Introduction to Activity Based Costing

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Cost Accounting CA 2011

Topic:Activity Based Costing

Submission Date:16 march 2011

Word Count:1770

Name:Mary Moss

Student No:L00084540

Class:Buss Yr 2

Contents

Page 2 ……………………………………..Introduction to Activity Based Costing

Page 2……………………………………..Benefits of ABC

Page 3……………………………………..Traditional Cost Accounting (TCA)

Page 4……………………………………..Difference between ABC and TCA

Page 5……………………………………..Numerical example using ABC and TCA

Page 8……………………………………..Bibliography

Introduction to Activity Based Costing

Activity Based Costing (ABC) emerged in the 1980s from the rising lack of relevance of traditional cost accounting methods. It took just a short time for ABC to be accepted as an original and potentially valuable costing methodology, yet it took a further 20 years to reach its full potential. ABC surfaced in response to competitive demands that exposed errors in cost accounting. Early uses helped companies see the deformities in cost accounting systems leading to changes in policy, processes, operations and improved competitive position. The ABC method originates from a simple principle, this being, ‘activities consume resources and customers consume activities’. It is a method of allocating costs to products and services and is commonly used as a tool for planning and control. It was developed as an approach to tackle problems that were related with traditional cost management systems, as this system inclines to have the lack of ability to precisely determine actual production and service costs, or supply useful information for operating decisions. With these deficiencies managers can be exposed to making choices based on imprecise data. ABC permits managers to assign costs to activities and products more precisely than traditional cost accounting methods allowed for

Benefits of ABC

This powerful tool is now being used by companies across many industries and within government and non profit organisations, it provides organisations with a more accurate and realistic measurement of the cost of doing business, which enables management to create better performance targets and effective decisions within the organisation which will help implement profit growth strategies, and if correctly utilised and applied can rank a companies customers in terms of profitability. This is done by its ability to precisely estimate the cost of its individual products and services for the purposes of pinpointing and removing those which are unprofitable and dropping the prices of those which are over priced. The system allows users to have an abundance of relevant information that can be used to make strategic decisions about products and pricing. It benefits managers by giving them more accurate measurements of activity driving costs, which gives them the ability to improve product and process value by making better design decisions and better customer support decisions. In addition to this another key benefit to companies especially now in this poor economic climate is the ability for management to identify the cost of idle capacity, as many companies have seasonal and recurring variances in sales and production, the company will still be incurring costs associated with the unused space, the main goal here is to manage capacity levels and to reduce waste and to have products and services priced appropriately.

Traditional cost accounting (TCA)

The traditional costing model contains six elements.
1.For product costing objectives, a company is divided into practical areas of activity - financing, marketing, manufacturing, and administration. 2.Manufacturing costs of direct materials, direct labour, and manufacturing overhead are subject to inventory costs. 3.Direct materiel and direct labour costs are thought to be traceable precisely to specific products. 4.Manufacturing overhead costs are regarded as indirect product costs, and are charged to...
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