

Output figure of stuff cost direct labour machine

Unit of measurements production per unit per unit hours per

tallies in the unit

Period ?

W 10 2 20 1 1

X 10 2 80 3 3

Y 100 5 20 1 1

Z 100 5 80 3 3

Direct labor cost per hr is ?5. Operating expense costs are as follows.

Short tally variable costs aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ ?3080

Set up costsaˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ ?10920

Production and scheduling costsaˆ¦aˆ¦ ?9100

Material managing costsaˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ ?7700

Calculate the merchandise cost utilizing the ABC attacks.

Using activity based costing and presuming that the figure of production tallies is the cost driver for set up costs, production and programming costs and stuffs managing costs that machine hours are the cost driver for short tally variable costs, unit costs would be as follows.

W X Y Z TOTAL

? ? ? ? ?

Direct stuff 200 800 2000 8000 11000

Direct labour 50 150 500 1500 2200

Short tally variable operating expenses ( w1 ) 70 210 700 2100 3080

Set up costs ( w2 ) 1560 1560 3900 3900 10920

Production and programming costs ( w3 ) 1300 1300 3250 3250 9100

Material handling costs ( w4 ) 1100 1100 2750 2750 7,700

4280 5120 13100 21500 44000

Unit of measurement produced 10 10 100 100

Cost per unit ?428 ?512 ?131 ?215

Workss:

1. ?3080/440 machine hours = ?7 per machine hr

2. ?10920/14 production runs = ?780 per tally

3. ?9100/14 production runs = ?650 per tally

4. ?7700/14 production runs = ?550 per tally

( BPP, F5,2008 )

Advantage

Here some advantages of ABC:

Because of fiscal describing demand we have to value stock lists at full cost, where soaking up costing has non given meaningful merchandise costs to bring forth the full cost. On the other manus, ABC focuses attending on the nature of the costs behaviour and attempts to supply accurate merchandise costs. ( BPP, F5, 2009 ) .

Multiple cost drivers are used in ABC to apportion indirect costs to activities and so to products.ABC can place that many indirect costs arise out of the diverseness and complexness of operations. ( BPP, F5, 2009 ) .

ABC recognises wider merchandise furies, shorter merchandise life rhythms, and more complex production procedure with its multiple cost drivers. ( BPP, F5, 2009 ) .

In fabricating administrations indirect costs maps include a batch of non – mill activities for illustration merchandise design, quality control and client services and in this sector ABC is concerned with all overhead costs. ( BPP, F5, 2009 ) .

ABC helps with future merchandise planning e.g. the cost of all activities associated with a merchandise or service can be accurately determined before it is launched. That is why concern can find about the monetary value and any other outgo easy. ( directors – cyberspace )

The application of ABC consequences in important betterment in the quality of information which obtained from bing system and better control and planning. ( Gowthorepe, C.2003 )

WEAKNESS OF ABC:

Critics think that activity bing system has some failing:

The work of Wegmann, G. ( 2009 ) emphasised that, many bookmans and practicians admit that ABC has several booby traps. We can name the major unfavorable judgments as follows:

A batch of practicians argue that ABC systems are expensive to implement, clip consuming and difficult to set.

Particularly in the service industries a batch of failures have been complained.

In add-on, some people think that this method ( ABC ) is excessively complex.

Analyzing operating expenses in order to place cost drivers is clip devouring and dearly-won ( Atrill, P & A ; Mclaney, E.2008 ) .

ABC does non supply relevant information for determination devising ( Atrill, P & A ; Mclaney, and E.2008 ) .

Gowthorepe, C ( 2003 ) emphasises that ABC is more complex system a batch of information has to be collected and administered and implement cost is high.

ABC is a stylish costing, non because it will be used by direction to supply meaningful merchandise costs or excess information. Management may be use traditional soaking up bing system than ABC information ( BPP, F5, 2009 ) .

BPP, F5, P.42 ( 2009 ) provinces: ‘To have functional cost driver, a cost must be caused by an activity that is measureable in quantitative footings and which can be related to production end product. But non all costs can be treated in this manner. For illustration, what drives the cost of the one-year external audit? ‘