Abc Is An Approach For Allocating Overhead Costs Accounting Essay

Section 1: Introduction

Harmonizing to the Jamaliah Abdul Majid and Maliah Sulaiman ( 2008 ) , they stated that activity-based costing is a good system because it has been used in different manner, for case client profitableness analyses ( Bellis-Jones, 1989 ) , cost decrease ( Brimson, 1991 ) , cost modeling ( Cooper, 1994 ) , product-range determinations ( Johnson and Kaplan, 1987 ) and budgeting ( Kaplan, 1994 ) . Activity-based costing system appoints costs to be objects such as merchandises and services and calculates the costs of personal activities on the fundamental of the activities engage to bring forth each merchandise or services.

Harmonizing to the John C. Lere ( 2000 ) , he stated that activity-based costing is a powerful tool for industrial selling determination shapers because activity-based costing has appeared over the past 20 old ages. Activity-based costing ( ABC ) is an attack for apportioning overhead costs and it is a system step the cost of activities and provided utile, seasonably and accurate information to the related direction.

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Activity-based costing ( ABC ) is an attack for apportioning overhead costs. Activity-based costing ( ABC ) is a system step the cost of activities and provided utile, seasonably and accurate information to the related direction.

Harmonizing to the Jamaliah Abdul Majid and Maliah Sulaiman ( 2008 ) , they stated that mensurating the cost and the public presentation of cost object and activity which are the ways of the activity-based costing. He agreed that cost object for case occupations, undertaking, client, service, merchandise that direction are seeking to be is the thought behind the activity-based costing. Resource driver and activity driver severally measure the ingestion of resource and ingestion of activity. In add-on, he besides claimed that activity-based bing attempt to specify what is cost drivers and bear down a cost object for merely overhead it really consume.

Section 2: Background Research

Harmonizing to the Jesper Thyssen, Poul Israelsen, Brian Jorgensen ( 2004 ) , they stated that the beginning of activity-based bing hint back to1983 – 1984 ( ( Kaplan 1983 ; 1984a, B ; 1985a, B ; 1986 ) although the term of activity-based costing have n’t make yet. Due to resentful of the traditional costing system, this was difference to be obsoleted in modern fabrication environments. Robin Cooper and Robert S. Kaplan was involved into a series of ‘innovative actions research rhythms ‘ ( Kaplan 1998 ) in 1987 – 1992 which is activity-based costing was developed. The current state-of-threat of ABC is reflected in Kaplan ‘s and Cooper ‘s book “ Cost and Effect ” ( 1998 ) to in hunt for an improved full-cost product-cost computation the theoretical account grew into a more fullfledged costing system for hierarchies of activities and cost objects.

Harmonizing to the Rotch ( 1990 ) ; Cooper ( 1994 ) ; King et Al ( 1994 ) Cooper and Kaplan ( 1998 ) , they stated that company in USA and UK for case telecommunication, information service, transit and selling of service sectors besides utilizing activity-based costing.

Harmonizing to Jamaliah Abdul Majid & A ; Maliah Sulaiman ( 2008 ) , they stated that traditional costing system allocates overhead to merchandises on the BASIC of preset works broad that is utilizing labour costs and machine hours and that is why the relation between indirect costs and the single merchandise seldom reflected the existent cause and consequence. Activity-based costing has been used by every company because of labour hours and machine hours of the traditional costing method is non carry throughing to apportioning all the overhead cost. In another words, it can state that activity-based costing is a system to work out the restrictions of traditional costing system.

Section 3: Literature Reappraisal

Activity Based Costing

Restriction of ABC

Advantages of ABC

Harmonizing to the chart, Activity Based Costing has the advantages and restriction when we are implementing in an organisation. Hence, we will farther explicate about it as follows.

Advantages of of ABC

Harmonizing to Carles Griful ( 2001 ) , he states that several writers have described the chief advantages and benefits of utilizing ABC bing [ Innes and Mitchell, 1990 ; Bellis-Jones and Develin, 1995 ; Malmi, 1997 ] , which as follows:

It reduces the hazard of the company and provides more utile determinations in the hereafter. Therefore, it is non merely depending on the analysis but besides depending on its ability to utilizing a right diagnosing in the company ‘s state of affairs to do an organisation successful.

