Calculating Cost Using Activity-Based Costing (ABC) System

Use of Management Accounting Systems

The present essay is developed for providing an understanding of the recently used management accounting systems by the accountants for allocating of costs to the products. In this context, it discusses the usefulness of activity based costing system over the traditionally used methods to allocate the costs to the products.

Calculating the Cost of an Individual Project by Activity-Based Costing (ABC) system

The increasing competition is causing the businesses to adopt the use of efficient management accounting systems for gathering accurate information about the costs of the processes, products and services. The traditional method of costing is largely criticized by the management accountants due to their inappropriateness to assign overhead costs on the basis of products (Wnuk-Pel, 2010).

As such, the management accountants are largely incorporating the use of Activity-Based Costing (ABC) system for calculating the cost of an individual project, service or activities within a department. The system is providing to be highly useful in identifying the important activities within a department and allocating accurately their overhead costs. The different activities required for manufacturing a product is considered as a cost driver such as consumption of power, quality inspections or machine setups. It then assigns the cost involved in carrying out these activities to the products that requires these activities for completion. As such, it helps in assigning accurately overhead costs to the activities and therefore highly useful in determining the price of product (Fadzil and Rababah, 2012).

The benefits of using ABC costing system in comparison to the conventional system of costing can be discussed in relation to the two products that are manufactured by the same company, that are, Product A and Product B. Product A requires many type of activities such as engineering, testing and machine set ups for completion and is produced in low volume. On the other hand, Product B does not require any special activities for its completion but it’s manufactured in high volume. As such, the use of conventional system of accounting will result in allocating the overall overhead to the products on the basis of machine hours consumed. This will result in allocation of only small overhead costs to the Product A as the machine hours consumed is less but it requires different type of special activities for completion. On the other hand, Product B will be allocated high amount of overhead although it has consumed very less overhead activity. Therefore, the use of traditional method of costing will result in inaccurate calculation of costs of products and this drawback can be effectively overcome with the use of ABC method of costing. ABC system will result in allocation of costs as per the resources consumed by each of the products for their overall completion. The costs of the activities will be allocated to the products on the basis of consumption and thus will result in accurate allocation of overhead costs to the products (Aryanezhad, Makui and Rashidi Komijan, 2009).

Following is a hypothetical example to explain the use of activity based costing:

The allocation of cost through use of activity based costing there is required to make various judgments so that overhead costs can be allocated properly to each product. The definition of the type of overhead cost and its cost driver it is very difficult to assign each overhead cost. So, there is need to make judgments while estimating the overhead costs and allocating the costs to each product as per cost driver.  

The various limitations associated with the system of ABC can be stated as follows:

• Complexity: The method of ABC costing is often complex to be understood by the accountant and requires larger amount of time for identifying the cost drivers and allocation of costs on their basis. Thus, the increasing complexity can require larger costs for the companies to determine the costs of the products.
• Non-useful for smaller firms: ABC method of costing may not be relevant for small-sized organizations for determining the accurate product cost (Bradtke, 2007).  

ABC is designed for providing management the accurate information regarding the costs of products that is useful in taking significant planning and control decisions. The association of the costs on the basis of activity consumed helps in developing a clear relationship between their sources and the related costs (Moisell, 2012). The costs consumed by different activities assist the manager in developing effective strategies for its reduction and optimizing the profitability. The calculation done through the use of ABC costing system can be effectively used for decision-making as it would help in determining the product costs on the basis of actual overhead activities consumed during their completion. As such, I would happily adopt the use of such system for cost determination as it would have a direct impact on maximizing the profitability of the company (Infandoudas and Gurd, 2010).

Conclusion

It can be stated from the overall discussion held in the essay that ABC costing system is more useful as compared with the use of traditional costing system. The traditionally used accounting system methods are not proving to be useful for the management accountants to allocate the products and enable the right decision-making. 

References

Aryanezhad, M. B., Makui, A. and Rashidi Komijan, A. 2009. A new euristic approach to solve product mix problems in a multibottleneck system. International Journal of Industrial Engineering 5 (9), pp. 46–57. 

Bradtke, D. 2007. Activity-Based-Costing. GRIN Verlag. 

Fadzil, F. and Rababah, A. 2012. Management Accounting Change: ABC Adoption and Implementation. IBIMA Publishing Journal of Accounting and Auditing.

Heisinger, K. 2009. Essentials of Managerial Accounting. Cengage Learning.

Infandoudas, P. and Gurd, B. 2010. Costing for decision-making in a theory of constraints environment. Journal of Applied Management Accounting Research 10 (1), pp. 43–58.

Moisell, A. 2012. Costing for Decision Making: Activity-based Costing vs. Theory of Constraints. International Journal of Knowledge, Culture and Change Management 12(1), pp. 1-13. 

Wnuk-Pel, T. 2010. Changes in Company’s Management Accounting Systems: Case Study on Activity- Based Costing Implementation and Operation in Medium-Sized Production Company. Eurasian Journal of Business and Economics 3(6), pp.85-111.

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