Question

You are part of a team responsible for implementing an activity-based costing system. Some of the members do not understand the steps involved in implementing such a system. Prepare a summary showing your team members the steps involved and a brief description of each step that are completed in the process.

Answer 1

Solution :   The Following steps are involved in implementing the ABC system and Brief Description as:

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 consumes.

I ll tell the member of my team the significance, advantage and also the limitations of ABC Process , so they can know the practice and process of implementing ABC in the organization, The Following is the significance as:

• Cost Reduction: ABC measures how much activities that are costly and then take steps to reduce their costs by changing the productions process or outsourcing those activities.

• Product pricing and decisions of whether to continue producing a product or keeping a particular customer.ABC implementers generally believe that ABC provides more accurate cost information than conventional costing does. Management can use this information to negotiate price increases with customers or to drop unprofitable products.

• Budgeting and performance measurement: Management can use more accurate cost information to improve budgets and measures of department and division performance.

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.

Final Conclusion:

Activity based costing has revolutionized product costing, planning, and forecasting in the last decade. It is based
on a philosophy of estimation that: “it is better to be approximately right, than precisely wrong.” In summary,
activity-based costing is a management decision-making tool. It provides financial support data structured in a
fashion fundamentally different from accounting data provided in the general ledger. By associating cost to the
activity, a clear relationship can be established between sources of activity demand and the related costs. This
association can benefit the distributor in determining where costs are being incurred, what is initiating the costs
and where to apply efforts to curb inflationary costs. This can be of particular value in tracking new products or
customers.