Paper on Activity Based Costing

This essay has a total of 960 words and 6 pages.

Activity Based Costing


Activity Based Costing (ABC) addresses internal operating concerns and is an augmentation
to the traditional cost management system. It is not a replacement for traditional
accounting, but makes use of the source documents provided from standard job costing
systems. ABC looks at a business unita€™s events as cost drivers and assigns all
company resources and accumulated costs against those events in a time-phased sequence.
Revenue tracking provides management with a different point of view on the profitability
of products and services, providing insight into pricing. Middle management and technical
performing organizations are involved in the line item reporting provided within the ABC
system, enabling management to achieve more responsibility of reported information
throughout all levels of the organization. ABC is being ostensible by the accounting
industry as the wave of the future and is gaining broad acceptance within larger
organizations. This system is intended to provide performing entities and management

History of ABC
Activity Based Costing (ABC) is an approach to costing that considers the resources
consumed by activities in order to create and deliver a product or service. It evolved in
the mid-1980s to improve the allocation of manufacturing overhead costs to products, but
it soon became apparent that activity-based costing systems could be expanded to include
non-manufacturing costs (Langfield-Smith, Thorne & Hilton, 2004).

Review of ABC
Whereas the underlying assumption of a conventional costing system is simply that products
cause costs, an activity based costing system assumes that cost objects (e.g. juice)
creates the demand for activities (e.g. manufacturing), which in turn causes resources to
be consumed (e.g. manufacturing time, outlet space, etc.) and causes costs. Cost objects
are the reason for performing activities, and activities are the processes or procedures
that cause work and create costs.

ABC analyses costs from the perception of the how much a particular activity costs, and
the amount of resources consumed by the end product of the activity. Using activity based
costing differs from traditional cost accounting in that the focus is on the activities
that are required to produce an end product, rather than assuming that the volume of the
end product is the only driver of costs.

A cost driver is a term used in activity-based costing. It simply refers to any activity
that causes a cost. It can be anything from machine hours, labor hours, number of machine
setups, or the number of parts in a product.

By understanding how resources are transformed into products or services, and by focusing
on the cost of activities, ABC helps an organisation to obtain a greater understanding of
how costs behave in their organisation and which activities create significant amounts of
cost. Organisations can then begin to control their costs based on tangible activities
rather than relatively uninformative general ledger or cost centre reports.

ABC is the assignment of costs from resources to activities and then from activities to cost objects:

ABC identifies the processes and activities involved in producing the cost object (e.g.
fruit juice) and then cost these activities. The activities are cost by taking the
traditional general ledger cost reports and determining an appropriate resource driver to
assign the resource costs to the various activities. This involves accumulating costs that
behave in a similar way into a€˜cost poolsa€™ (e.g. salary costs, machinery costs),
and then identifying appropriate resource drivers to assign the costs from the cost pools
to the activities (e.g. % of manufacturing time, factory space, etc).

The next step in ABC is to assign the activity costs to products or services. This
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