Question

a. Would you expect companies that adopt ABC to add value to shareholders? How would you measure such added value?

b. Accountants need to identify four steps in activity-based costing. What are the four steps?

Answer 1

Measurement of added value to companies using Activity Based Costing (ABC) system:

1. Overheads are high in relation to direct costs. Further there is a great diversity in the product range. So, there is a need for accurately estimating the cost of overhead to various products.

2. Products use different amount of overhead resources. Consumption of overhead resources is not primarily driven by volume or hours. Products profitability can be measured reasonably accurately, only if consumption of resources can be traced to each individual product using ABC system.

3. New production techniques have resulted in the increase of the proportion of support service cost in the total cost of delivering value to customers. ABC improves accuracy of accounting.

4. Competitive pressure has resulted in reduction in profit margins. ABC helps to estimate cost of individual products more accurately than traditional absorption costing.

5. Reduction in the cost of data processing has reduced the cost of tracking resources consumption to a large number of activities. Hence costs can be traced and tracked better than traditional costing system.

Four steps to be identified by the accountants in ABC (ABC) system are:

1. Determination of total manufacturing overheads

2. Determination of cost drivers for each manufacturing overhead.

3. Determination of number of activities consumed by each product

4. Determination of ABC recovery rate i.e. cost per activity