Question

Response must be 300 words

You are working as a graduate within the engineering department of a manufacturing and consulting focused public listed company. You and your team are working on the post-COVID recovery and how best to allocate capital. Your team has $1,000,000 in capital at their disposal. The entire department is going to have a conference call next week and you have been asked to prepare a memo for the team regarding the financial options being considered. As the accounting department will be joining your memo is to prepare the staff for the call. The accountants are expected to use terms which may not be fully understood by the greater department. So your memo will be distributed before the call or you may be asked to speak on the call to assist everyone's understanding. The memo should discuss: That your company has been using traditional costing and is considering moving to Activity Based Costings for a number of product lines. Explain what is meant by Activity Based Costings, how it differs from traditional costing, and how it may be advantageous.

Answer 1

Activity Based Accounting

Activity Based Accounting assigns costs to activities, and not to products or services. Because of this accounting methodology, costs are rightly assigned to products and services that consume them. This technique identifies cost with each cost driving activity and apportions that cost over different products. It creates a link between the cost and the activities.

At first, different activities are identified within the organisation, for example, material handling, purchasing, quality control, etc. Then the overheads are assigned to these activities. Then activity cost drivers are determined which will create relation between cost and products. Atlast, Activity cost driver rate is calculated for each activity, which is Total cost of activity divided by Activity driver.

Definitions used in Activity Based Accounting

1. Activity- Event that incurs cost.

2. Cost Object- Object for which cost evalutaion is required.

3. Cost Driver- Factor that is used to assign cost to an activity. For example, Marketing costs depend on cost drivers, like sales revenue or number of advertisements.

How it differs from Traditional Costing?

1. In traditional Costing, overheads are related to cost centres, wheras in Activity based costing, overheads are related to activities.

2. Traditional Costing is not considered realistic as compared to Activity based costing.

3. In traditional Costing, single overhead recovery rate is determined for absorbing overheads, wheras in Activity based costing, activity wise recovery rates are determined.

4. In traditional Costing, costs are assigned to jobs, products or hours, wheras in Activity based costing, costs are assigned to services, customers, products or departments.

5. Traditional Costing is not suitable for cost controls, whereas Activity based costing is suitable for cost controls.

Advantages of activity based costing

1. It is best suited for companies having wide range of products.

2. It is best suited for concerns where production overheads are very high.

3. It is best suited for those concerns where activities like inspection, material handling are done.

4. It computes costs accurately.