Focuss on the value-added activities, which are those activities that create value to clients. On the other manus, the company should place the non-value-added activities and seek to extinguish them although the non-value-added activities that enables value adding activities to happen at the same clip.

The merchandise and service costing is more accurate, particularly the non-volume -related operating expense in the organisation.

It is a cost behaviour that makes people more understand. It is besides placing the costs of complexness, assortment, and alteration inherent in both sort of service offered and customer-specific demands.

To assist to analyse client profitableness, activity-based costing is used to analyse costs by countries of managerial duty and clients. It helps to acknowledge the manner in which clients straight influence the cost construction of the concern.

We will utilize the practical capacity, in order to executing capacity analysis which measures the costs of resources used instead than the costs of resources supplied because

that has the large difference being extra capacity.

Restrictions of ABC

Activity-based costing is a system to work out the restriction of traditional costing system but does non stand for it is perfect. Below is the restriction of the activity-based costing.

The restriction of activity-based costing is troubles in roll uping the accurate informations of the sum of work because several activities cross section bonder. Besides that, put to death activity-based costing is a multi-step procedure and it necessitating non merely cod and processing of informations, besides need to construing the consequence.

Harmonizing to Peter F.Druker ( 1999 ) , some companies that activity-based costing will do disbursement excessively much clip, attempt and even money on assemblage and traveling over the informations that is collected. The director annoyed in an organisation because there have excessively many inside informations that involve in ABC. On the other manus, insufficient informations will happen when we are missing of inside informations. The information provides in an organisation will impact the consequences when utilizing ABC. This will happens in concerns that were no purpose of utilizing ABC costing as chief attack.

Besides that, an article aimed at certified public comptrollers who hard to back up the new attack ( activity-based costing ) was written by Cokins ( 1999 ) . Hence, in his articles, he explained that activity-based bing normally will demo the best with little sum of item and estimated more cost figures. However, he stated that when comptrollers try to use ABC, they will seek to accomplish and obtain more accurate information that is both hard to carry through and necessitate clip to carry through it. However, it will be likely to be a failure when people are traveling to use it.

Furthermore, another article entitled “ Get the better ofing the Obstacles to Implementing Activity-Based Costing ” was besides written by Cokins ( 2000 ) . Hence, he noted that the directors ignore the central regulation so the activity based bing normally leads to a failure. Furthermore, the advantage of mean cost rates, many excessively elaborate information and the failure to link information to action that proved that it besides interferes with ABC undertakings. By cognizing these constructs, Cokins ( 2000 ) agreed that CPAs can better their functions as concern spouses and advisers.

In add-on, another restriction is that activity-based bing package can be dearly-won. Mark Henricks ( 1999 ) stated that most ABC practicians find that special-purpose ABC package is required to do the undertaking manageable and easy to undergo in an organisation.

Furthermore, clip can besides be a factor for concerns seeking a speedy hole which means that ABC costing can be successful in a short tally.Continuingly, Henricks ( 1999 ) noted that although some companies see consequences about immediately, it typically long clip to see the benefits of ABC.

Harmonizing to Peter ( 1999 ) , he stated that some operating expense costs, such as main executive wage, are hard to be assigned to merchandises and clients. ‘Business prolonging ‘ which are termed by the costs and are non assigned to merchandises and clients because it is non meaningful to an organisation. Although person may reason that costs can non follow to activities should be “ randomly allocated ” to merchandises and it is of import to recognize that the chief intent of ABC is to supply accurate information to direction. Hence, it can non deny that any cost of the organisation by utilizing ABC attack, should be assigned in an arbitrary mode.

Stairss in implementing activity based costing

Harmonizing to Mr. Ian, an ABC system involves the undermentioned phases as follows:

Identify the major activities which happen in an organisation.

Determine the cost driver for each chief activity ( for illustration, figure of set-ups, machine hours, figure of reviews etc. )

Make a cost pool for each major activity

Trace the costs of activities to merchandises ( goods or services ) harmonizing to the merchandises

ingestion of these activities ( Using the extent to which the cost drivers are used as a

step of this demand ) .

