Activity based costing.docx - Activity based costing...

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Activity based costing Features of conventional (traditional)product costing systems Direct material and direct labour costs are traced to products Overheads are aggregated into very large cost pools, sometimes for individual departments but often for the whole plant Manufacturing overhead costs are allocated to products using a predetermined overhead rate, either plant wide or departmental Manufacturing overhead rate is calculated using some measure of production volume (for example direct labour hours or machine hours) Non-manufacturing costs (upstream and downstream) are not assigned to products Problems with traditional product costing systems Failure to adapt to the changing business environment o Increasing levels of non-volume-driven manufacturing overhead costs o Increasing proportions of non-manufacturing costs Cause of changes in cost structures include: o Increased automation— incur overhead cost, such as depreciation, maintenance , but is not relevant to the volume of product that being produce , this means that , THE COST OF THESE WILL BE SAME, NO MATTER HOW MANY PRODUCT BEING PRODUCE. o Increase product diversity and complexity o Increased emphasis on upstream and downstream areas of the value chain, for example, customer demand for improved service, quality, marketing and customer support (incur more non manufacturing cost) Indicators of problems with a product costing system Traditional product costing systems are likely to result in inaccurate product costs when: o product diversity increases o the proportion of direct labour costs decreases and the proportion of manufacturing overhead costs increases o the proportion of manufacturing overhead costs, not related directly to increase in production volume o non-manufacturing costs that are product-related become substantial Activity-based costing A method that can be used to measure both the cost of cost objects and the performance of activities Can help solve problems such as: o Distorted product costs o Poor cost control Activity: A unit of work performed within the organisation
ABC approach Other activity cost pools Allocated using activity cost drivers o Do not confuse overhead costs with activity cost pools o Overhead costs represent all the manufacturing (and/or non-manufacturing) costs of the organisation o These are allocated to activity cost pools using resource drivers (a cost driver used to estimate the cost of resources consumed by activity ) o Activity cost pools are an amalgamation of the overhead costs that are used to carry out a particular activity
o These costs are then applied collectively to cost objects (for example, products) using a common activity cost driver (a cost driver used to estimate the cost of an activity consumed by the cost object)

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