Activity Based Costing Is A Cost Accounting Concept Accounting Essay

Harmonizing to the Burch ( 1994 ) , he stated that mensurating the cost and the public presentation of cost object and activity is a method of the activity-based costing. He claim that cost object for case occupations, undertaking, client, service, merchandise that direction are seeking to be is the thought behind the activity-based costing. Resource driver and activity driver severally measure the ingestion of resource and ingestion of activity. In add-on, he besides claim that activity-based bing attempt to specify what is driving costs and bear down a cost object for merely overhead it really consume.

Harmonizing to the Jamaliah Abdul Majid and Maliah Sulaiman ( 2008 ) , they stated that activity-based costing is a multipurpose tool. For case, it can utilize in client profitableness analyses ( Bellis-Jones, 1989 ) , cost decrease ( Brimson, 1991 ) , cost mold ( Cooper, 1994 ) , product-range determinations ( Johnson and Kaplan, 1987 ) and budgeting ( Kaplan, 1994 ) . Activity-based costing system appoints costs to be objects such as merchandises and services and calculates the costs of personal activities on the fundamental of the activities engage to bring forth each merchandise or services.

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On another position, activity-based costing is a cost accounting construct based on the premiss that merchandises require an organisation to execute activities and that those activities require an organisation to incur costs. The systems are designed so that any costs that can non be attributed straight to a merchandise and flow into the activities that make them necessary. The cost of each activity so flows to the merchandises that enable the activity necessary based on their several ingestion of that activity ( Hicks,1992 ) .

Harmonizing to the Activity-based costing ( ABC ) is an attack for apportioning overhead costs. Besides that, activity-based costing is a powerful tool for industrial selling determination shapers because activity-based costing has appear over the past 20 old ages

An earlier article ( Stevenson et al. , 1993 ) introduces ABC and discusses general utilizations of ABC in industrial selling determination doing with peculiar accent on the impact of ABC on profitableness steps. ( John C. Lere,2000 ) Activity-based costing ( ABC ) is a system step the cost of activities and provided utile, seasonably and accurate information to the related direction.

Section 2: Background Research

Harmonizing to Robert Kaplan and Robin Cooper, activity based costing ( ABC ) as a was foremost introduced in 1987 that published in the book titled “ Accounting and Management: A Field Study Perspective. “ They focused on fabrication environments where increasing engineering and productiveness betterments have decreased the per centum of costs represented by direct labour and stuffs. In 1990, the ABC was fist expanded.Besides that, they stated that fiscal establishments besides have different merchandise sets which have created opportunities for cross-product subsidies. In the terminal, they concluded that it could be used to more exactly in apportioning costs.

Besides that, some alterations had undergone in banking industry in footings of its sensitiveness to staffing degrees and related productiveness during the past five old ages. The industry would be seeking for ways to more accurately allocate such costs to merchandises and clients because force disbursals is the biggest portion of non-interest disbursal in fiscal establishments. Activity based costing can be a utile tool to doing determinations for apportioning the costs.

For the fabrication sector, harmonizing to the Dr.P.Chellasamy, he stated that the constructs of ABC were developed of the United States during the 1970s and 1980s.According to Jesper Thyssen, he stated that the beginning of ABC dates back to 1983-1984 ( Kaplan 1983 ; 1984a, B ; 1985a, B ; 1986 ) although the term “ Activity-Based Costing ” was non coined yet. The beginning grew out of dissatisfaction with ruling bing processs at the clip, variable costing and traditional full costing, which were argued to be disused in modern fabrication environment. In 1987-1992, Robin Cooper and Robert S. Kaplan besides ventured into a series of “ advanced actions research rhythms ” ( Kaplan 1998 ) when the ABC was developed.

Section 3: Literature Reappraisal

Activity Based Costing

Restriction of ABC

Advantages of ABC

Harmonizing to the chart, Activity Based Costing has the advantages and restriction when we are implementing in an organisation. Hence, we will farther explicate about it as follows.

