Managerial accounting

Managerial accounting

Part I - Activity Based Costing

Introduction

Generally, activity based costing is a tool for identifying and allocating overhead costs. In addition to this, in activity based costing overhead cost is allocated to various cost pools, and the cost pool associate cost to product or service based on their cost drivers. In easier words, activity based costing refers to an activity or an event, transaction, action or sequence of work that affects cost of the product or service.

Discussion

An activity cost pool refers to association of cost to specific type of activity such as storing, ordering or transporting. In the end, a cost driver refers to direct cause effect relationship of consumed resources with any factor (Fritzsch, 2011). There are certain advantages of ABC costing; this costing technique brings effectiveness in assessing cost of product more accurately based on cause effect relationship of product; in advance technology, this provides more realistic cost of product; it identifies the actual behavior of cost and hence improve the process of eliminating unnecessary costs of product; and due to multiple cost drives overhead can be easily related to product with accuracy. ABC costing helps managers to identify their cost areas and improves its decision making process.

In traditional costing system the cost driver is based on a single system which is volume based costing. This is the main reason behind the unclear costing of the product. The problem with traditional costing is that overhead cost of the product is based on relative usage of direct labor. These are the fact on which traditional costing often provide unclear and inaccurate findings. The problem with traditional costing system occurs at its basic methodologies. This system sticks with costing of the product rather than activity involved in the production. Therefore, this results in affecting directly to the product ...