Variations of Activity-Based Costing ABC

It can be quite difficult to maintain this extra database, since it calls for significant extra staff time for which there may not be an adequate budget. The best work-around is to design the system to require the minimum amount of additional information other than that which is already available in the general ledger. An ABC system may require data input from multiple departments, and each of those departments may have greater priorities than the ABC system. Thus, the larger the number of departments involved in the system, the greater the risk that data inputs will fail over time. This problem can be avoided by designing the system to only need information from the most supportive managers.

While an ABC/M system alone will not transform a firm into a world-class competitor, it is an important tool to help world-class firms make effective strategic decisions. A significant amount of research is available that deals with the design and implementation of ABC/M systems (Cooper and Kaplan, 1991, Shank and Govindarajan, 1993, Turney, 1992b, Damito et al., 2000). Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. This accounting method of costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than traditional costing methods.

Objectives of the ABC System of Costing

ABC requires identifying and measuring the activities and cost drivers that consume resources, and collecting and analyzing data on the usage of those resources by the products or services. This can involve a lot of time, effort, and expertise, and may require sophisticated software and systems. ABC also requires updating and revising the cost information regularly, as the activities and cost drivers may change over time. Activity-based costing focuses on identifying the activities required to make products, on forming cost pools for each activity, and on allocating overhead costs to the products based on their use of each activity.

  • The primary difference between activity-based costing and the traditional allocation methods is the amount of detail; particularly, the number of activities used to assign overhead costs to products.
  • It can be quite difficult to maintain this extra database, since it calls for significant extra staff time for which there may not be an adequate budget.
  • This can involve a lot of time, effort, and expertise, and may require sophisticated software and systems.
  • Traditional cost accounting techniques allocate costs to products based on attributes of a single unit.
  • One of the main benefits of using ABC for cost classification is that it can provide more accurate product costing than traditional methods, such as direct labor hours or machine hours.
  • Robin Cooper and Robert S. Kaplan, proponents of the Balanced Scorecard, brought notice to these concepts in a number of articles published in Harvard Business Review beginning in 1988.

By understanding which activities drive the most costs, you can identify areas to improve efficiency and reduce waste. The articles and research support materials available on this site are educational and are not intended to be investment Activity-Based Costing or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. It encourages management to evaluate the efficiency and cost-effectiveness of program activities.

Activity-Based Costing Process

Remember, these are overhead costs, not direct materials or direct labor costs. As a result, traditional systems tend to over-cost high volume products, services and customers and under-cost low volume. Moreover, Activity-Based Costing (ABC) has been developed as a more modern absorption costing method to overcome the problems of under-costing and over-costing and to produce more accurate product costs. Traditional costing is simpler but less specific than activity-based costing.

What is the purpose of activity-based costing?

The objective of ABC is to assign specific resources and break overhead costs between production-related activities. This type of costing relies on different activities, such as product design or unit of work.

The overhead costs assigned to each activity comprise an activity cost pool. In the table below, we present several examples of the cost drivers companies use. Most cost drivers are related to either the volume of production or to the complexity of the production or marketing process. Identifying cost drivers requires gathering information and interviewing key personnel in various areas of the organization, such as purchasing, production, quality control, and accounting. However, the total is broken out into different activities rather than departments, and an overhead rate is established for each activity.

Step 3. Load Primary Cost Pools

ABC is not a perfect or comprehensive method of cost classification, as it may not capture all the costs or activities that are relevant or important for the organization. ABC also relies on some assumptions, such as the linearity and proportionality of the cost drivers, and the homogeneity and independence of the activities, that may not hold true in reality. Therefore, P&L managers need to use ABC with caution and judgment, and supplement it with other methods or tools when necessary. Activity-based costing (ABC) uses several cost pools, organized by activity, to allocate overhead costs. Activity-based costing (ABC) is a costing method that assigns costs to specific activities or tasks within the production process. Manufacturing businesses with high overhead costs use activity-based costing to get a clearer picture of where money is going.

ABC systems are notoriously difficult to install, with multi-year installations being the norm when a company attempts to install it across all product lines and facilities. For such comprehensive installations, it is difficult to maintain a high level of management and budgetary support as the months roll by without installation being completed. With proper overhead allocation from an ABC system, you can determine the margins of various products, product lines, and entire subsidiaries. This can be quite useful for determining where to position company resources to earn the largest margins.

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