Advantages of of ABC

Harmonizing to Carles ( 2001 ) , he stated that several writers have described the chief advantages of utilizing ABC bing [ Innes and Mitchell, 1990 ; Bellis-Jones and Develin, 1995 ; Malmi, 1997 ] . , which as follows:

The merchandise and service costing is more accurate, particularly the non-volume -related operating expense in the organisation.

It is possible to analyse costs by countries of managerial duty and

clients by utilizing the ABC.It helps to acknowledge the manner in which clients straight influence the cost construction of the concern. Hence, it helps to analyse client profitableness.

It is a cost behaviour that makes people more understand.It is besides placing the costs of complexness, assortment, and alteration inherent in both sort of service offered and customer-specific demands.

Focuss on the value-added activities, which are those activities that create value to clients. On the other manus, the company should place the non-value-added activities and seek to extinguish them although the non-value-added activities that enables value adding activities to happen at the same clip.

It is good to executing capacity analysis which measures the costs of resources

used instead than the costs of resources supplied because that has the large difference being extra capacity. We will utilize the practical capacity, which means the capacity reflecting the maximal degree at the efficient organisation to undergo this analysis,

It reduces the hazard of the company and provides a more utile determinations in the hereafter. Therefore, it is non merely depending on the analysis but besides depending on its ability to utilizing a right diagnosing in the company ‘s state of affairs to do an organisation successful.

Restrictions of ABC

Harmonizing to Peter F.Druker ( 1999 ) , some companies that activity-based costing will do disbursement excessively much clip, attempt and even money on assemblage and traveling over the informations that is collected. The director annoyed in an organisation because there have excessively many inside informations that invovle in ABC. On the other manus, insufficient informations will happen when we are missing of inside informations. The information provides in an organisation will impact the consequences when utilizing ABC. This will happens in concerns that were no purpose of utilizing ABC costing as chief attack.

Besides that, an article aimed at certified public comptrollers who hard to back up the new attack ( activity-based costing ) was written by Cokins ( 1999 ) . Hence, in his articles, he explained that activity-based bing normally will demo the best with little sum of item and estimated more cost figures. However, he stated that when comptrollers try to use ABC, they will seek to accomplish the obtain more accurate inormation that is both hard to carry through and necessitate clip to acomplish it. However, it will be likely to be a failure when people are traveling to use it.

Furthermore, another article entitled “ Get the better ofing the Obstacles to Implementing Activity-Based Costing ” was besides written by Cokins ( 2000 ) . Hence, he noted that the directors ignore the central regulation so the activity based bing normally leads to a failure. Furthermore, the advantage of mean cost rates, many excessively elaborate information and the failure to link information to action that proved that it besides interferes with ABC undertakings. By cognizing these constructs, Cokins ( 2000 ) agreed that CPAs can better their functions as concern spouses and advisers.

In add-on, another restriction is that activity-based bing package can be dearly-won. Mark Henricks ( 1999 ) stated that most ABC practicians find that special-purpose ABC package is required to do the undertaking manageable and easy to undergoes in an organisation.

Furthermore, clip can besides be a factor for concerns seeking a speedy hole which means that ABC costing can be successful in a short tally.Continuingly, Henricks ( 1999 ) noted that although some companies see consequences about immediately, it typically long clip to see the benefits of ABC.

Harmonizing to Peter ( 1999 ) , he stated that some operating expense costs, such as main executive wage, are hard to be assigned to merchandises and clients. ‘Business prolonging ‘ which are termed by the costs and are non assigned to merchandises and clients because it is non meaningful to an administration. Although person may reason that costs can non follow to activities should be “ randomly allocated ” to merchandises and it is of import to recognize that the chief intent of ABC is to supply accurate information to direction. Hence, it can non deny that any cost of the organisation by utilizing ABC attack, should be assigned in an arbitrary mode.

Stairss in implementing activity based costing

Harmonizing to Mr. Ian ( 2003 ) , an ABC system involves the undermentioned phases as follows:

The major activities should be identified which happen in an organisation.

