Abc Costing

Cost Management Accounting

Requirement of the article: Activity

based

strategic

costing

(ABC)

costing technique

is

with

a the

objective of demonstrating what makes it

a

superior

costing

comparison to the techniques.

technique

traditional

Discuss

in

costing

the significance

of the philosophy underpinning use of ABC as a strategic costing technique. Introduction Is a costing model that identifies activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each: it assigns more indirect costs (overhead) into cost, However Activity-based costing is a process where costs are assigned due to the cause and effect relationship between costs and the activities that drive costs. Traditional costing systems have a tendency to assign indirect costs based on something easy to identify (such as direct labor hours). This method to assigning costs can be very inaccurate, as there is not necessarily a relationship between the costs that are being assigned, and the activity they are being assigned to. This can make evaluating costs tricky and inaccurate. Therefore activity base costs identify. There is not direct relationship between overhead cost incurred and the product services provide to customers. ABC system give visibility to

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Cost Management Accounting how effectively resources are used and how all activity contribute to the cost of the product services

Different between Traditional and ABC cost. Traditional Salaries $100 Equipment $80 Supplies $20 Overhead $45 Total $245

ABC Clean door $40 Paint door $75 Inspect door $75 Send door to assemble $55 Total $245

As u can see in the example ABC provide information about how cost are actually consumed. ABC did not eliminate or change cost. Using the ABC system then a manager could evaluate the costs for each activity and may decide to combine the some of the steps in order to lower cost. Definition:Activity Base Costing is a costing method that is designed to provide managers with cost information for the strategic and other decisions that potentially affect capacity and therefore “Fixed Cost”. In ABC the objective is to understand overhead and the profitability of product and customers and to manage overhead. Characteristics:It is superior to traditional costing and the rationale behind ABC is that the provision of product and services require the performance of activities. The performance of the activities in turn consumes resource. It

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Cost Management Accounting is use of these resources that generate cost, most of which are overhead (indirect cost).

Benefits of ABC  Activity based costing brings accuracy and reliability in product cost determination by focusing on cause and effect relationship in the cost incurrence.  Managers manage activities and not products. The changes in activities lead to changes in costs. Therefore if the activities are managed well, costs will fall and resulting product will be more competitive.  ABC highlights the problem areas that deserve the management’s attentions and more detailed analysis.  ABC system is used in setting priorities for action.  Makes “Indirect” expenses “Direct”.

The

relationship

between

primary

and

secondary

overhead: If the company wants to reduce the cost then it can reduce the cost by down sizing of the labor cost. It can be better in condition where the company earns more profits. But in situation where demand becoming high again of the products then recruiting and hiring of the staff and labor raised the cost again. Here Traditional cost always fails but activity based costing helped the company to solved the problems because ABC costing allocating the exact cost pools to the actual products. In results high volumes made in low cost and low volumes made in high cost.

1. Complexity with ABC Costing: Gift Business School

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Cost Management Accounting If the proportion of over head cost to total cost is relatively high, it is necessary that over head cost is applied to products fairly and accurately in order to prevent over costing of some products and under costing of others .The extent of automation, complexity of production, etc generally increases the over head cost today .In such a situation cost assignment should be based on the suitable cost drivers .As result product cost are distorted. Actions taken on the basis of disported product cost cannot give good result in the long run. 2. Product complexity or diversity: When products consume activities and inputs in different proportions product diversity occurs. In such a situation, there is a difference in the size, complexity, materials, components or other characteristics and demands made on firms’ resources by product lines. The complex products may consume more non-unit level inputs such as machine setups than less complex products. Therefore unless the complexity or diversity of product is given due weight age in absorption of costs, product costs are likely to be distorted.

3. Converting the Fixed into Variable Cost: In situation where company earns no profit then most of the companies turn their fixed cost into variable cost. For example when company’s products do not sold in the market then they higher commission base staff. They does not facilitate with fixed salary but the commission, If the employees sell their products according to specification then company facilitate them with commission according to specification.

Philosophy: Determining the best product mix of a company correctly is an important requirement to increase the profitability of a company. To make right

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Cost Management Accounting decisions, management needs more accurate information about the optimal product mix and the restrictive bottlenecks of a company. Activity-based costing (ABC), together with the theory of constraints philosophy

(TOC)

and

mathematical

programming,

can

provide

management with more accurate information about the optimal product mix of a company and can help to identify the right bottlenecks that should be focused on to improve the system  It can be extremely useful tool for anyone involved in process improvement and cost reduction.  Using ABC means that all the individual activities that are part of process can be accurately costed.  Process improvement activities could then focus on then most expensive part of the process.  Likewise, when assessing the cost product and services, ABC can illustrate the cost of them and help in establishing the profitability of individual product and services.

REQUIREMENT OF STRATEGIC COST MANAGEMENT:It requires that a cost management designed in such a way that the structure and life cycle evolve to support a company’s changing competitive strategy with respect to product/service,market,H.R and technologies.

ABC INFORMATION:ABC information should be used to support organizational strategy by creating cost visibility, reducing cost and improving processes.

FACTORS INFLUENCE MANAGEMENT ABILITY:-

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Cost Management Accounting  Management freedom to set prices  The ratio of period cost to total cost  Strategic consideration  The climate and culture of cost management  The frequency of analysis that is desirable or necessary

Conclusion: There is no doubt that there are many benefits of ABC costing but in the other hand it has also complexities so it depends upon the managerial skill that decision makers take decision in particular situation.

Thank you,

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