Question

Assigned (3 PAGES) to write by my own word about Activity-based accounting (ABC): its concept, how to implement it, its advantages and disadvantages.( no Plagiarism).

Answer 1

Dear Student,

I made solution better for you. I have written somthing self and brought simple language solution for you. Solution is lengthy but if you read and try to understand it is very each concept. Try to read and learn 4 to 5 times before exam.

CONCEPT

Activity Based Costing is an accounting methodology that assigns costs to activities rather than products or services. This enables resources and overhead costs to be more accurately assigned to products and services that consume them.

In order to correctly associate costs with products and services, ABC assign costs to activities based on their usage of resources. It then assigns cost to cost object such as products or customers, based on their usage of activities.

IMPLEMENTATION

Implementation Steps

Step 1: Activity Identification

First, activities must be identified and grouped together in activity pools. Activity pools are the supporting activities that tie in to a product line or service These pools or buckets may include fractionally assigned costs of supporting activities to individual products as appropriate during the second step.

Step 2: Activity Analysis

ABC continues with activity analysis, clearly identifying the processes which support a product and avoiding some of the systemic inaccuracies of traditional costing. ABC costing requires activity analysis, similar to the process mapping found in lean manufacturing. This activity analysis identifies indirect cost relationships and allows assignment of some percentage of that activity to an end product directly.

Step 3: Assignment of Costs

Based on the findings of step 1 and 2, costs are assigned to an activity pool. For example, human resources costs would be assigned to indirect administrative or indirect management costs. These pools will each have some contribution to object cost.

Step 4: Calculate Activity Rates

Initial analysis may include direct labor hours, or indirect support labor. These activities must be assigned a value in real currency. All weightings must be added at this step. For instance, production labor hours should be in terms of a weighted labor rate including benefit costs.

Step 5: Assign Costs to Cost Objects

Once activity costs, pools and rates are identified and clearly defined, the next step is to assign them to cost objects. Objects are generally defined as the results offered to a customer. In both manufacturing and non-manufacturing environments, this product should have some saleable value to compare to the assigned costs.

Step 6: Prepare and Distribute Management Reports

Once ABC costing analysis is complete, that cost data should be placed in a concise and coherent manner for cost object and process owners. This communication of the costing analysis is critical to justify the cost of the analysis, as often this is not an inconsequential cost.

Conclusion

ABC costing does nothing for the organization if the information is collected but no action follows. The key to the value of this form of costing is that it is actionable. This analysis allows companies to make decisions about product lines, where to direct sales efforts, and to validate the true value provided by capital equipment.

Advantages:

• ABC provides a more accurate cost per unit. As a result, pricing, sales strategy, performance management and decision making should be improved.
• It provides much better insight into what drives overhead costs.
• ABC recognises that overhead costs are not all related to production and sales volume.
• In many businesses, overhead costs are a significant proportion of total costs, and management needs to understand the drivers of overhead costs in order to manage the business properly. Overhead costs can be controlled by managing cost drivers.
• It can be applied to derive realistic costs in a complex business environment.
• ABC can be applied to all overhead costs, not just production overheads.
• ABC can be used just as easily in service costing as in product costing.

Disadvantages of ABC:

• ABC will be of limited benefit if the overhead costs are primarily volume related or if the overhead is a small proportion of the overall cost.
• It is impossible to allocate all overhead costs to specific activities.
• The choice of both activities and cost drivers might be inappropriate.
• ABC can be more complex to explain to the stakeholders of the costing exercise.
• The benefits obtained from ABC might not justify the costs.
• Other systems may need to be changed - for example, how variances are calculated.