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Cost Accounting Essay

848 words - 4 pages

Activity-based costing (ABC) is a costing method that first assigns cost to activities and then assigns them to products based on the products’ consumption of activities (Lanen, Anderson, & Maher, 2011). Activities are tasks that are required in order for a company to finish its product. ABC was first written about by Alexander Hamilton Church in 1901. He believed that overhead was the cost of different activities of production. He believed that in order to report accurate costs, all of the cost of that product, including portions of overhead, should be reflected in the number (Weil & Maher, 2005). It was made popular in 1988 by Robin Cooper and Robert Kaplan. They defined ABC as “an ...view middle of the document...

Using the ABC method though, overhead allocation is based on activities and cost drivers. Product B may use less labor time but it probably will use more time setting up machines, an overhead cost.
The first step in implementing activity based costing is to determine which activities use resources. Some examples of activities are materials, labor and equipment. After determining what the activities are, next it needs to be determined what drives the cost of these activities, or the cost drivers. Cost drivers are based on the numbers or events or transactions involved in the process of providing a product or service (valuebasedmanagement.net). Sometimes during this step managers will realize that there are activities that use resources but do not add anything to the end product. These are called non-value added activities. Some examples are idle employee time while waiting for work, moving products from one spot in a warehouse to another, or storing inventory. Next the predetermined rate is calculated by dividing the estimated indirect costs with the estimated volume of the allocation base. Then the predetermined rate is applied to the indirect costs by multiplying the rate by the volume of the activity used (Lanen, et al., 2011).
Some advantages to ABC are that managers are better able to view actual costs. It allows them to identify which products they should keep and which products they should eliminate. Managers are able to add value to companies by using the information that activity based costing reveals that conventional costing was not able to accurately determine. It is especially useful in more complex companies because many...

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