Free Accounting Dissertations - This Process Is Then Followed By Assigning Part Of The Cost Of Each Activity
This process is then followed by assigning part of the cost of each activity to different products based on the extent to which each product has caused the activity to occur.
It is important to understand that not all overheads increase in proportion to the number of units produced. The traditional approach on the other hand assumes all overheads to be a contributing factor in all production, that is, they all increase as output increases.
Times
Following is the chart representation of overhead cost estimation as per activity based cost estimation. We can determine the operating machinery activity costs by multiplying cost driver rates (£/Machine Hour) by the number of machine hours. Same can be done with many other activities. Using this strategy, we can identify each activity/activities and derive a precise and accurate cost for that activity/activities and its contribution to the overall product costs. However, it would be inappropriate to say that ABC is free from flaws. It requires major inputs from almost every area of the business factory, warehousing, maintenance, purchasing, quality control etc. Some costs such as heating applies to more than one activity and to divide it amongst all the appropriate cost pools, some subjective method of apportionment, as in absorption costing, is for all logical reasons doubtful.
2.1.1a Identifying Cost Drivers.
The Cost Drivers is a quantitative measure associated with the workload of the activity. It typically should provide a good explanation of the behaviour of costs in the pool and should be identifiable with each product line for the final stage of product costing. One major flaw witnesses while selecting a particular cost drivers is that no historical date are generally available to undertake statistical testing of the relationship between the behaviour of costs in the cost pool and the cost driver itself.
To complete the operation of the system the cost driver rates are applied to the costing of product output. This costing system requires that cost driver must be able to associate itself with the specific products for e.g. the machine hour rate applied to Machinery Operation in the chart seen earlier. Another precondition is that the rate must be predetermined, that is, it must be based on estimated activity cost levels and cost driver volumes for the current period.
The major drawback associated with this rates estimation is that it needs constant monitoring and, if necessary, adjusting regularly. Such process comes with additional costs which can be captured by the final product costs.
2.1.1b Value Added or Non Value Added.
This is an essential component in the cost estimation technique under ABC system. As we have seen earlier, ABC system works towards reducing costs and increasing profitability.
