Question

Activity Based costing accounting (ABC): An introduction about it and how to apply it.((((( NO PLAGIARISM)))

Answer 1

Answer:

INTRODUCTION:

The Activity Based Cost Accounting (ABC) is a costing technique that assigns costs to products based on the activities those products require. The activity can be defined as an event that consumes resources.

Chartered Institute of Management Accountants (CIMA) defines Activity Based Cost Accounting as, "Cost attribution to cost units on the basis of benefits received from indirect activities i.e. ordering, setting up, assuring quality etc."

Therefore, activities include tasks such as ordering materials, processing purchase orders and setting up machines. Costs are incurred while obtaining resources like factories, machinery and workers. These resources are consumed in the activities performed that manufactures the product. The aim of ABC is to allocate the cost in such a manner that it shows the amount of resources consumed in the activity for producing a particular product.

For finding the cost of a product, company should identify the activities required to make the product, identify the resources used to provide for those activities and finally compute the cost of those resources.

Activity Based Cost Accounting is suitable when there are wide range of products, operations are more complex and diverse and require support of services. It is used when overhead allocations are made in proposition to activities and such overhead form high proportion in total costs.

HOW TO APPLY ACTIVITY BASED COST ACCOUNTING:

Management applies Activity Based Cost Accounting in the following manner, explained below:

1. IDENTIFY THE ACTIVITY:

The first step in ABC is to identify the organisation's major activities. Activity may be of four types: UNIT LEVEL, BATCH LEVEL, PRODUCT LEVEL AND FACILITY LEVEL.

A) Unit level Activities are primary activities that are directly related to units produced. For example, use of indirect material increases with increase of units produced.

B) Batch level Activities are supporting activities for production such as ordering of materials, inspection of products, etc.

C) Product level activities are considered as once-only activities which occur only at the time of introduction of new product line. For example, designing, keeping technical drawings, etc.

D) Facility level activities include the activities related to maintaining facilities for production such as maintenance of Building and Machinery.

2. IDENTIFY COST DRIVERS:

Cost drivers are the unit of an activity that causes the change in activities cost. The ABC relates indirect cost to the activities that drive them to be incurred. The cost drivers are link between the activities and the cost.

3. IDENTIFY COST POOLS:

Cost pools are the point of focus for the costs pertaining to a specific activity. In ABC system, a cost pool is established for each cost driver. A cost pool represents a grouping of individual cost items. It may be employed for every identified activity or sub-activity.

4. CALCULATION OF OVERHEAD RATE:

The activity cost rates for each activity is calculated by dividing activity cost pools by activity cost drivers. Hence following formula will be used:

Activity cost driver rate = Activity cost pool ÷ Activity cost driver.

5. CALCULATION OF TOTAL PRODUCT COSTS:

The activity cost driver rates are used for determining the amount of overhead chargeable to different products. The amount of overhead chargeable to a specific product is calculated by multiplying the activity cost drivers rates by different amounts of each activity that each product or other cost object consumes. The total cost of products is calculated by adding all direct and indirect cost assigned to them.

Hence, these are the steps in application of Activity Based Cost Accounting.