Determine the cost driver for each chief activity ( for illustration, figure of set-ups, machine hours, figure of reviews etc. )

Make a cost pool for each major activity

The costs of activities to merchandises ( goods or services ) harmonizing to the merchandises to ingestion of these activities ( Using the extent to which the cost drivers are used as a step of this demand ) to be traced


Therefore, the illustrations will farther explicate how the stairss are undergone.

Assume Henry ‘s Company produces two merchandises, which are merchandise ‘A ‘ and ‘B ‘ . Both of them are produced on the same equipment and undergoing same procedures. The merchandises will alter with the volumes in which they are sold and hence the volumes in which they are produced.

Product ‘A ‘ is a high volume merchandise whereas merchandise ‘B ‘ is a low volume point. The tabular array shows the all inside informations as follows:


Machine hours per unit

Direct labour per unit

Annual end product units

Entire Machine Hours

Entire Direct Labor Hours

No. of purchase orders

No. of “ set-ups ”

Merchandise A








Merchandise B













The cost of these activities as follows:


Volume related


Purchase related


Set up related




An ‘Activity Based Costing system would manage it this manner:


Volume related

Purchase related

Set-up related

Cost Traced to activities




Consumption of activities

60,000 machine hour

220 purchase orders

110 set-ups

Cost per unit of ingestion

RM6 per machine hour

RM500 per order

RM2,000per set-up

Cost hint to merchandise



( 12,000XRM6 )


( 120XRM500 )


( 60XRM2000 )



( 1,200XRM6 )


( 100XRM500 )


( 50XRM2,000 )

Hence, cost per unit under ABC:

For merchandise A=RM21 { ( RM72,000+RM60,000+RM120,000 ) /12,000units }

For merchandise B=RM131 { ( RM7,200+RM50,000+RM100,000 ) /1,200units }

A Traditional volume based costing system would manage it this manner:

Cost Centre allocated costs RM420,000

Overhead rate per machine hr RM7 ( RM420,000/60,000 hour )

Overhead rate per direct labour hr RM6 ( RM420,000/70,000hrs )

Cost per unit of ‘A ‘ = RM28 ( 4 machines hours at RM7 )

Cost per unit of ‘B’= RM24 ( RM6X 4, at RM6per hr )

Therefore entire cost allocated to merchandise ‘A ‘ = RM336,000 ( 12,000 X RM28 )

And entire cost allocated to merchandise ‘B’= RM28,800 ( 1,200 X RM24 )

From the computations, it shows the large difference by utilizing the traditional volume based costing and ABC.

Section 4: Analysiss and Discussion

Other than ABC bing system, there have another system called traditional costing system. It allocates overhead straight that is based on the BASIC of preset such as machine hours or the labour costs. Activity-based costing ( ABC ) provides information more accurate than traditional costing system because its assign operating expense costs utilizing the undermentioned stairss that we mentioned at subdivision 3.

Traditional costing system allocates overhead to merchandises on the BASIC of preset works broad that is utilizing direct cost and machine hours. The entire overhead cost such as depreciation on expensive works, belongings and equipment, care has increased in the rapid development environment. On the other manus, the sum of direct labour used in industries has been reduced. In this state of affairs, it is non suited to utilize the basic preset operating expense rates based on direct labour because direct labour and operating expense have no correlativity.

It will go on the merchandise costs being wrongly because the companies are utilizing overhead rates based on direct labour. Companies prevent the deformation by utilizing the machine hours as the basic to apportion operating expense in an machine-controlled fabrication. Manufacturing procedure is complex, merely machine hr is non carry throughing to apportioning all the overhead cost. In this state of affairs, directors decide to us “ activity based costing ” .

Michael H. Granof Professor, David E. Platt Assistant Professor and Igor Vaysman Assistant Professor had done some researches about the ABC. They had analyzed about the difference between ABC and traditional costing.

The tabular array below shows the differences between traditional costing and activity-based costing.

