Activity Based Costing Systems

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Activity-Based Costing Systems
Research Paper

|Matthew East | | | | | | | | | | | |ACCT 311 Cost Accounting | |Professor Keith Wargo | |September 26, 2011 |

Activity-Based Costing Systems

All over the world businesses, from major corporations to small sole proprietorships, use different costing systems to account for their operations. These costing systems help a company to gauge the cost of producing their product. From the cost of labor to the cost of materials, costing systems provide a basis for companies to gain important information on operations and performance. Activity-Based Costing is one of many costing systems currently used by companies today. In this paper, it is the intent of this writer to describe Activity-Based Costing, identify why a company would use this method of costing, and in contrast show why it might not be as cost effective as one might hope.

Activity-Based Costing (ABC) is defined as “Costing method that first assigns costs to activities and then assigns them to products based on the products’ consumption of activities (Lanen, Anderson, and Maher, 2011, p. 14). However, Pieter Buys and Kevin Green describe Activity-Based Costing in a more detailed way when describing the development of an “ABC costing methodology” (Buys and Green, 2006, p. 36). They state that “an ABC costing methodology could typically be analyzed with focus on the following phases”

1. The determination of the significant operational activities. (Buys and Green, 2006, p. 36).

2. The identification and collection of costs specific to each of these activities. (Buys and Green, 2006, p. 36).

3. The identification of the cost drivers for each of these activities. (Buys and Green, 2006, p. 36).

4. The determination of the activity unit costs. (Buys and Green, 2006, p. 36).

5. The allocation of the costs to the cost objects based on the activity consumption.

On the other hand, Buys and Green explain what Activity-Based Costing is not. They go on to state that “It is important to understand that ABC is not intended to replace the organizations general ledger, but should rather be seen as a tool to translate the general ledger information into usable management information” (Buys and Green, 2006, p. 36). Activity-Based Costing is certainly not the perfect costing system however; it does simplify and streamline the process of materials to product.

What would motivate a company to switch from a more traditional costing system to Activity-Based Costing? There are several factors that contribute to the implementation of this costing system. In 2006, Adebayo Agbejule set about to study “two different business units of the same company which approached ABC implementation with...
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