ABC
ABC
ABC has been defined by CIMA as ‘cost attribution to cost units on the
basis of benefit received from indirect activities e.g. ordering setting up,
assuring quality’. According to Horngren, Foster and Datar ‘ABC is not
an alternative costing system to job costing or process costing. Rather
ABC is an approach to developing the cost numbers used in job costing
or process costing systems. The distinctive feature of ABC is its focus on
activities as the fundamental cost objects. In contrast most traditional
approaches used in job and process costing systems rely on general
purpose accounting systems, not tailored to the activities found in
individual organisations. The ABC approach has the potential to provide
managers with information they find more useful for costing purposes’.
Activity Based Costing is based on the belief that in production process
there are various activities which give rise to costs. ABC creates a link
between activities and products by assigning a cost of activities to
products based on an individual product.
According to Dansby and Lawrence ‘In ABC costs are not initially traced
to departments. Instead, costs are first traced to activities and then to
products: Activities causing overheads (or cost drivers) are identified.
These activities are later used as a base for allocating overhead costs to
products.
ABC system assumes that activities cause costs and also that products
create demands for activities. The system recognizes that businesses
must understand the factors that drive each major activity, the cost
activities and how activities relate to products.
(1) Identifying activities i.e. identifying major activities that take place in
an organisation.
(2) Assigning costs to activity cost centres i.e. assigning costs to cost
pools or cost centres for each activity.
(3) Selecting appropriate cost drivers i.e. identifying the factors that
influence the costs of particular activities.
(4) Assigning the cost of activities to products i.e. assigning such cost
according to each products demand for activities.
The second stage requires that a cost centre (also called a cost pool) be
created for each activity. After the activities have been identified the
cost of resources consumed over a specified period must be assigned to
each activity. These costs will have to be apportioned on some suitable
basis. For example the total costs of all set ups might constitute one
cost centre for all setup related costs.
The third stage of designing ABC system is to identify the factors that
influence the cost of a particular activity. The term cost-driver is used to
describe the significant determinant of the cost of the activity. The
most suitable cost driver in each activity under functional areas should
be identified. A cost driver is any factor that influences costs.
The final stage is to trace the cost of the activities to products according
to each product’s demand for these activities using cost drivers as a
measure of demand. A product’s demand for the activities is measured
by the number of transactions it generates for the cost driver. The cost
driver should be measurable in a way that enables it to be identified
with individual products.
ABC produces reliable and correct product cost data in case of greater
diversity among the products manufactured such as low-volume
products, high-volume products. Traditional costing system is likely to
bring errors and approximation in product cost determination due to
using arbitrary apportionment and absorption methods.
2. Information about Cost Behaviour:
ABC identifies the real nature of cost behaviour and helps in reducing
costs and identifying activities which do not add value to the product.
With ABC, managers are able to control many fixed overhead costs by
exercising more control over the activities which have caused these
fixed overhead costs. This is possible since behaviour of many fixed
overhead costs in relation to activities now become more visible and
clear.
ABC uses multiple cost drivers, many of which are transaction based
rather than product volume. Further, ABC is concerned with all
activities within and beyond the factory to trace more overheads to the
products.
ABC improves greatly the manager’s decision making as they can use
more reliable product cost data. ABC helps usefully in fixing selling
prices of products as more correct data of product cost is now readily
available.
6. Cost Management:
ABC has numerous cost pools and multiple cost drivers and therefore
can-be more complex than traditional product costing systems. It can
prove costly to manage ABC system.
2. Selection of Drivers:
ABC has different levels of utility for different organisation such as large
manufacturing firm can use it more usefully than the smaller firms.
Also, it is likely that firms depending on cost-plus pricing can take
advantages from ABC as it gives accurate product cost. But those firms
who use market based prices may not favour ABC. The level of
technology and manufacturing environment prevailing in different firms
also affect the application of ABC.
4. Measurement Difficulties:
The main costs and limitations of an ABC system are the measurements
necessary to implement it. ABC systems require management to
estimate costs of activity pools and to identify and measure cost drivers
to serve as cost allocation bases. Even basic ABC systems require many
calculations to determine costs of products and services. These
measurements are costly. Activity cost rates also need to be updated
regularly.
MCQs:
1. An approach in which company under-costs it's one product
and over-costs at least one product is classified as
a) different task
b) purpose cost
c) an activity
d) an allocation cost
a) batch size
b) complexity
c) process steps
d) all of above
a) activity list
b) activity dictionary
c) active purpose
d) both a and b
10. Cost pool category, which have similar cause and effect
relationship, with each cost driver uses as an allocation base is
classified as
a) no cost pool
b) One or two cost pools
c) sustained tracing
d) support tracing
a) manufactured costing
b) activity based costing
c) allocation costing
d) base costing
a) indirect costs
b) direct cost
c) labor cost
d) raw material cost
a) cost hierarchy
b) price hierarchy
c) activity hierarchy
d) purpose hierarchy
a) expected sustaining
b) input sustaining
c) output sustaining
d) product sustaining costs
Answers:
1. c
2. c
3. b
4. d
5. a
6. c
7. d
8. d
9. d
10. b
11. b
12. b
13. b
14. a
15. a
16. a
17. d