# Costing Method And The Activity Based Costing Accounting Essay

The aim of making this Management Accounting Assignment is to understand how to make a proper computation of traditional costing method and the Activity-based Costing. It is of import to hold this basic pattern to assist us in the experience of making this computation while we are analyzing other subject. Through the procedure of computation of both methods, I have done by given the history of both method, the definition of both method, and the account of both methods. Other than that, I besides have given the differences of the traditional costing method and activity-based costing.

## Table OF CONTENT

Page NO.

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1.

Executive Summary

1

2.

1.0 TRADITIONAL / CONVENTIONAL METHOD ( CURRENT METHOD )

1.1 PRODUCT COST PER UNIT

3

3

3.

2.0 ACTIVITY-BASED COSTING METHOD

2.1 PRODUCT COST PER UNIT

4

5

4.

6-9

5.

4.0 ACTIVITY-BASED COSTING ( ABC )

10-13

6.

5.0 DIFFERENCE BETWEEN TRADITIONAL AND ABC SYSTEMS

14-15

7.

Mentions

16-17

## 1.0 TRADITIONAL / CONVENTIONAL METHOD ( CURRENT METHOD )

Budgeted Activity degree

OAR =

OAR =

OAR =

## A ( RM ) B ( RM ) C ( RM )

Direct stuff ( RM ) 10 4 2

Direct labor ( proceedingss ) 1.25 2.5 3.75

Prime cost 11.25 6.5 5.75

OAR =

OAR =

OAR =

OAR =

OAR =

OAR =

OAR =

OAR =

## A ( RM ) B ( RM ) C ( RM )

Direct stuff ( RM ) 10 4 2

Direct labor ( proceedingss ) 1.25 2.5 3.75

Prime cost 11.25 6.5 5.75

Production operating expense

Material review cost 0.58 1.25 3.5

Material managing cost { RM 1.55 } 7.5 { RM 1.58 } 12 { RM 1.54 } 6

Power cost { RM 2.00 8 } 16 { RM2.005 } 10 { RM2.003 ) 6

## 35.33 29.75 21.25

During the most of the 1900s, about all companies used traditional bing systems that those do non roll up or describe costs of activities or procedures ( Anderson, 1995 ) . Traditional soaking up bing methods attribute production operating expenses to units of end product without trying to apportion disposal, selling or distribution operating expenses and many activities are non straight related to production volume ( e.g. telling, bringing, transit, equipment set-up, machining and disposal ) ( Miller and Vollman, 1985 ) .

These require non-volume based cost drivers if costs are to be suitably traced and supply the motive for the development of activity based costing ( ABC ) systems ( Horngren, Sandem, Stratton, Burgstahler and Schatzberg, 2008 ) . Direct stuff and direct labor costs can be easy be traced to occupations and procedures, but fabricating operating expense may bear no obvious relationship to single units of merchandise and assignment of operating expense made through a volume-based activity base ( or be driver ) , effort to guarantee that merchandises which cause big sums of operating expense costs correspond with those which require big sums of the cost driver ( Sizer, 1989 ) .

The allotment of fabricating operating expense ( indirect fabrication costs ) to merchandises on the footing of a volume metric such as direct labour hours or production machine hours ( Sizer, 1989 ) . As fabrication becomes more sophisticated the fabrication operating expense costs normally increase while the direct labour hours or production machine hours lessening hence, the direct labour or machine hours are improbable to be the root cause of the fabrication operating expense ( Hilton, 1994 ) .

There are four phases can be identified in traditional costing system ( Anderson, 1995 ) . First is apportioning and allocating the operating expenses to cost centres, so absorbing them into cost units ( Hilton, 1994 ) . The phases explained such as: –

Phase 1 is the assorted mill operating expense costs are allocated or apportioned to the production and service cost centres ( Argyris and Kaplan, 1994 ) .

Phases 2 is the cost of the service are re-apportioned to the production centres ( Anderson, 1995 ) .

Phase 3 are appropriate departmental overhead soaking up rates are calculated ( Hilton, 1994 ) .

Phase 4 is the overhead costs are absorbed into cost units by using the soaking up rates to occupation go throughing through each Centre ( Anderson, 1995 ) .

