Revision Notes On Activity-based costing(ABC)

May 3rd, 2008 Comments off
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Salient points On Activity-based costing(ABC)

1.0 Activity-based costing(ABC) was developed/designed during the 1980s to avoid the shortcoming of absorption costing and marginal costing.

1.1 Shortcoming of Absorption costing –produce misleading product costs

1.2 Shortcoming of Marginal costing-does not attempt to connect general overhead costs to products. Also produce misleading product costs

2.0 CIMA defines ABC as:

· An approach to the costing and monitoring of activities which involves tracing resources consumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates. The latter use cost drivers to attach activity costs to outputs.

3.0 ABC is called a “ one-step cost attribution system” as costs are not apportioned between activities- the costs of each activity are related directly to products. Cost attribution is “the process of relating cost to cost centres or cost units using cost allocation or cost apportionment”

4.0 ABC can help managers to control (a) product costs because it concentrates their attention on the volume of each cost driver consumed by each product and (b) overhead costs because ABC highlights the cost per unit of each cost driver.

5.0 ABC is very effective in modern manufacturing firms where they have high overhead costs and in the service industry. In service industry, the units of service are often the cost drivers themselves.

6.0 The steps/stages involve in ABC are as follows:

(a) Identify all the activities which support production

(b) Collect the costs of each activity into cost pools ( Cost pools are similar to cost centres in absorption costing except that cost pools do no contained any apportioned costs)

© Find out what it is that causes the cost of an activity to increase. This is called its cost driver

(d) Calculate the cost per unit of each driver by dividing the value of each cost pool by the volume of its cost driver

(e) Find out how much of each driver is used in making each product

(f) Lastly, multiply the quantity of each cost driver used by each product by the cost per unit of each driver which gives a figure for the overhead attributed to each product.

7.0 When ABC is used for planning and budgeting, it is called activity based budgeting or ABB

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