Question

If you have utilized an activity-based costing system in your former or current employment, describe how this system had been used. In your response, be sure to include your experience and position on the effectiveness of the activity-based costing system. Support your ideas by drawing on your readings and scholarly articles.

If you have not encountered this type of system in your work experience, assume a company needs to switch to an ABC system. Describe the common cost drivers that could be used.

How would the organization identify the cost drivers?

How would the organization use them in the implementation of this system? You may use your former or current company for the analysis.

Answer 1

There are two common costing systems used in a business. These are Traditional Costing and Activity Based Costing.

Activity Based costing system is a more accurate way of determining the cost of the product as it defines the activities required in the manufacturing of the product or rendering of services and then allocate the cost to those activities.

Cost drivers are the total no units of the activity required in the manufacturing of the said product or services that cause the business to incur costs. For eg. no of purchase orders, machine hours, labour hours, etc.

Common cost drivers under ABC system are -

Purchasing Department ----- No of Purchse Orders

Direct Labour ----- No of Direct Labour Hours

Materials Handling ----- No of Materials Requisitions

Setup ----- No of machine setups required

Inspection ----- No of Inspections

To implement ABC system in the organisation, first it need to identify it's cost drivers. Ther are basically three types of cost drivers -

Volume - The cost driver based on the units of work. For eg no of orders

Time - The cost driver based on the length of time taken to complete the activity. For eg. No of labour Hours

Charge: The cost for the entire activity is charged directly to the cost object. For eg. all costs associated with the retooling of machines for a product is charged directly to the end-product. in general such type of driver is rarely used.

To implement the ABC system, an organisation needs to follow the following steps -

1. Activity Identification - Activities must be identified and grouped together in an activity pool. Activity pools are the supporting activities that form a product or a service line.

2. Analysis - This leads to identification of processes that gives us the final product. This activity analysis leads to identification of some indirect cost relationships and assignment of some percentage of that activity to the ned product directly.

3. Assignment of Costs - Based on the above two steps, costs are assigned to activity pools. For eg human resources costs would be assigned to indirect administrative or management cost.These will have some contribution to the object cost.

4. Calculate Activity Rates - It may include direct labour hours or indirect support labour. These activities must be assigned a value in real currency.

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.

6. Prepare and Distribute Management Reports - Once ABC costing is complete, the cost data should be prepared in concise for cost object and process owners.

Thus, ABC System is a much organised system that helps an organisation to attribute all the direct and indirect costs to the product or services offered by it in a much more accurate method than in Traditional System of Costing.