Harmonizing to several writer, phase 1 boulder clay 4 explain like this. Phase 1 is Allocation and Apportionment ( Hilton, 1994 ) . Those costs which are entirely identifiable with one cost centre are allocated to that centre ( Cooper, 1990 ) . For illustration, the wage of a machine supervisor can be allocated to the machining section, the rewards of a cook to the canteen ( Hilton, 1994 ) . There are some operating expenses nevertheless which can non be charged to merely one centre, because the benefit of the outgo is felt by several centres, illustration rent and rates ( Cooper, 1990 ) . The sum has to be shared or apportioned over the cost centres on some just footing ( Hilton, 1994 ) . With rent and rates since the charge is a map of country, comparative countries covered by the cost centres is a just footing of allotment ( Cooper, 1990 ) . Other tenancy costs such as visible radiation and heat should besides be shared by floor infinite ( Hilton, 1994 ) . With depreciation of fixed assets and insurance, book value might be the best footing. The cost of power and electricity should be related to use ( Cooper, 1990 ) .

Phase 2 is Re-apportionment ( Horngren, Sandem, Stratton, Burgstahler and Schatzberg, 2008 ) . Since the donees of a service of a service section are non existent merchandises but production sections, their costs must be charged to those sections ( Smith, 1995 ) . In this there is once more more than one method and the chosen one should be that which best reflects the comparative benefits derived by the other sections ( Horngren, Sandem, Stratton, Burgstahler and Schatzberg, 2008 ) . For illustration the entire cost of runing a canteen could be charged on the footing of figure of employees in each section, the cost of shops on the footing of value of stuffs or figure of shops requisitions issued ( Smith, 1995 ) . In some inquiry the comparative benefits of a service section to other sections is given in per centum, these should so organize the footing of re-apportionment ( Horngren, Sandem, Stratton, Burgstahler and Schatzberg, 2008 ) . A trouble arises here since the costs of service section written off to other section may be re-activated by being charged its portion of costs of another service section from which it benefits and this charge must now be re-apportionment back to the user sections so making another service sections whose costs have been written off can be re-activated and so on ( Smith, 1995 ) . This procedure can go on for a long clip before it is complete ( Horngren, Sandem, Stratton, Burgstahler and Schatzberg, 2008 ) . There are three methods of re-apportionment such as uninterrupted or repeated distribution method, riddance method, and coincident equation or mutual method ( Smith, 1995 ) .

Phase 3 and 4 is Absorption ( Anderson, 1995 ) . The sum of operating expenses charged to each production cost centre it merely remains for him to set up rates for their recovery through the occupations which pass through them ( Miller and Vollman, 1985 ) . In this there is once more more than one method in fact there are six ( Anderson, 1995 ) .

The job with this attack is that for most overhead activities, the proportions of the activity really consumed by a specific merchandise, does non universally correspond with a individual cost driver, this holds true for most modern companies where merchandises are produced by a combination of work force and engineering ( Ward, 1992 ) . The traditional cost accounting theoretical account employs a volume-based driver, such as direct labor hours or machine hours for the assignment of all fabricating overhead costs ( Dyson, 2007 ) . The conventional cost accounting theoretical account ends up with a cost of goods sold based on soaking up costing and includes merely merchandise costs as defined in fiscal accounting ( Ward, 1992 ) . Basically, traditional costing systems try to delegate cost straight to merchandises, instead than to activities foremost and so from the activities to merchandise units ( Dyson, 2007 ) .

This type of traditional direction accounting system provides two chief type of use to the organisation ( Hopper, Northcott and Scapens, 2007 ) . First, the analysis and planning procedure sets out the prognosis fiscal result of the proposed concern schemes for the planning period and this enables the directors to make up one’s mind whether this result is satisfactory or non, nevertheless, if the result is non acceptable, the program can be modified until the best possible consequence is obtained ( Drury, 2004 ) . Besides, if the critical success factors have been decently highlighted in the analysis procedure, the sensitiveness analysis on these critical success factors can be applied to the fiscal program so that director can place the cardinal hazards and chances which may happen ( Hopper, Northcott and Scapens, 2007 ) . This can once more enable the program to be modified anterior to execution, if this is considered to be appropriate, or the concern may seek to cut down its exposure to any peculiar key hazard by following some appropriate hedge scheme ( Drury, 2004 ) .

Second, one time the program has been implemented the control procedure provides a method of comparing existent public presentation against planned public presentation ( Hopper, Northcott and Scapens, 2007 ) . This comparing enables alterations to be made to the program as necessary in the visible radiation of the existent results of the initial strategic determinations ( Drury, 2004 ) . These subsequent determination should, as ever, be based on the latest information available and this requires that the program should be updated to take history of stuff alterations since it was formulated, therefore many concerns how usage a turn overing prognosis system as the footing against which existent public presentation is compared ( Hopper, Northcott and Scapens, 2007 ) .

