CHPT 5 all - Activity-based costing(ABC may be used by...

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Activity-based costing (ABC) may be used by manufacturing, service, or retailing entities and in job-order or process costing systems. It has been popularized because of the rapid advance of technology, which has led to significant increase in the incurrence of indirect costs and consequent need for more accurate cost assignment. These developments in computer and related technology (such as bar coding) also allow management to obtain better and timelier information at relatively low cost. ABC is one means of improving a cost system to avoid what has been called peanut-butter costing . Inaccurately averaging or spreading costs like peanut butter over products or service units that use different amounts of resources results in product-cost cross- subsidization . This term describes the condition in which the miscasting of one product causes the miscasting of other products. In a traditional system, direct labor and direct materials are traced to products or service units, a single pool of costs (overhead) is accumulated for a given organizational unit, and these costs are then assigned using an allocative rather than a tracing procedure. The effect is an averaging of costs that may result in significant inaccuracy when products or service units do not use similar amounts of resources. To improve its costing system, an organization can attempt to identify as many direct costs as economically feasible. It can also increase the number of separate pools for costs not directly attributable to cost objects. Each of these indirect cost pools should be homogeneous, that is, each should consist of costs that have substantially similar relationships with the driver or other base used for assignment of cost objects. Thus, choosing the appropriate base, preferably one with a driver or cause-and-effect relationship (a high correlation) between the demands of the cost object and the costs in the pool, is another way to improve a costing system. ABC attempts to improve costing by assigning costs to activities rather than to an organizational unit. Accordingly, ABC requires identification of the activities that consume resources and that are subject to demands by ultimate cost objects. Design of an ABC system starts with process value analysis , a comprehensive understanding of how an organization generates its output. It involves a determination of which activities that use resources are value-adding or non-value-adding and how the latter may be reduced or eliminated. This linkage of product costing and continuous improvement of processes is activity-based management (ABM) . It encompasses driver analysis, activity analysis, and performance measurement. Once an ABC system has been designed, costs may be assigned to the identified activities, costs of related activities that can be reassigned using the same driver or other base are combined in homogeneous cost pools, and an overhead rate is calculated for each pool. The next step, as in traditional methods, is to assign costs to ultimate cost
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This note was uploaded on 08/10/2011 for the course ECON 123 taught by Professor Other during the Spring '11 term at Pontificia Universidad Catolica Madre y Maestra.

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CHPT 5 all - Activity-based costing(ABC may be used by...

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