Activity Based Costing Changes in the business environment often compel companies to change the way they report and manage costs. This change entailsreplacing old methods of cost accounting with new methods that are in accordance with the present environment. The traditional costing systems have often been criticized for distorting product costs and leading to poor strategic decision making. Adoption of a mechanism that can list down activities and can assign operating costs to them can help a company dump unprofitable products and/or disband expensive channels of distribution. Introduction to Activity Based Costing (ABC) This is where Activity Based Costing (ABC) chips.
Simply put, ABC is an accounting methodology that assigns costs to activities rather than to products or services. The basis of ABC as a concept is that the cost of a product is the sum of the costs of all activities required to manufacture and deliver that product. Thus, the concept thrives on the principle that money is spent on activities and not on products. It is noteworthy to mention here that ABC is an alternative paradigm to traditional volume based costing system. The latter consider direct materials and labor as the only costs that can be traced directly to the product.
The limitation of the traditional systems is their inability to accurately determine actual production and service costs. Advantages of ABC The ABC system is ideal for companies that have multiple products or services in their repertoire. This system, by accurately assigning costs, will help the company separate the profitable products from the non profitable ones. ABC has the potency to reduce costs with the help of activities analysis, for e. g. it may transpire that two distinct products pass through two different distinct activities.
However both these activities serve the same purpose. In such a scenario the company may resort to activity elimination or activity reduction, which in itself will save cost. With the help of the ABC system, activities can be classified as value-added and non-value-added activities. The non-value-added activities can be eliminated to improve the performance of the system. Adoption by Delphis Ltd Delphis Ltd should employ ABC for it will provide better insights into which of its products are more profitable.
The company can also figure out the exact costs associated with its different channels of distribution and calculate the profitability of each channel. This information will also help Delphis take important strategic decisions on its proposed ski wear product. It must be remembered that although ABC is easy to understand and has proven advantages over the conventional systems of accounting, data collection for the purpose of calculating activity cost may be a time consuming exercise. To employ ABC, an organization needs to adopt the following steps. The process begins with the identification of activities and resources.
Thereafter the cost of resources used to perform each activity has to be measured followed by the determination of cost drivers and resource consumption rates. Costs can be assigned to products by multiplying the use of the cost drivers by the resource consumption. Bibliography Akyol, Derya Eren. Tuncel, Gonca and Bayhan G. Mirac. “ A comparative analysis of activity-based costing and traditional costing. ” World Academy of Science, Engineering and Technology No. 3 (2005): 44-47. Roztocki Narcyz. “Introduction to Activity Based Costing (ABC). ” Internet ABC Online Presentation.
University of Pittsburgh. Turney Peter B. B. “Activity-Based Costing: An Emerging Foundation for Performance Management. ” Cost Technology Report.