COSTING

Activity Based Costing

Assignment

[Name of Subject]

Activity Based Costing

Critically discuss the way ABC operates, referring to pools, drivers and activity hierarchies.

Activity based costing is a method of cost which indicates the activities in the company and corresponds the price of each operation with its respective inputs to every product and service. This technique organizes more overhead costs on direct costs as related to traditional cost methods. Activity based costing (ABC) allows firms to forecast estimations regarding cost factors in the line of services and products. Many supporters of ABC argue that the system manages to yield accurate data costs for products which help in decision making. However, El-Daour (2001) highlights that there is a definite “trade off” between the advantages which are obtained through increasing the cost drivers as well as the associated costs of cost drivers.

This increases the amount of cost drivers granting further judgment to managers being assessed by cost systems which reduces the capability of the system in terms of monitoring their behaviour. If the costs which are incurred due to lack of control on part of the manager in selecting the cost driver are added to the direct costs of reporting and collecting data on the activity levels, they will drive the net benefits down. Moreover, the maximum quantities of the cost drivers for control and resolution will be less than in the case of only decision making (Skaik, 2006, pp 18-39). Therefore, few cost drivers as well as lesser number of accurate costs of products would be seemly in this scenario. However, additional accurate product costs are also considered adverse if they lead to a slack in decision control. For example, many businesses favour a system of upward costs which helps in preventing the labour from “flaking off” margins by basing prices on low scales which only covers the variable costs (Skaik, 2006, pp 18-39).

The most obvious and crucial issue arising from the use of this system is the lack of sufficient internal resources, specifically the computer resources and staff time, as well as the relevance of decision making. For example, General Motors wanted to implement ABC, but upon consideration of the different factors like the task, the organisation structure, the individuals, the employed technology as well as the external environment, it became very difficult to execute ABC (Skaik, 2006, pp 18-39). Furthermore, ABC has many limitations concerning practical deficiencies, as in theory organisations can “trace” all their overheads with accuracy, nevertheless, in practical application it is not possible to be accurate to that extent, and some overhead costs are usually missed. Multiple cost drivers are implemented by ABC as it is based upon the assumption that costs are only caused by activities, whereas time, decisions and volumes are also factors in causing costs. All these factors combined together with “lagged relations in between the cash expenditure and resource consumption, points that ABC is a far from perfect prediction model or cost control method (Skaik, 2006, pp 18-39).

The costing strategy keeps its focus on activities ...