Question

Find an article about activity-based costing systems. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply that knowledge. Please provide the link. Do not copy what's already in Chegg.com.

Answer 1

Activity-Based Costing

The concepts of ABC were developed in the manufacturing sector .It is a practice in which activities are identified and all related costs of performing them are calculated, providing actual costs chargeable. The focus of activity based costing is activities. Thus identifying activities is a logical first step in designing an activity based costing. An activity is an event, task or unit of work with a specified purpose. For example; designing products, setting up machines, operating machines and distributing products

Stages of Activity Based Costing

: 1. Identify the chosen cost objects The cost objects of any organization are the products or services and the goal is to first calculate the total cost of manufacturing and distributing these products and their unit cost.

2. Identify the different activities within the organization After the identification of cost objects, the main activities, which are being performed in the organization, have to be identified. Usually the number of activities over cost centers in ABC will be much more as compared to traditional overhead system. The exact number will depend on how the management subdivides the organizations activities

. 3. Identifying the direct cost of products The direct cost of products or objects may comprise direct material cost, direct labor cost and direct expenses. Classification of as many of the total costs as direct costs as is economically feasible should be made. It reduces the amount of costs classified as indirect.

4. Relating the overhead to the activities After identifying the organizations activities, the various items of overhead are related to activities both support and primary, that caused them. As a result of relating the items of overhead to various activities, cost pool or cost buckets are created.

5. Spreading the support activities across the primary activities The spreading of support activities (i.e., activities which support or assist manufacturing) across the primary activities (correlated to the number of units produced) is done on some suitable base which reflects the use of support activity. The base is the cost driver and is measured of how the support activities are used.

6. Determining the activity cost drivers The determination of the activity cost drivers is done in order to relate the overhead collected in cost pools to the cost objects of products. It is done on the basis of the factor that drives the consumption of the activities.

7. Calculating the activity cost driver rates The activity cost rates for each activity are calculated in the way in which overhead absorption rates would be calculated under the traditional system. It can be presented as follows:

Activity cost driver rate = Total cost of activity/Activity driver

These activity cost driver rates are to be used for ascertaining the amount of overhead chargeable to various cost objects or products.

8. Computing the total cost of products or cost objects

The total costs of the products shall be computed by adding all direct and indirect costs assigned to them. The amount of overhead chargeable to a product or cost object shall be calculated by multiplying the activity cost drivers rates by different amounts of each activity that each product or other cost object consume

Advantages of Activity Based Costing

(i) It provides more accurate product costing information by reducing arbitrary cost allocations.

(ii) It improves the quality of information available for decision making by answering the questions such as what activities and events are driving cost and where efforts should be made to control cost

iii) It is easiest way to allocate overhead in the product.

(iv) It helps to identify the activities that can be eliminated.

(v) It links up cause and effect relationship.

(vi) ABC helps to identify the value added activities (that increase the customer’s satisfaction) and non- value added activities (that creates the problems in customer’s satisfaction)

(vii) ABC translates cost in to a language that people can understand and that can be linked up to business activities.

Limitations of Activity Based Costing

(i) More time consuming to collect data

(ii) Cost of buying, implementing and maintaining activity based system

(iii) In some cases, the establishment of cause and effect relationship between cost driver and costs not be a simple affair.

(iv) ABC does not conform to generally accepted accounting principles in some areas.

Example

The cost drivers for various functions i.e., production, marketing, research, and developments are given below.

Production: Number of units, Number of set-ups

Marketing: Number of sales personnel,Number of sales orders

Research& development :Number of research projects Personnel hours spend on projects Technical complexities of the projects

Customer service :Number of service calls ,Number of products serviced Hours spend on servicing products