Examples:

Therefore, the illustrations will farther explicate how the stairss are undergone.

Assume Henry ‘s Company produces two merchandises, which are merchandise ‘A ‘ and ‘B ‘ . Both of them are produced on the same equipment and undergoing same procedures. The merchandises will change with the volumes in which they are sold and hence the volumes in which they are produced.

Product ‘A ‘ is a high volume merchandise whereas merchandise ‘B ‘ is a low volume point. Detailss of merchandises ‘ inputs and end products and the costs of activities involved are as follows:

Merchandises

Machine hours per unit

Direct labour per unit

Annual end product units

Entire Machine Hours

Entire Direct Labor Hours

No. of purchase orders

No. of “ set-ups ”

Merchandise A

4

8

12,000

40,000

40,000

120

60

Merchandise B

4

8

1,200

20,000

30,000

100

50

Entire

60,000

70,000

220

110

The cost of these activities as follows:

RM

Volume related

120,000

Purchase related

100,000

Set up related

200,000

Entire

420,000

An ‘Activity Based Costing system would manage it this manner:

Activities

Volume related

Purchase related

Set-up related

Cost Traced to activities

RM120,000

RM100,000

RM200,000

Consumption of activities

60,000 machine hour

220 purchase orders

110 set-ups

Cost per unit of ingestion

RM6 per machine hour

RM500 per order

RM2,000per set-up

Cost hint to merchandise

A

RM72,000

( 12,000XRM6 )

RM60,000

( 120XRM500 )

RM120,000

( 60XRM2000 )

Bacillus

RM7,200

( 1,200XRM6 )

RM50,000

( 100XRM500 )

RM100,000

( 50XRM2,000 )

Hence, cost per unit under ABC:

For merchandise A=RM21 { ( RM72,000+RM60,000+RM120,000 ) /12,000units }

For merchandise B=RM131 { ( RM7,200+RM50,000+RM100,000 ) /1,200units }

A Traditional volume based costing system would manage it this manner:

Cost Centre allocated costs RM420,000

Overhead rate per machine hr RM7 ( RM420,000/60,000 hour )

Overhead rate per direct labour hr RM6 ( RM420,000/70,000hrs )

Cost per unit of ‘A ‘ = RM28 ( 4 machines hours at RM7 )

Cost per unit of ‘B’= RM24 ( RM6X 4, at RM6per hr )

Therefore entire cost allocated to merchandise ‘A ‘ = RM336,000 ( 12,000 X RM28 )

And entire cost allocated to merchandise ‘B’= RM28,800 ( 1,200 X RM24 )

From the computations, it shows the large difference by utilizing the traditional volume based costing and ABC.

Section 4: Analysiss and Discussion

Other than ABC bing system, there have another system called traditional costing system. Traditional bing system allocates overhead through a really direct manner that is based on the BASIC of preset such as machine hours or the labour costs. Activity-based costing ( ABC ) is provided information more accurate than traditional costing system, because its assign operating expense costs utilizing the undermentioned stairss that we mentioned at subdivision 3.

Traditional costing system allocates overhead to merchandises on the BASIC of preset works broad that is utilizing direct cost and machine hours. In the rapid development environment, the entire overhead cost such as depreciation on expensive works, belongings and equipment, care has increased. On the other manus, the sum of direct labour used in industries has reduced. In this state of affairs, it is inappropriate to utilize the basic preset operating expense rates based on direct labour because direct labour and operating expense have no correlativity.

It will go on merchandise cost deformations because the companies are utilizing overhead rates based on direct labour. Companies prevent the deformation by utilizing the machine hours as the basic to apportion operating expense in an machine-controlled fabrication. Manufacturing procedure is involutes and composite, merely machine hr is non carry throughing to apportioning all the overhead cost. In this state of affairs, directors decide to us “ activity based costing ” .

Michael H. Granof Professor, David E. Platt Assistant Professor and Igor Vaysman Assistant Professor ( 2000 ) had done some researches about the ABC. They had analyzed about the difference between ABC and traditional costing.