Traditional Costing Systems

ABC Costing Systems

Cost pools

Accumulate costs into departmental cost pools.

The costs in each cost pool are heterogenous because they are costs of many major procedures and by and large are non caused by a individual factor.

Accumulate costs into activity cost pools, which are designed to match to the major activities or concern procedures.

By design, the costs in each cost pool are chiefly caused by a individual factor called ‘cost driver ‘ .

Allotment base

Allocate costs to merchandises utilizing volume-based allotment bases such as units, direct labour input and machine hours.

Allocate costs to merchandises, services and other cost objects from the activity cost pools by utilizing allotment bases matching to be drivers of activity costs.

Cost object

Focuss on the cost of the individual cost object ( e.g. unit of merchandise or service )

Focuss on the costs of many cost objects of involvement ( e.g. units, batches, merchandise lines and concern procedures ) .


Cheap to utilize and keep.

Expensive to utilize and keep.

Decision support

Leads to overcosting and undercosting jobs.

As they unable to aline allotment bases with cost drivers

Provides more precise information to back up the determination made by an organisation.

As they able to aline allotment bases with cost drivers

Cost control

Considered as departmental exercising instead than a transverse functional attempt.

By supplying drumhead costs of organisational activities, they allow for prioritization of cost-management attempts.

Example of ABC and Traditional costing

Now we will hold an illustration for doing determination to pricing and production by utilizing ABC and traditional costing.

Assume that the Craze Ball Company produces two types of resiling balls ; one has a hollow centre and the other has a solid centre. The same equipment is operated to bring forth the balls in different tallies. Between batches, the equipment is cleaned, maintained and set up in the proper signifier for the following batch. The hollow centre balls are packaged with two balls per bundle whereas the solid centre balls are packaged one per bundle. During the twelvemonth, Craze Ball expects to bring forth 1,200,000 hollow centre balls and 1,400,000 solid centre balls. The operating expense costs incurred have been allocated to activity pools as follows:



Buying of stuffs


Apparatus of machines






Cleaning and care


Entire operating expense costs

1, ,380,000

By analysing the activity pools, we have to place the cost drivers, estimated the entire expected units for each merchandise and calculated the unit cost for each cost driver.


Cost Driver

Entire Expected Units for Cost Driver ( 1 )

Entire Cost ( 2 ) ( RM )

Unit of measurement Cost per Cost Driver ( 3 ) = ( 2 ) ? ( 1 ) ( RM )

Buying of Materials

No. of purchase orders




Set up of Machines

No. of apparatuss





No. of containers filled



0.14 ( rounded up )


No. of trials




Cleaning and care

No. of tallies



1,166.67 ( rounded up )

The activity by merchandise is shown in the undermentioned tabular array.

Expected Use

ABC Cost Assigned


Cost Driver

Unit of measurement Cost ( 3 ) ( RM )

Hollow Center ( 4 )

Solid Center ( 5 )

Hollow Center ( 3 ) A- ( 4 )

Solid Center ( 3 ) A- ( 5 )


No. of purchase orders





$ 100,000


No. of apparatuss







No. of containers filled







No. of trials






Cleaning and care

No. of tallies









To cipher the per unit overhead costs under ABC system, the costs assigned to each merchandise are divided by the figure of units produced. The unit cost for a hollow centre ball is RM0.39 and the unit cost for a solid centre ball is RM0.64.

Operating expense costs assigned to excavate centre balls/Number of hollow balls


=0.39 ( RM )

Operating expense costs assigned to solid centre balls/Number of solid balls


=0.64 ( RM )

Under the traditional method, the entire costs for all balls would be divided by entire direct labour costs for all balls to find per unit cost. Estimated direct labour costs for the twelvemonth are RM1,500,000, which are RM500,000 and RM1,000,000 severally. Therefore, per unit direct labour costs are RM0.42 for hollow centre balls ( RM500,000 ? 1,200,000 ) and RM0.71 for solid centre balls ( RM1,000,000 ? 1,400,000 ) . Per unit cost to bring forth balls incurred two stairss:

The predetermined overhead rate is calculated by spliting entire overhead costs by entire direct labour dollars.

