ABC and Traditional Product Costing Methods
Activity Base Costing hereafter referred to as ABC and Traditional Product Costing Methods are used for the sole purpose of utilizing cost information to make strategic decisions that affect fixed and variable. Even though ABC is used by manager for making strategic decisions, it is not used independently. It is utilized to supplement official costing systems that are used for preparing external financial reports. (Garrison, Noreen, & Brewer, 2010) In the Traditional Product Costing Method emphasis is put on absorption cost used by manufacturing companies to calculate unit cost for the purpose of valuing inventories and determining cost of goods sold for external financial reports. (Garrison, Noreen, & Brewer, 2010) Traditional Product Costing determines cost of goods sold by combining direct material, direct labor and manufacturing overhead. Having the accurate cost information assist manager in numerous ways to plan, control, and evaluate decisions. With the right information as a part of the planning process companies can determine whether it can or should compete in certain markets. Using the information to control operations a company can analyze relationship between production levels and costs determining whether to increase or decrease production levels of certain products. Furthermore this control data can help with future operations plans because it can determine if the increased costs of additional production would less than the revenue that would be derived from sales of the products. Finally the evaluation process allows the company can compare actual cost against budgeted cost and identify both progress and problems for subsequent management action. (Albrecht, Stice, Stice...
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...n, Noreen, & Brewer, 2010)
Due to technology ABC has made this complex problem more feasible and provided an alternative to the traditional plantwide and departmental approaches to deining costs pols and selecting allocation bases. An activity in ABC is the event that cause consumption of overhead resources and the activity cost pool is the “bucket”. The allocation base is the acitivity measure.
Allocation bases driven by the volume of production is exclusively relied upon in the traditional costs system. On the other hand ABC has defined five levels that do not largely relate to the volume of units produced.
References
Albrecht, W. S., Stice, J. D., Stice, E. K., & Skousen, k. F. (2002). Accounting Concepts and Applications. Cincinnati: South-Western.
Garrison, R. H., Noreen, E. W., & Brewer, P. c. (2010). Managerial Accounting. New York: McGraw Hill/Irwin.
If done right, I believe that all of the costs can be allocated to each of the three products through both direct and overhead costs. The only direct costs that are being included currently are labor and manufacturing costs. I broke up overhead into overhead based off direct labor and overhead based on units sold.
Romney, Marshal, and Paul Steinbart. Accounting Information Systmes. 10th ed. Upper Saddle River: Pearson Education, 2006. 193-195.
The pros of using ABC is the capacity to estimate the cost of services and individual products. By transferring overhead costs to individual units of products or services, ABC helps identify inefficient or non-profitable products or activities that eat into the profitability of efficient processes or highly profitable products (Nayab, 2011). This will help the company to determine whether to implement processes for improvement or outsource those processes. ABC highlights non-remunerative distribution channels allowing the management to adopt alternative marketing strategies or close down the channel for a more pro...
Marshall, M.H., McManus, W.W., Viele, V.F. (2003). Accounting: What the Numbers Mean. 6th ed. New York: McGraw-Hill Companies.
Marshall, D. H., McManus, W. W, & Viele, D. (2002). Accounting: What the Numbers Mean. 5th ed. San Francisco: Irwin/McGraw-Hill.
Besides, an organisation can adopt a technique of activity-based costing (ABC) as an approach to support its sustainability objectives. ABC system is a technique of assigning overhead costs to products and services by identifying the cost drivers. ABC technique will first identify each activity cost that is involved in the process of production, then assign the cost to each product and service on the basis of each activity consumption in the production of each product and service (Drury, 2012, p. 253). ABC system is an effective method to account for costs of products and services. This is because ABC system allocates indirect costs based on a cause-and-effect relationship (Drury, 2012, p. 269). ABC system allocates overhead costs to cost
Cost allocation is the process of identifying, aggregating, and assigning of cost to various separate activities. There is no overly precise method of charging cost to objects, hence resulting to approximate methods being used to do so. Amongst the approximation basis used includes square footage, headcount, cost of assets employed, and electricity usage amongst others. The main aim of cost allocation is to spread cost in the fairest possible method and also to impact the behavior pattern of the cost.
Activity-based costing (ABC) is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” as well as variable costs. Activity-based costing is mostly used for internal decision making and managing activities while traditional costing method is used to provide data for external financial reports. Most organization uses activity-based costing as an addition system for using traditional absorption costing as sometimes the traditional cost system misleads the product’s profitability. In a company, there are many products on sale, if one product is sold at a high price with low product margin and a product with high product margin at a low price, it may result in a loss. In addition, due to the reason that cost drivers and enterprises business may change, activity-based costing analysis also needs to be revised periodically. This amendment should be prompted to change pricing, product, customer focus and market share strategy to improve corporate profitability.
Comparing two cost systems, the new system added two new cost pools based on the traditional one, which usually allocated support costs to material, labor and supported related cost pools. The old system did not reflect the increasing support costs of specialty products so that it was unable to reduce costs and provide a good choice for the plant on how to choose profitable orders. From our calculations (Exhibit 3), the new system transferred engineering costs and Administrative costs to order processing costs pool and special components cost pool similarly. It shows that the new system is more clear and efficient on cost reduced and al...
From the A12 redesign proposal, it shows that the current standard cost system is unable to link the reduction in the number of parts to activity reductions and cost savings. The labor-direct-based standard cost system reflects the cost of A12 is distorted. Using the ABC system, according to the activities of A12 allocate the overhead cost to A12 that could find that the current overhead cost of A12 was overstated by the standard cost system. At last, A12 Junction Box could be identified it is an attractive and profitable product, at the same time, it demonstrates the value of ABC.
There are two general approaches to allocating costs that are not direct costs associated with producing a product or rendering a service. These approaches are activity-based costing (ABC) and traditional costing. The former is effort-intensive but more accurate as it identifies the associated cost per activities involved in the production or service and used this information to assign the cost of the finished product or service. The latter, on the other hand, used an average rate that is derived from estimating a pooled indirect cost for a certain period (e.g. year-long time frame) and spread this cost to a chosen cost-driver parameter such as man-hours or machine-hours (“Difference Between Activity-Based Costing and Traditional
For example: with the increase of the number of products produced, the cost of operating a machine also increase. Second we have batch level costs which is associated with batches; producing a multiple units of the same product that are processed together is called a batch. The third type is product level costs which arise from any activity in order to support the production of products. The fourth and the last type is facility level costs, this costs cannot be determined with a particular unit, product or batch; this costs are fixed with respect to batches, products and number of units produced. A single measure of volume is used for allocating costs to each service or product in traditional method for example: direct material cost, machine hours, direct labor cost and direct labor hours. A cost driver is an activity that generate costs, it can be generated by two types of costs the first is a particular machine 's running costs where the costs is driven by production volume as machine hours; the second is quality inspection costs where the cost is driven by the number of times the relevant activity occurs as the number of
middle of paper ... ... 8. Lewis, R.J. "Activity-Based Costing for Marketing." Management Accounting, November 1991, pp. 33-38.
Heisinger, K., & Hoyle, J. B.(2012). Accounting for Managers. Creative Commons by-nc-sa 3.0. Retrieved from: https://open.umn.edu/opentextbooks/BookDetail.aspx?bookId=137
Cost control and management. The study also identifies several other advantages of using the ABC