## 4.0 ABC ( Activity-based Costing )

ABC ( Activity-Based Costing ) arise in the 1980s from the increasing deficiency of relevancy of traditional cost accounting methods ( Weetman,2006 ) . The traditional cost accounting methods were designed around 1870 – 1920 and in those yearss industry was labour intensive, there was no mechanization, the merchandise assortment was little and the operating expense costs in companies were by and large really low compared to today, from the 1960s – peculiarly 1980s – this changed quickly ( Whitehead and Upson, 1982 ) . For these grounds, and more, traditional cost accounting has been called everything from ‘number 1 enemy of production ‘ and inquiries whether it is ‘an plus or a liability ‘ have been raised ( Innes and Mitchell, 1998 ) .

ABC has been promoted by Johnson ( 1988 ) , Kaplan ( 1988 ) and Cooper ( 1988 ) , among others, as a agency of bettering the quality of direction accounting information when traditional methods of allotment operating expense costs might be misdirecting to the users of merchandise cost information ( Smith, 1995 ) . Harvard Business School Professor Robert S. Kaplan was an early advocator of the ABC system, while chiefly used for private concerns, ABC has late been used in public forums, such as those that measure authorities efficiency ( Cooper, 1990 ) . ABC recognizes that many important operating expenses are related to activities which are independent of volume and identifies those cost drivers which consume resources to find procedure and merchandise costs ( Innes and Mitchell, 1998 ) .

ABC is an alternate to traditional accounting where concern operating expense ( indirect costs such as lighting, warming, and selling ) provided in the per centum of direct costs of the activities but this is non satisfactory because the two activities that absorb the costs are straight can utilize really different sums of operating expense ( Izhar, 1990 ) . An industrial automaton is a big graduated table, for illustration, can utilize the same sum of labour and stuffs as a automaton. But the specific automaton uses far more clip ( overhead ) applied scientists from a mass production company ( Johnson and Kaplan, 1987 ) .

ABC is an accounting method that allows concerns to garner informations about their operating costs and they are assigned to specific activities such as planning, technology, or fabrication and so the activities are associated with different merchandises or services ( Jones and Dugdale, 2002 ) . In this manner, the ABC method enables a concern to make up one’s mind which merchandises, services, and resources are increasing their profitableness, and which are lending to losingss ( Johnson and Kaplan, 1987 ) . Directors are so able to bring forth informations to make a better budget and derive a greater overall apprehension of the disbursals that are required to maintain the company running swimmingly ( Izhar, 1990 ) . By and large, activity-based costing is most effectual when used over a long period of clip, as opposed to shorter-term solutions such as the theory of restraints ( Smith, 1995 ) .

ABC is a method of apportioning costs to merchandises and services ( Izhar, 1990 ) . It is by and large used as a tool for planning and control and it was developed as an attack to turn to jobs associated with traditional cost direction systems that tend to hold the inability to accurately find existent production and service costs, or supply utile information for operating determinations ( Hopper, Northcott and Scapens, 2007 ) . With these defiencies directors can be exposed to doing determinations based on inaccurate informations. The higher exposure is for companies with multiple merchandises or services ( Innes and Mitchell, 1998 ) .

There are two primary phases in ABC which are first, following costs to activities, 2nd, following activities to merchandises ( Garrison and Noreen, 1997 ) . The different stairss in the two phases of ABC are explained such as: –

Measure 1 is placing the chief activity in the organisation ( Whitehead and Upson, 1982 ) . Example include: stuffs managing, buying, reception, despatch, maching, assembly and so on ( Whitehead and Upson, 1982 ) .

Measure 2 is placing the factors which determine the costs of an activity and these are known as fingerstall drivers ( Garrison and Noreen, 1997 ) . Examples include: figure of purchase orders, figure of order delivered, figure of apparatuss and so on ( Izhar, 1990 ) .

Measure 3 is roll uping the costs of each activity ( Garrison and Noreen, 1997 ) . These are known as cost pools and are straight tantamount to conventional cost centres ( Whitehead and Upson, 1982 ) .

Measure 4 are charge support operating expenses to merchandises on the footing of their use of the activity, expressed in footings of the chosen cost drivers ( Izhar, 1990 ) .

The use of ABC systems are this is difference that can non be seen in traditional costing systems ( Weetman, 2006 ) . Therefore, a company that is doing more and more specific merchandises ( and establishing the monetary value on historic costings ) can shortly happen themselves doing immense losingss ( Drury, 2004 ) . As new engineerings make it easier for houses to custom-make merchandises, the importance of the indirect costs of supplying accurate up, ABC allows directors to impute costs to activities and merchandises more accurately than traditional cost accounting methods ( Weetman, 2006 ) .

