Unlike other traditional costing systems, one of the importance of activity based costing is to determine the “true” cost for a cost object which is a product, service or customer
Why is then the necessity to know the “true” cost of a product?
Some of the reasons includes the following:
- To identify money makers/money losers;
- To finding an economic break-even point;
- To compare different options;
- To discover opportunities for cost improvement;
- To prepare and actualize a business plan and
- To improve strategic decision making.
Interestingly, the aforesaid “true” products( e.g. total manufacturing costs) have only a minor importance in final market price determination which are more dependent on competitions and customer value.
Append below an illustration of a scenario on both Traditional Cost Accounting and Activity based costing:
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Under Traditional Cost Accounting: |
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Direct Cost: Product A: requires 1 hour of direct labor Direct labor cost per hour say:1 x$10/hour=$10 Demand for A =100 units Product B requires 2 hours of direct labor Direct labor cost per hour say 2 hours x$10/hour=$20 Demand for B=950 units Overheads: Total Overheads=$50,000 Total direct labor=1,000 hours Overheads per direct labor hour=50,000/1000=$50/hour Under Traditional Costing System: Cost For Product A: Direct cost=$10.00 Total overhead allocation= 1x$50=$50.00 Cost for Product B: Direct cost=$20.00 Total overhead allocation: 2x$50=$100 |
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Under Activity Based Costing methodology: |
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Steps as described in earlier article:
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4.Collection Of Activity Data:
Under Activity-based costing-
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Product Costs Results Under TCA & ABC
Using traditional cost methodology, it looks like Product A has a lower cost than Product B. However, using ABC, on the contrary, management is able to see clearer that Product A is in fact has a higher cost than Product B. Conclusion:
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FCCA,CA(MIA)with more than 26 years of post-qualifying working experiences. Previous working stints with one of the big accounting four, Regional GFC & Group Treasurer in a group of Malaysian and Group CFO in Singapore public listed concern.
Also author to another very popular free educational accounting cum finance blog: http://basiccollegeaccounting.com under the branding of College Accounting Coach.
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