Activity Based Costing - Essay 4

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Topic Gateway Series

Activity Based Costing

Activity Based Costing
Topic Gateway Series No. 1

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Prepared by Stephanie Edwards and Technical Information Service

Revised November 2008

Topic Gateway Series

Activity Based Costing

About Topic Gateways
Topic Gateways are intended as a refresher or introduction to topics of interest to CIMA members. They include a basic definition, a brief overview and a fuller explanation of practical application. Finally they signpost some further resources for detailed understanding and research. Topic Gateways are available electronically to CIMA Members only in the CPD Centre on the CIMA website, along with a number of electronic resources.

About the Technical Information Service
CIMA supports its members and students with its Technical Information Service (TIS) for their work and CPD needs. Our information specialists and accounting specialists work closely together to identify or create authoritative resources to help members resolve their work related information needs. Additionally, our accounting specialists can help CIMA members and students with the interpretation of guidance on financial reporting, financial management and performance management, as defined in the CIMA Official Terminology 2005 edition. CIMA members and students should sign into My CIMA to access these services and resources. The Chartered Institute of Management Accountants 26 Chapter Street London SW1P 4NP United Kingdom T. +44 (0)20 8849 2259 F. +44 (0)20 8849 2468 E. tis@cimaglobal.com www.cimaglobal.com

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Topic Gateway Series

Activity Based Costing

Activity based costing
Definition and concept
‘An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilise cost drivers to attach activity costs to outputs.’ CIMA Official Terminology, 2005 A development of the principles of activity based costing (ABC) is activity based management (ABM). Operational ABM is defined as: ‘Actions, based on activity driver analysis, that increase efficiency, lower costs and/or improve asset utilisation.’ CIMA Official Terminology, 2005 Strategic ABM is defined as: ‘Actions, based on activity based cost analysis, that aim to change the demand for activities so as to improve profitability.’ CIMA Official Terminology, 2005 The main focus of this topic gateway is ABC. However, the development of ABC into ABM will be discussed further under Application.

Context
In the current syllabus, CIMA students will learn and may be examined on this topic in Paper P1, Management Accounting Performance Evaluation, Chapter 8, Developments in management accounting, and Paper P2, Management Accounting Decision Management, Chapter 10, Activity based approaches. Study systems for these papers are available from CIMA Publishing.

Related concepts
Activity based management; activity based budgeting; time driven activity based costing.

Alternative approaches
Traditional costing approaches. 3

Topic Gateway Series

Activity Based Costing

Overview
The concept of ABC was first defined in the late 1980s by Robert Kaplan and William Burns. Initially ABC focused on manufacturing industry where technological developments and productivity improvements had reduced the proportion of direct labour and material costs, but increased the proportion of indirect or overhead costs.

Comparison of traditional costing and ABC
The traditional method of costing relied on the arbitrary addition of a proportion of overhead costs on to direct costs to attain a total product cost. The traditional approach to cost allocation relies on three basic steps. 1. Accumulate costs within a production or non-production department. 2. Allocate non-production costs to production departments. 3. Allocate the resulting production department costs to...
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