- ane Activity Based Costing (ABC)
- one.1 Problems with traditional absorption costing
- 1.1.i Overheads used to be small in relation to other costs in traditional manufacturing
- 1.1.2 Overheads are now a larger proportion of total costs in mod manufacturing
- 1.one.3 The nature of manufacturing has changed.
- i.two Computing the total production cost per unit using ABC
- 1.ii.1 Stride 1: Grouping production overheads into activities, co-ordinate to how they are driven.
- 1.ii.2 Step 2: Identify price drivers for each activity, i.east. what causes these activeness costs to be incurred.
- 1.2.3 Footstep 3: Calculate an OAR for each activity.
- ane.2.4 Footstep 4: Blot the activity costs into the product.
- 1.2.5 Step 5: Calculate the total production price per unit and/ or the turn a profit or loss.
- one.three Advantages and disadvantages of ABC
- 1.3.ane Advantages:
- 1.3.2 Disadvantages of ABC:
Activity Based Costing (ABC)
Action based costing is a costing method that has been developed to deal with the perceived weaknesses of traditional assimilation costing.
Bug with traditional assimilation costing
Traditional absorption costing is based on the main that product overheads are driven by the level of production. This is reflected in the choice of activity level in the overhead absorption rate (OAR) calculation - typically units, labour hours or motorcar hours. These all increase as the level of production increases.This was true in the by, because businesses only produced one simple product or a few simple and similar products.
However, the post-obit points are significant:
Overheads used to be minor in relation to other costs in traditional manufacturing
In add-on, production overheads, such as machine depreciation, will have been a small proportion of overall costs. This is because production was more labour intensive and, as a issue, direct costs would have been much higher than indirect costs. A crude guess of the product overhead per unit was therefore fine.
Overheads are now a larger proportion of total costs in modern manufacturing
Manufacturing has get more machine intensive and, equally a issue, the proportion of production overheads, compared to directly costs, has increased. Therefore, information technology is of import that an accurate estimate is made of the production overhead per unit.
The nature of manufacturing has changed.
Many companies must now operate in a highly competitive environment and, as a consequence, the diversity and complexity of products has increased.
Calculating the full production price per unit using ABC
At that place are five basic steps:
Step i: Group production overheads into activities, according to how they are driven.
A cost pool is an action which consumes resources and for which overhead costs are identified and allocated.
For each cost pool, there should be a cost driver. The terms 'activity' and 'cost pool' are often used interchangeably.
For example, one activity could be "quality control"
Step 2: Identify price drivers for each action, i.east. what causes these activity costs to be incurred.
A cost commuter is a factor that influences (or drives) the level of cost.
For example, nosotros could fence that the cost of quality command is driven by the number of inspections made, rather than the total number of units produced
Pace 3: Summate an OAR for each activity.
The overhead absorption rate (OAR) is calculated in the same way as the absorption costing OAR. Nonetheless, a split up OAR will exist calculated for each activity, by taking the activity cost and dividing past the cost driver data.
For instance, we could determine a cost per inspection for quality control costs.
Step iv: Blot the activity costs into the product.
The activity costs should be absorbed back into the individual products.
For case, if we know how many inspections were made on product Ten then nosotros can absorb a corresponding quantity of quality control costs.
Step v: Calculate the total production toll per unit of measurement and/ or the profit or loss.
Total action costs can them be added to labour and material costs every bit normal.
Advantages and disadvantages of ABC
Advantages:
- ABC provides a more accurate toll per unit. As a result, pricing, sales strategy, performance management and decision making should exist improved.
- It provides much better insight into what drives overhead costs.
- ABC recognises that overhead costs are non all related to production and sales volume.
- In many businesses, overhead costs are a significant proportion of full costs, and management needs to empathize the drivers of overhead costs in order to manage the business properly. Overhead costs tin be controlled past managing cost drivers.
- It tin can exist applied to derive realistic costs in a circuitous business surroundings.
- ABC can be applied to all overhead costs, not just production overheads.
- ABC tin be used just as hands in service costing as in product costing.
Disadvantages of ABC:
- ABC volition exist of express do good if the overhead costs are primarily volume related or if the overhead is a small proportion of the overall price.
- It is impossible to classify all overhead costs to specific activities.
- The selection of both activities and price drivers might be inappropriate.
- ABC tin be more complex to explicate to the stakeholders of the costing do.
- The benefits obtained from ABC might not justify the costs.
- Other systems may need to be changed - for example, how variances are calculated.
| Created at 8/vii/2012 ii:26 PM by System Business relationship (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London |
Last modified at 11/1/2016 four:20 PM by System Account (GMT) Greenwich Hateful Time : Dublin, Edinburgh, Lisbon, London
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Tags: | ABC;Activity based costing;absorption costing;costing |
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