Operating expense to each type of merchandise is to be allocated by multiplying the overhead cost per direct labour cost by the per unit direct labour costs for the two balls.

Measure 1: Calculate the direct labour cost

Entire overhead costs/Total direct labour costs=1380,000/1,500,000

=0.92 per direct labour cost

Measure 2: Allotment of operating expense

Overhead cost per direct labour cost X per unit direct labour cost

For hollow balls: 0.42 X 0.39=0.16 overhead per unit

For solid balls: 0.71 X 0.64=0.45 overhead per unit

A comparing of the overhead per unit calculated utilizing the ABC and traditional methods frequently shows a different consequence:

Craze Ball Company 20X0 Overhead per Unit

ABC method ( RM )

Traditional method ( RM )

Hollow Ball



Solid Ball



In this illustration, the operating expense charged to the hollow ball utilizing ABC is RM0.39 and much higher than the RM0.16 calculated under the traditional method. The RM0.39 is a more accurate cost for doing determinations about pricing and production. For the solid centre ball, the operating expense calculated is RM0.64 per unit utilizing ABC method and RM0.45 per unit utilizing traditional method. The ground for the differences is the traditional method determines the cost allotment utilizing direct labour costs merely. Hence, a merchandise with high direct labour costs will apportion more of the operating expense costs than a merchandise with low direct labour costs. The figure of orders, apparatuss, or tests the merchandise really uses does non impact the allotment of operating expense costs when direct labour dollars are used to apportion operating expense.

Section 5: Decision

In decision, ABC is an attack that helps us in an organisation when we make determination. On the other manus, it besides has the restrictions of the ABC attack. Besides that, harmonizing to Mr. Ian ( 2003 ) , the volume of the merchandise are non related to some activities, by utilizing cost drivers that are independent of volume.

He stated that three major classs are divided at the merchandise degree:

Unit degree


Merchandise sustaining

Merchandise costs are accumulated by these classs.

Facility-sustaining disbursals ( Head Office, PR etc ) are incurred to back up the full house, therefore it is a common and joint activity.Hence, they should non be assigned to the merchandise ‘s cost.

ABC systems are theoretical accounts of resource ingestion in an organisation but non disbursement in the house. The entire organisational resources required to bring forth a good, or execute a service ( for illustration, the merchandise ) by utilizing the ABC systems.

It is of import to stress that ABC systems identified precedences for managerial attending and non to supply the footing of determinations relevant to costs by themselves.

Possibly, it is non merely provides the footing on the merchandise costs that calculates accurately, but it besides manages overhead costs in general so the ABC systems have attracted many people of the Accountancy Profession. Furthermore, it is likely to understand and pull off costs more efficaciously by roll uping and describing on the important activities in which a concern engages. By the manner, it is in the country of cost direction, where Activity Based Costing may hold its greatest potency. ABC system was foremost developed more than ten old ages and some houses go to the extent of implementing this attack to set uping more realistic costing for their merchandises and services.

Fortunenately, we feel familiar about the subject because in the old trimester we had learned about the subject. However, the more challenge portion is we had gone through the diaries by happening via web site or in library online database. In the procedure, many journalists, specializer of accounting Fieldss had done their research by utilizing ABC system on their industry such as universities, fabricating companies and infirmaries.In add-on, we had searched about the ABC that is implemented in the other manner. Therefore, the illustrations we are given is somewhat different from the text edition that we learned.

The portion 4 illustration, which mentioned that ABC provides a manner to apportion costs more accurately when overhead costs are non incurred at the same rate as direct labour costs. Therefore, the more activities identified the more complex the costing system becomes. Computer systems are necessary for complex ABC systems.On the other manus, to maintain it manageable, some companies may restrict the figure of activities. Yet this attack may hold some allotments in being arbitrary.Thus, ABC provides a more accurate estimation of costs in doing direction determinations.

Mentions – muz follow A-Z

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