CA 4 - Activity Based Costing

CA 4 - ACTIVITY BASED COSTING

Introduction

Probably the most popular proposal to upgrade the traditional cost accounting system is activity-based costing (ABC . The purpose of ABC systems is to focus on the causes behind indirect costs . It is primarily a system of allocation . Activities rather than traditional departments are emphasized in to isolate the cost drivers , which are the factors most likely to cause or contribute to the incurrence of costs ABC systems are designed to be complementary with the technological changes in the factories due to enhanced global competition . t

refers to the basis for cost accumulation , either direct or indirect , to products or services . The traditional approach to assigning costs to products is to attach those costs that are directly traceable to the product and allocate the indirect costs by a measure of volume , such as direct labor hours , direct labor dollars , or machine hours . According to Anderson and Kaplan (2004 , a cardinal principle of ABC is this : if products or services are made to specifications known to add value for the customer then activities , and hence costs , that can be removed without compromising these specifications are unnecessary and should be removed

Benefits of ABC Systems to Companies

Companies can benefit from ABC through the system 's attempt to improve the allocation of indirect costs by identifying the activities that are responsible for the costs . Costs and expenses that cannot be economically traced directly to a cost objective are to be allocated on a rational basis . Costs and expenses that can be directly traced to a revenue-producing division , a single product line , or to any defined cost objective need not be allocated . Traditionally , only direct materials and direct labor were assumed to be directly traceable to separate product lines . That assumption will no longer be followed Instead , it will be assumed that elements of manufacturing overhead administrative expenses , and marketing expenses may be economically traced to product lines , or revenue-producing divisions

ABC as a process-based approach represents one capital budgeting strategy for analyzing investment opportunities which allows managers to vary the underlying activity drivers in business processes in to study the impact of different levels in the process itself . Managers have the potential to learn much more about investment risks when they study the uncertainties in the business processes , rather than the traditional overview approach . This traditional approach has typically focused upon highly aggregated revenue and cost items that are merely the result of business processes . Contemporary organizations normally develop activity-based costing systems to provide more accuracy in assigning indirect and support costs to activities , business processes products , services , and customers . ABC systems have recognized that organizational resources are needed both for direct production of goods and services and for indirect or support activities (Neely , 2002

The goal of organizations is for the ABC to measure and then price out all the resources used for activities that generate the production off and services for customers . The principal difference between the traditional costing methods and ABC systems...