The tabular array below shows the differences between traditional costing and activity-based costing.

Traditional Costing System

ABC Costing System

Cost pools

Accumulates costs into section pools is heterogenous. The costs are non cause by individual factor and it is caused of many major procedures.

Company allocates overhead costs to activity cost pools, after that company uses ‘cost driver ‘ to find the costs to delegate to the single merchandise based on each merchandise ‘s usage of each activity.

Allotment base

Company allocates costs to merchandises utilizing basic predetermined works broad, which are units, direct labour input, machine hours.

Allocates cost merchandise from the activity cost pools utilizing allocates matching to be driver of activity costs

Cost object

Focuss on individual cost object ( e.g. unit of merchandise or service )

Focuss on many cost objects of involvement ( e.g. Batches, concern procedures ) .

Cost

Not expensive to implement, cost are lower than ABC bing

Expensive to implement.

Decision support

Leads to overcosting and undercosting jobs.

As they unable to aline allotment bases with cost drivers

Provided accurate information to back up the determination made by organisation.

Cost control

Can be considered as departmental exercising instead than a transverse functional attempt.

Organization activities provided the drumhead cost which allows the precedence of cost direction attempts.

Example of ABC and Traditional costing

Now we will hold an illustration for doing determination to pricing and production by utilizing ABC and traditional costing.

Assume that the Craze Ball Company produces two types of resiling balls ; one has a hollow centre and the other has a solid centre. The same equipment is operated to bring forth the balls in different tallies. Between batches, the equipment is cleaned, maintained and set up in the proper signifier for the following batch. The hollow centre balls are packaged with two balls per bundle whereas the solid centre balls are packaged one per bundle. During the twelvemonth, Craze Ball expects to bring forth 1,200,000 hollow centre balls and 1,400,000 solid centre balls. The operating expense costs incurred have been allocated to activity pools as follows:

Activity

RM

Buying of stuffs

220,000

Apparatus of machines

300,000

Boxing

360,000

Testing

240,000

Cleaning and care

280,000

Entire operating expense costs

1, ,380,000

By analysing the activity pools, we have to place the cost drivers, estimated the entire expected units for each merchandise and calculated the unit cost for each cost driver.

Activity

Cost Driver

Entire Expected Units for Cost Driver ( 1 )

Entire Cost ( 2 ) ( RM )

Unit of measurement Cost per Cost Driver ( 3 ) = ( 2 ) ? ( 1 ) ( RM )

Buying of Materials

No. of purchase orders

120

240,000

2,000

Set up of Machines

No. of apparatuss

300

300,000

1,000

Boxing

No. of containers filled

2,600,000

360,000

0.14 ( rounded up )

Testing

No. of trials

4,000

240,000

60.00

Cleaning and care

No. of tallies

240

280,000

1,166.67 ( rounded up )

The activity by merchandise is shown in the undermentioned tabular array.

Expected Use

ABC Cost Assigned

Activity

Cost Driver

Unit of measurement Cost ( 3 ) ( RM )

Hollow Center ( 4 )

Solid Center ( 5 )

Hollow Center ( 3 ) A- ( 4 )

Buying

No. of purchase orders

2,000

50

50

RM100,000

Apparatus

No. of apparatuss

1,000

120

120

120,000

Boxing

No. of containers filled

0.14

400,000

2,400,000

56,000

Testing

No. of trials

60.00

1,600

2,500

96,000

Cleaning and care

No. of tallies

1,166.67

80

160

93,333,60

Sums

RM465,333.60

To cipher the per unit overhead costs under ABC system, the costs assigned to each merchandise are divided by the figure of units produced. Hence, the unit cost for a hollow centre ball is RM0.39 and the unit cost for a solid centre ball is RM0.64.

