The discussion centred around the traditional method currently in use, compared and contrasted with ABC, Activity Based Costing a technique which re-examines the problem that has faced accountants for decades – that of allocation and absorption of overhead.
Traditional pricing method has been based upon absorption costing and the treatment of overhead usually followed a set procedure.
• Cost centres are identified and established within the organisation.
• Cost centres may be producing or service centres.
• Wherever possible a direct charge is made to a cost centre ie allocated overhead.
• Where overhead is jointly incurred it is apportioned to the cost centres on an equitable base.
• The overhead cost for the service centre is then transferred to producing centres.
• The total overhead cost for each producing centre is then divided by for example, machine or labour hours per the cost centre.
• An overhead recovery rate results.
• This is then used to absorb the overhead to products.
• If planned activity levels are actually achieved then overhead may be fully recovered in the short run.
Such method may successfully be used where there is a limited product range and predetermined rates are well planned on achievable production budget volumes.
Present situation – existing method
The firm has three major producing cost centres; Machining, Finishing and Packing.
The process of allocation and apportionment for the periods 1 – 3, 2003, had been complete and the predetermined figures were:... [continues]
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