MCAFR ASSIGNMENT

Product Costing: Absorption or Activity Based

[NCC Education]

[I.D Number]

Table of Contents

Abstract3

Introduction4

Discussion5

Comparison6

Diagrammatical Difference7

Merits and demerits of Activity Based Costing7

Calculation for unit cost using Traditional Costing Method10

Calculation for unit cost using Activity based Costing11

Summary and Conclusion12

References13

Abstract

The purpose of the paper is to compare and contrast the tradition method of costing with Activity Based Costing method (A.B.C) in a manufacturing industry. ABC costing method was developed as a result of problems arising in traditional costing method. The main reason why ABC is being used by many companies today is that the range of products has become wide, manufacturing has shifted from labor intensive environment to capital intensive environment, direct material and direct labor costs have become a very small proportion of the total cost. Cost of processing information has also gone down, and automated manufacturing technology is being used in the production. All of these specifications require an advance costing system such as the ABC system.ABC system is capable of handling production processes that are complex and updated. ABC is now being used for decision making with regards to pricing, promoting or discontinuing products and developing and redesigning products. With the benefits of the new system, there are also problems associated with it. Such as high cost and more time in its implementation, staff resistance to change and unreliable information leading to distorted result creating further problems. However, both methods have their advantages and disadvantages.

Product Costing: Absorption or Activity Based

Introduction

Costing can be defined to as a process of determining the cost of the product or services. Cost is the cash or non cash asset used for the production of goods or services that are expected to bring current or future benefit to the organization. Allocating cost accurately is very important as it helps in product pricing, inventory valuation and making informed decisions. It is necessary to calculate relevant and accurate cost so that management can make correct decisions (Cokins & Hicks, 2007: p23)

Absorption costing is a method of costing a product in which both the type of cost (fixed and variable) are apportioned to the cost centers using absorption rate. The absorption rate is calculated by dividing the total overheads by the level of activity. The overhead allocation is done in three stages. In the first stage the overheads are allocated, then in the second stage they are apportioned to the department and then finally absorbed in the product cost using the respective absorption rates. In absorption costing, the level of activity is limited to direct labor hours, machine hours and production units.

The traditional method of absorption costing was developed at the time when the range of products was narrow and the overhead cost of production was a very small proportion of total cost. The direct labor and direct material cost accounted for the largest proportion of cost in the manufacturing industry (Cokins, 1998: p11.; Drucker, 1990: p95). In other words, it was a labor intensive environment. In addition to this, the cost of information processing was ...