Activity Based Costing - Essay 4

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Topic Gateway Series

Activity Based Costing

Activity Based Costing
Topic Gateway Series No. 1

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Prepared by Stephanie Edwards and Technical Information Service

Revised November 2008

Topic Gateway Series

Activity Based Costing

About Topic Gateways
Topic Gateways are intended as a refresher or introduction to topics of interest to CIMA members. They include a basic definition, a brief overview and a fuller explanation of practical application. Finally they signpost some further resources for detailed understanding and research. Topic Gateways are available electronically to CIMA Members only in the CPD Centre on the CIMA website, along with a number of electronic resources.

About the Technical Information
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While using such a simplistic volume measure to allocate overheads as an overall cost driver, this approach seldom meets the cause-and-effect criteria desired in accurate cost allocation. This method of costing has become increasing inaccurate as the relative proportion of overhead costs has risen. This distortion of costs can result in inappropriate decision making. ABC is therefore an alternative approach to the traditional method or arbitrary allocation of overheads to product, services and customers.

Stage 1. Activity cost pools Material Handling

Stage 1. Activity cost pools Cost per material movement

OVERHEAD COSTS

Procurement

Cost per purchase order

Product lines

Set-up

Cost per set-up

Figure 1. Framework of activity based costing

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Topic Gateway Series

Activity Based Costing

Application
In contrast to traditional cost accounting systems, ABC systems first accumulate overheads for each organisational activity. They then assign the costs of these activities to products, services or customers (referred to as cost objects) causing that activity. The initial activity analysis is clearly the most difficult aspect of ABC. Activity analysis is the process of identifying appropriate output measures of activities and resources (cost drivers) and their effects on the costs of making a product or providing a service. ABC systems have the flexibility to provide special
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