The activities responsible for the costs can be identified and passed on to users merely when the merchandise or service uses the activity ( Drury, 2004 ) . Some of the advantages ABC offers are an improved agencies of placing high operating expense costs per unit and happening ways to cut down the costs ( Cooper, 1990 ) . Introducing activity-based costing is non a simple undertaking, it is by no agencies every bit easy as ABC ( Weetman, 2006 ) . For a start, all concern activities must be broken down into their distinct constituents ( Drury, 2004 ) .

Large houses should seek a pilot strategy before implementing the system throughout their administration ( Drury, 2004 ) . The information necessity for ABC may non be readily available and may hold to be calculated specially for the intent such as involves doing many new measurings ( Smith, 1995 ) . Larger companies frequently hire advisers who are specializers in the country to assist them acquire a system up and running ( Weetman, 2006 ) .

The easy attack is to utilize ABC package in concurrence with a company ‘s bing accounting system ( Drury, 2004 ) . The traditional system continues to be used as earlier, with the ABC construction an excess to be called upon when specific cost information is required to assist do a peculiar determination ( Lal and Srivastava, 2009 ) . The development of concern accounting package plans has made the debut of activity-based bing more executable while puting up an activity-based costing system is a requirement for bettering concern procedures and for any re-engineering programme and many houses besides use ABC informations for the steps required for a balanced scorecard ( Hilton, 1994 ) .

Activity-based costing became popular in the early 1980s mostly because of turning dissatisfaction with traditional ways of apportioning costs, nevertheless, it fell into a period of discredit ( Lal and Srivastava, 2009 ) . Even Robert Kaplan, a Harvard Business School professor sometimes credited with being its initiation male parent, has admitted that it stagnated in the 1990s ( Cooper, 1990 ) . The trouble ballad in interpreting the theory into action. Many companies were non prepared to give up their traditional cost-control mechanisms in favor of ABC ( Argyris and Kaplan, 1994 ) .

In 2007 Kaplan brought out a new book that tried to do activity-based bing easier that called TDABC ( time-driven activity-based costing ) , it attempted to associate the measuring of cost to clip ( Argyris and Kaplan, 1994 ) .

## 5.0 DIFFERENCES BETWEEN TRADITIONAL AND ABC SYSTEMS

There is a basic philosophical difference between the traditional and the ABC attacks. Traditionally sees operating expenses as riping a service to be units, the cost of which must be charged to those units ( Atrill and Laney, 2007 ) . ABC sees overheads as being caused by activities, and so it is the cost units that cause the activities that must be charged with the cost cause ( Drury, 2005 ) .

It is non ever easy to see how and why some operating expense costs have arisen ( Atrill and Laney, 2007 ) . This has traditionally made them more hard to command that direct labor and stuffs costs, if, nevertheless an analysis of operating expenses can place the cost drivers, inquiry can be asked about whether the activity driving certain costs is necessary at all, and whether the cost justifies the benefit ( Warren, Reeve and Fess, 2005 ) .

Adopting ABC requires that most operating expenses can be analysed and the cost drivers identified ( Drury, 2005 ) . This means that it might be possible to derive much cleaner penetrations about the operating expense costs that are caused, activity by activity, so that fairer and more accurate merchandise costs can be identified, and costs can be controlled more efficaciously ( Warren, Reeve and Fess, 2005 ) .

Under ABC, an operating expense cost pool is established for each cost driver in which all of the costs caused by that driver are placed ( Atrill and Laney, 2007 ) . All costs associated with this activity would be allocated to that cost pool and the entire costs in that pool would so be allocated to end product, utilizing the cost driver identified, harmonizing to the extent to which each unit of end product ‘drove ‘ those costs ( Warren, Reeve and Fess, 2005 ) .

Allocating operating expenses costs to be pools, as is necessary with ABC, contrasts with the traditional attack, where the operating expenses are usually allocated to production sections ( cost centres ) ( Atrill and Laney, 2007 ) . In both instances, nevertheless, the operating expenses are so charged to be units ( goods or service ) ( Drury, 2005 ) .

With the traditional attack, operating expenses are apportioned to merchandise sections ( cost centres ) ( Dyson, 2007 ) . Each section would so deduce an overhead recovery rate, typically overheads per direct labour hr ( Weetman, 2006 ) . Overheads would so be applied to units of end product harmonizing to how many direct labor hours were worked on them ( Abraham, Glynn, Murphy and Wilkinson, 2008 ) .

With ABC, the operating expenses are analysed into cost pools, with one cost pool for each cost driver ( Drury, 2005 ) . The operating expenses are so charged to units of end product, through activity cost driver rates, and these rates are an effort to stand for the extent to which each peculiar cost unit is believed to do the peculiar portion of the operating expenses ( Abraham, Glynn, Murphy and Wilkinson, 2008 ) .

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