Abstract Activity‐based costing identifies key activities and focuses on. To determine appropriate cost drivers that are used to trace activity costs to. The costs of production support activities, such as production scheduling,. Drivers are used to trace resources to activities and activities to cost objects. Resource drivers trace the resources to the activities and activity drivers trace the activities to the cost objects. These drivers.

A cost driver triggers a change in the of an. The concept is most commonly used to assign costs to the number of produced units. It can also be used in analysis to determine the causes of overhead, which can be used to minimize overhead costs. Examples of cost drivers are as follows:.hours worked.Number of contacts.Number of issued.Number of machine hours used.Number of product returns from customersIf a business is only concerned with following the minimum accounting requirements to overhead to produced goods, then just a single cost driver should be used.Related Courses. Sophocles the theban plays penguin classics pdf to excel free.

ADVERTISEMENTS:Read this article to learn about the concept, Kalpan and Cooper’s approach, characteristics, development and implementation of Activity Based Costing (ABC). Concept:ABC has been defined by CAM-1 organization of Arlinton Taxas as “the collection of financial and operation performance information tracing the significant activities of the firm of product costs”.ABC is a recent development in Cost Accounting which attempts of absorbs overheads in to product costs on a more realistic basis. Supporters of the technique argue that many costs ate unnecessarily treated as common costs and are arbitrarily absorbed using a basis such as direct labour hours, machine hours, etc. Many organizations have now adopted advanced manufacturing technology (AMT ) with the result that overheads are increasing and labour costs are becoming a smaller portion of total costs portion of total costs.

ADVERTISEMENTS:Costing system which absorb overheads on a direct labour basis are therefore, not relevant in an AMT environment. The basic idea of ABC is that coasts are grouped according to what drives them or causes them to be incurred. The cost drivers are then used as an absorption base.The CIMA official terminology defines ABC as “Cost attribution to cost units on the basis of benefit received from indirect activities e.g., ordering, setting up, assuring quality”. Kalpan and Cooper’s Approach to ABC:Kalpan and Cooper of Harvard Business School, who have developed this new approach in costing to calculate product costs, claim that the costs should be classified as long-term variable costs and short-term variable costs.Traditionally short-term variable costs are known as variable costs and long-term variable costs are known as fixed costs. Short-term variable costs are volume related and change proportionately with the volume of production. ADVERTISEMENTS:Long-term variable costs vary in long-term but not instantaneously. For example, production scheduling cost can be changed in the long-term by changing number of runs rather than changing number of units produced.They further claim that this approach relates overhead costs to the forces behind them.

The forces behind overhead costs are named ‘cost drives’. Cost drivers can be defined as those activities or transactions that are significant determinants of costs.Under ABC system, product cost is determined by obtaining a greater understanding of cost behavior and using new measures of quantity of resources consumed by each product. A cost driver is ‘an activity which generates cost’. ABC system is based on the belief that activities cause costs and that a link should therefore be made between activities and products by assigning costs of activities to products based on an individual product’s demand for each activity. Characteristics of ABC:The important characteristics of ABC are noted below. ADVERTISEMENTS:Simple traditional distinction made between fixed and variable cost is not enough guide to provide quality of information to design a cost system.i. The more appropriate distinction between cost behavior patterns are volume (scale) related, diversity (scope) related, events (decisions) related and time related.ii.

Cost drives need to be identified. A cost driver is a structural determinant, of cost related activity. The logic behind is that the cost behavior pattern must be understood so that behavior pattern is dictated by cost drivers.

In tracing overhead cost product, a cost behavior pattern must be understood so that appropriate cost driver could be identified. Development of an ABC System?The following are the three key areas of ABC. ADVERTISEMENTS:ABC is the planed and systematic study and determination of cost of each of the branches of business activities that add to the value of product and services.The matrix of activities showing the sort-term and long-term cost strategy is presented as follows:Steps to Develop ABC System:The steps required to develop an ABC system are as follows:Identify the main activities performed in the organization, such as manufacturing, assembly etc., as well as support activities, including purchasing, packing and dispatching.i.

Identify the factors which influence the cost of each activity- the cost drivers.ii. Collect accurate data on direct labour, material and overhead costs.iii. Establish the demands made by particular products on activities, using the cost drivers as a measure of demand.iv.

Trace the cost of activities to products according to a product’s demand for each activity.The rules developed by Kaplan and Cooper for this process is:i. Focus on expensive resources, thus directing attention to resource categories where the new costing process has the potential to make big differences on product costs,ii. Emphasis resources whose consumption varies significantly by product and product type – look for diversity, andiii. Focus whose demand patterns are un-correlated with traditional allocation measures. Implementation of ABC System?In ABC the hidden weaknesses and high cost segments are identified for maximum effectiveness of cost accounting system. The process of designing and implementing an ABC system for support departments usually by way interviewing the concerned departmental heads to have an insight into the departmental operations and in to the departmental operations and into the factors that trigger departmental actives.

What other factors affect your department’s work load?v. Do you usually disburse the total amount of material required for a production run all at once or does it go out in smaller quantities?

How ABC System Supports Corporate Strategy?ABC supports corporate strategy in many ways such as:i. ABC system can effectively support the management by furnishing data, at the operational level and strategic level. Accurate product costing will help the management to compare the profits that various customers, product lines, brands or regions generate and to decide on pricing strategy, dropping unprofitable products, lines etc.,ii. Information generated by ABC system can also encourage management to re-design the products.,iii. ABC system can change the method of evaluation of new process technologies, to reduce setup times, rationalization of plant layout in order to reduce or lower material handling cost, improve quality etc.iv. ABC system will report on the resource spending vis-a-vis resource consumption, and reduced demand in organizational resources lead to increase in profits.v.

ABC analysis helps managers focus their attention and energy on improving activities and the actions allow the insights from ABC to be translated into increased profits.vi. The cost driver’s rates established by the system can be used to measure activity performance and efficiency and provide a more suitable basis for budgeting,vii.

The accurate feedback can be provided to cost centre managers on their performance based on their consumption of resources during a period rather than the allocations of cost over which they have no control, andviii. The provision of accurate information of product costs enables better decisions to be made on pricing, marketing design and product mix.Illustration:A Company manufactures two products A and B using the same equipment and similar processes. An extract of the production data for these products in one period is shown below:Required:Calculate the production overhead to be absorbed by one unit of each of products using theFollowing costing methods:(a) A traditional costing approach using a direct labor hour rate to absorb overheads.(b) An activity based costing approach, using suitable cost drives to trace overheads to products.(a) Direct labour hours:These figures suggest that product B absorbs an unrealistic amount of overhead using a direct labor hour basis. Overhead absorption should be based on the activities which drive the costs, in this case machine hours, the number of production run setups and the number of orders handled for each product.