Costing Systems
The costing systems aid companies in determining the cost of a product in relation to the revenue the product generates. The costing systems commonly used in businesses include activity-based costing and traditional costing. Traditional costing system assigns the manufacturing overhead based on the capacity of a cost driver. For example, the amount of direct working hours required to produce a particular item. Cost drivers are factors that cause cost to incur, like machine hours, direct material hours, and direct labor hours. Activity-based costing system allocates cost of manufacturing a product in accordance to the activities required to produce the particular item. It’s therefore essential for managers to understand the merits
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They require some particular information like units produced and direct labor hours to be essential and valued. From the input data, product costs as well as other information is determined in accordance to the particular costing system. The results obtained are dependent on the costing system applied as similar data can be used in various ways. Costing systems provide information to assist in minimizing wastes i.e. the resources required in designing, implementing and maintaining a costing system should not exceed the benefits derived from use of the system. A proper understanding of the working of both systems is necessary when comparing the two systems.
Activity-based Costing (ABC)
Activity-based costing (ABC) is a costing technique which identifies activities in a company and assigns cost of each activity with the resources to all services and products according to actual consumption of each. The model assigns additional indirect costs into direct costs as compared to the convectional costing systems.
The Chartered Institute of Management Accountants (CIMA) identifies ABC as an approach to monitoring and costing of activities involving costing final outputs and tracing resource consumption. The resources are assigned to an activity, and activity to cost objects based on the consumption estimates. Cost drivers are utilized to attach an activity cost to the
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For example, in a banking context, the activity of a bank teller is ascribed to each item through measuring how long each item transaction (cost driver) takes at a counter and them measuring the number of each form of transaction. In a machinery context for the activity of running machinery, the driver is often the machine operating hours i.e. machine operating hour’s maintenance, power cost in the running of machinery and labor cost activities.
ABC systems use activities as the main cost objects. The system works on the notion that activities cause costs, and cost objects create demand for activities. The system is flexible as it relates costs to customers, management responsibility and processor and not just the products. ABC system applies activities as the basic cost objects while using the costs of such activities as the building blocks for compiling costs of other cost objects.
The application of activity based costing system embraces advanced planning, control and monitoring system that encompasses: activity based costing; activity-based budgeting; activity reporting; activity-based cost management; performance benchmarking and measurement; customer/product and sector profitability, business process re-engineering; and continuous
This type of cost system further allows the activities to be specifically tracked in each of the company’s markets.
Overhead costs are not in proportion to the production output because of the method they are using. This leads to inaccurate pricing and costing decisions. An Activity Based Costing System would help find the real relationship between the products produced and overhead.
Activity-based costing can be defined as the managers allocate costs depending on the quantity of resources a product or service consumed in the manufacture of goods and services. The activity based
This type of cost system further allows the activities to be specifically tracked in each of the company’s markets.
Activity-based costing is a system of accounting that puts emphases on activities performed to produce products or services (Schneider, 2012). In this costing system every activity is assigned a cost (Schneider, 2012). The goal of activity-based costing is not to allot common costs to products but to measure and then price out all the resources used for activities that sustain the production and delivery of products and services to customers (Mazumder, 2007). Activity-based costing is a cost system that is useful in business because of the fact that it does account for the cost of the products, resources used to produce the product and delivery of the product.
Glaser Health Products manufactures medical items for the health care industry. Production involves machining, assembly and painting. Finished units are then packed and shipped. The financial controller is interested to introduce an activity-based costing (ABC) system to allocate (or distribute) indirect costs to products. Indirect costs, as distinct from direct costs, cannot be unambiguously linked to specific products. The controller would like to calculate product costs based on ABC for planning and control, not inventory valuation.
Under a traditional system, overhead cost is allocated to an activity based on hours or rates for direct labor or machine usage. However, this approach does not clearly indicate how much overhead cost will be needed in order to complete a job through a particular function. ABC methodology is to be used as an alternative to traditional accounting where a business 's overhead costs (indirect costs such as electrical energy consumption for heating or cooling, or indirect cost associated with marketing) are allocated as a proportion of direct costs, to an activity. This approach is unsatisfactory because there can be cases where two activities could absorb the same direct costs
3. Under the new activity-based costing (ABC) system, compute the indirect cost allocation rates for each of the three activities:
An organization costing system is a system that helps the management with the strategy planning while the system plays an important role in providing accurate cost information about the products and customers (Curtin, 2006). UPS utilizes the Activity-Based Costing (ABC) system. ABC assumes that activities cause costs and that cost objects create the demand for activities (Marx,
In college, Erik learned about an alternative costing approach called activitybased costing (ABC). However, the examples he remembered involved manufacturing firms. He wondered whether East Penn could develop an ABC system, with
Activity-based-costing (ABC) system find activities as the drive for each cost, calculate the average cost per driver’s activity, and times budgeted activities for budgeted cost. It is worth mentioning that ABC system is not used to find problems in cost records, or predict future cost based on that.
Activity based costing is defined as "an accounting method that identifies the activities that a firm performs, and then assigns indirect costs to products" (Investopedia, 2011). It has been argued that the way a company measures its costs can have a significant difference on the managerial decisions that it makes (No author, 2011). For example, this New Millennium Linen's management believes that the company makes most of its money from small gift shops, because an analysis based on contribution margin has illustrated that this type of customer has the highest contribution margin (80%) of the three types of customers that New Millennium sells to. What activity-based costing does in this situation is it allows managers to see how much of each activity is required to service each customer.
Nowadays, we know that activity based costing system assigns overhead costs to products or services products that using a two-stage process, which focuses on activities. ABC is a relatively new and very important topic in managerial accounting. ABC allows us to find a way that we could determine the profitability of every product, profitability of every customer we serve, and the profitability of our process. Contents in brief, first that comparing potential advantages of ABC versus traditional costing methods. The
C. T. Horngren, A. Bhimani, S. M. Datar, G. Foster (2005), 'Activity-Based Costing', Management and Cost Accounting (Prentice Hall Europe), 345-363
ABC refers to cost attribution to cost units on the basis of benefit received from indirect activities e.g. material ordering, material handling, machine setups, quality assuring, customer support services etc. For each such activity, it is necessary to identify a cost driver that causes incurrence of cost relating to that activity. For example, hours spent on testing for a quality assurance activity may be used as application base of cost driver for this activity.