Costing Techniques

PRODUCT COSTING - ABSORPTION OR ACTIVITY BASED

Table of Contents

Introduction1

Purpose and value Full costing techniques1

Critical Analysis and Literature review2

Activity Based Costing: Evolution of framework3

Absorption Costing vs. Activity Based Costing3

Development of processes and strategy5

Quantification of Quality Costs5

Activity Based Management6

ABC and flaws6

Summary7

References8

Product Costing - Absorption or Activity Based

Introduction

The purpose of this paper is to provide a critical analysis on the traditional absorption costing and Activity Based Costing (ABC). Businesses who are involved in manufacturing processes use a costing technique in order to identify the costs incurred as result of production. Businesses then allocate the costs to the products in the hope to recover the costs when selling those products. However implementation of new costing techniques is carried out in business arena which is helping manufacturing units in achieving cost reductions and accuracy. The competition is increasing in the markets and businesses needed to stay up-to-date with costing and other techniques in order to keep up with the competition and remain profitable and efficient.

Purpose and value Full costing techniques

Purpose of full value costing is to assign a cost to the product which can be traced within a product and to identify the profitability generated by the production. Businesses operating in today's world face many challenges which they need to incorporate in their strategies in order to perform effectively and efficiently. The cost structure in modern businesses has changed extensively because of production and non production overheads are increasing in monetary terms and importance. The Direct labour costs have been reduced on a massive scale due to increased adoption of capital intensive methods for the efficiency and to remain at par with the competitors. The methodology of traditional absorption costing has remained unchanged despite major changes in the structure of costs of different firms. In traditional costing methods; direct labour hours and machine hours remained the major bases for the overhead absorption by the products. Non-production overheads are frequently attached to production overheads in the proportion of their consumption. This remains a method for unitization of large scale costs incurred in production (Maelah & Ibrahim, 2007, pp. 113-122).

ABC costing then comes into action when firms have a diversified portfolio, uses capital intensive methods to produce products. Activity Based Costing (ABC) uses activities as source for incurring costs and then allocates the overhead costs according o the ratio in which they have been consumed by certain activities. Then cost drivers are used to allocate these costs to the products according to the activity and cost spent on products. ABC unveils several issues which were previously not discovered by absorption costing techniques and similarly presents a clearer picture of costs.

The value of full costing techniques is immense to the businesses as it helps in decision making which impacts the future policies of the business.

Direct cost can be identified directly in product therefore it is easy to include them in decision making and observe the impact on them in future. Indirect costs cannot be traced directly therefore, impact on them with respect to decision ...