Operating expense costs assigned to excavate centre balls/Number of hollow balls

=465,333.60/1,200,000

=0.39 ( RM )

Operating expense costs assigned to solid centre balls/Number of solid balls

=892,667.20/1,400,000

=0.64 ( RM )

Under the traditional method, the entire costs for all balls would be divided by entire direct labour costs for all balls to find per unit cost. Estimated direct labour costs for the twelvemonth are RM1,500,000, which are RM500,000 and RM1,000,000 severally. Therefore, per unit direct labour costs are RM0.42 for hollow centre balls ( RM500,000 ? 1,200,000 ) and RM0.71 for solid centre balls ( RM1,000,000 ? 1,400,000 ) . Per unit cost to bring forth balls incurred two stairss:

Calculate the preset overhead rate by spliting entire overhead costs by entire direct labour dollars.

Allocate operating expense to each type of merchandise by multiplying the overhead cost per direct labour cost by the per unit direct labour costs for the two balls.

Measure 1: Calculate the direct labour cost

Entire overhead costs/Total direct labour costs=1380,000/1,500,000

=0.92 per direct labour cost

Measure 2: Allotment of operating expense

Overhead cost per direct labour cost X per unit direct labour cost

For hollow balls: 0.42 X 0.39=0.16 overhead per unit

For solid balls: 0.71 X 0.64=0.45 overhead per unit

A comparing of the overhead per unit calculated utilizing the ABC and traditional methods frequently shows a different consequence:

Craze Ball Company 20X0 Overhead per Unit

ABC method ( RM )

Traditional method ( RM )

Hollow Ball

0.39

0.16

Solid Ball

0.64

0.45

In this illustration, the operating expense charged to the hollow ball utilizing ABC is RM0.39 and much higher than the RM0.16 calculated under the traditional method. The RM0.39 is a more accurate cost for doing determinations about pricing and production. For the solid centre ball, the operating expense calculated is RM0.64 per unit utilizing ABC method and RM0.45 per unit utilizing traditional method. The ground for the differences is the traditional method determines the cost allotment utilizing direct labour costs merely. Hence, a merchandise with high direct labour costs will apportion more of the operating expense costs than a merchandise with low direct labour costs. The figure of orders, apparatuss, or tests the merchandise really uses does non impact the allotment of operating expense costs when direct labour dollars are used to apportion operating expense.

Section 5: Decision

ABC is an attack that helps us in an organisation when we make determination. On the other manus, it besides has the restrictions of the ABC attack. Besides that, harmonizing to Mr. Ian, ABC systems recognize that some activities are unrelated to the volume of the merchandise, by utilizing cost drivers that are independent of volume.

He stated that the activities are divided into three major classs at the merchandise degree:

Unit degree

Batch-related

Merchandise sustaining

Merchandise costs are accumulated by these classs.

In the past 10years, merchandise costing, be aftering and calculating have wholly changed under activity-based costing.

Harmonizing to the John C. Lere ( 2000 ) , we know that activity-based costing is a powerful tool for the determination shapers. Financial information from general leger are non same with the fiscal information from the activity-based costing. Consequently, activity-based bing provides utile fiscal back uping information when the company implements the activity-based costing.

Associating cost to the activity is good to the distributer such as jobber, franchiser know that what the start-up cost is, measures the costs incurred in which portion, and where to use attempts to control the cost of rising prices.

It is a particular value that enables to track new merchandises and clients.

As last but non least, we can see that activity-based costing improves the traditional costing in the undermentioned attack:

Differentiates the parts of traditional costing and activity-based costing which is the former cost of the merchandise. The costs are non harmonizing to recognized accounting rules ( GAAP ) and the latter collect costs that under accepted accounting rules ( GAAP ) .

Activity-based bing gives look to the hierarchal construction of the variable costs.

Indirect costs under the activity-based costing are assigned to activity pools that reflect the chief concern procedure and traverse the boundaries of the endeavor ‘s functional section.

Fortunately, we feel familiar about the subject because in the old trimester we had learned about the subject. However, the more challenge portion is we had gone through the diaries by happening via web site or in library online database. In the procedure, many journalists, specializer of accounting Fieldss had done their research by utilizing ABC system on their industry such as universities, fabricating companies and infirmaries.In add-on, we had searched about the ABC that is implemented in the other manner. Therefore, the illustrations we are given is somewhat different from the text edition that we learned.

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