There is always saying, pricing product is one of the crucial decision that can either bring success to the business or break down its reputation by hampering financial. Earlier the focus of traditional costing system on product costing done by tracing cost to the product and allocating indirect cost with the help of cost centres. This doesn’t provide a solution to cost overheads also include direct cost i.e. material and labour cost to product formation (Almeida Cunha 2017).
The activity-based costing provides an effective solution to calculate all the necessitate cost goes into products such as cost of goods sold. The focus of this article attributed to defining the activity-based costing system, illustrating the ABC model, and its limitation.
Defining Activity Based Costing
As defined by online assignment help experts, The activity-based costing is a system based on spending capabilities on resources to the product and services delivered to customers.
It first accumulates indirect cost for each activity of a particular department, value chain functions of an organization, and then assigning an actual cost to product and services or other cost objectives require to accomplish that activity.
Under the ABC system, both direct and indirect cost has been taken into consideration, the majority focuses on the cost required for decision making.
It often expands cost allocation beyond product processes such as designing, marketing process ordering and customer service. Though it is more complex, it substantially generates an accurate cost to support decision making.
The basic idea behind opting ABC system is that costs are group accordingly what derive activities to be incurred (Rajabi, 2008). These cost drives are basically defined as activities transactions that are significant determinants of the cost that is considered as the absorption rate. For instance, costs associated with marketing, ordering, namely, procurement storing etc would be included in cost pool and cost driver. Thus it can be said, ABC focuses on different costing and they’re purposed along with identifies those cost that is relevant for decision making
How Cost Is Allocated In ABC System
Generally, the ABC system used two-stage approaches
- Tracing cost to activities
- Tracing costs from activities to products
Tracing Cost To Activities- The first step under the ABC system is to identify those activities causing overheads cost (Overheads costing are ongoing business expenses not directly utilizes in product formation). Those activities might be related to production volume and grouped in cost pool. As defined by essay helpers, some of the common activities and under associated cost are mentioned in the given table-
Processing purchase order for materials
Labor cost determine preparing purchasing order power
Number of purchased order processed
Labor costs for handling material and parts,
Inspection of material and parts
Labor cost performing inspection
Labor cost involved in setting equipments
Set ups numbers
Producing goods and services using equipments
How much cost has been utilized
Labors hours assembled
Packing customer orders
Labor costs for packing orders
Tracing Cost From Activities To Products
In the next step, costs to products are assigned using cost drivers as a measuring activity.
Activity cost drivers present the activities quantity used to produce individual products. Activity cost drivers, measures, identifies and links activities and cost objects for activity outcome.
As defined by essay help USA, These activity cost drivers can be volume related, for example, machine hours and labour hour’s assemblage. But some costs are not related to production volume such as several steps another cost drivers that are not related to volume.
Steps Included In The ABC System
- First activities are identified which are significant for decision making
- Each activity is separate in its own cost pool also determining total overheads of each cost (Gray 2018)
- Assigning activity cost driver to each cost pool, these cost drivers can be units, hours, parts etc.
- Divide each cost pool overhead by each one cost driver to extricate cost driver rate
- Compute units, hours and parts generated and then multiple it with cost driver rate
Merits Of ABC Systems
- It gives accurate cost and reliable calculated production cost that focuses on causes and effect relationship in costs incurrence
- It identifies the real nature of cost behavior also helps in reducing costs if necessary
- It uses multiple cost drivers rather product volume
- It determines overheads costs fall under the areas of managerial responsibility, process etc
- It improves managers decisions implying effectiveness in the solution
- It is used to project future resources requirements
- According to Weil and Maher ABC system focuses on changing activities and gathering them required to reduce cost. If you want more about ABC model, you can also take assistance from essay deustchof SourceEssay
Limitation Of ABC Systems
- ABC system consists of numerous cost pool that makes it complex also increases its cost
- It is difficult to implement the ABC system such as the selection of cost drivers was enough complicated(Zhang and ISA, 2010)
- Large firms can utilize it more rather small firms
- It is difficult to determine measurement and estimated cost of each activity pool
In this blog, we have first defined why the business uses ABC system what is its application, through analyzing effectiveness of ABC system. It is deduced the activity-based costing is a system based on spending capabilities on resources to the product and services delivered to customers. We first defined how the cost is allocated under ABC system that suggested the first step under ABC system is to identify those activities causing overheads cost and in the second step costs to products are assigned using cost drivers as a measuring activity. Next, we defined the steps involved in the ABC system for allocating cost, aftermath we enumerated several merits of ABC system such as it identifies real nature of cost behavior also helps in reducing costs if necessary. At last, we defined some limitation of ABC system like it is difficult to implement the ABC system such as the selection of cost drivers was enough complicated.
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