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Activity Based Costing and the Theory of Constraints are, respectively, Overhead Absorption Costing and Marginal Costing in a different guise
In this assignment I will be investigating the assertion that Activity Based Costing and the Theory of Constraints are, respectively, Overhead Absorption Costing and Marginal Costing in a different guise. To analyse this statement I will compare ABC with Overhead Absorption Costing and Theory of Constraints with Marginal Costing. All of these methods are well know and generally used in organisations, however Activity Based Costing and Theory of Constraints are relatively new methods, as both were developed in around 1970s whereas the other two are more than seventy years old. This is why it will be interesting to see how those methods compare, whether older methods will be still relevant and can they really be replaced by more contemporary techniques if those methods are alternative to each other. The results should show similarities and differences between each method used in cost and management accounting, primarily whether each method is an alternative to each other, assuming it is used depending on required outcome, suitability to given information or size of the organisation.
Activity Based Costing vs. Overhead Absorption Costing
Overhead Absorption costing is a two stage process of allocating organisation’s overhead costs to particular cost objects. In allocation process, all variable and fixed overhead costs are charged to cost units produced. It was developed during 1920s, when most organisations were labour intensive. Although this method is probably the oldest method developed in cost allocation, still this day is most widely used by most organisations. Absorption Costing is recognised by Ireland Revenue, as stock is not undervalued, moreover all companies must use this method in preparing financial accounts. Absorption process has two stages: allocation and apportionment of costs into departments called cost centres where they are reapportioned and finally absorbed to specific cost object which is the cost for specific unit. “Received wisdom has it that absorption costing should not be used for decision making, i.e. non-volume related costs should not be allocated to the product unit level.” (Absorption costing for decision making by Mike Lucas, Management Accounting; London: Oct 1997) This is because some of the cost incurred by the company will be self-determining of the number of units produced. Major flaw to overhead absorption costing is that its absorption bases (cost drivers) are mainly volume related, such as machine hours or labour hours and in present times indirect overheads become larger proportion of total costs. Therefore allocating these overheads using this cost drives causes under or over absorption. The consequence of this is variance between budgeted costs and actual cost. That is why this method is not appropriate for cost control. This is the main difference from ABC method, where there are more of costs centres know as...
...Activity-BasedCostingActivity-BasedCostingActivitybasedcosting (ABC) is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity. Activitybasedcosting is a subset of activity-based management. Activitybasedcosting is used to determine product costs and for internal decision-making and for managing activities. Traditional Absorptioncosting is for external financial reporting.
Activity-basedcosting is a suitable and appropriate method for companies with multiple products or services who are having problem of inaccurate costing information and need to know which products are really profitable and which are the one that is making loss. For these companies the effort required to successfully implement activitybasedcosting is worth the time and resources. Activitybasedcosting can identify high overhead costs per unit and find ways to reduce the costs, avoid decreases in head counts due to inaccurate allocation of costs, and measure...
AbsorptionBasedCosting – Managerial Analysis
11 May 2014
Professor Jill Datema
AbsorptionBasedCosting – Managerial Analysis
Absorptionbasedcosting method (ABC) is used by companies to identify activities that it performs and then assigns direct and indirect costs to the product’s overall pricing. This method helps businesses determine the cost drivers that influence the product’s sales price by increase or decrease. ABC uses cost drivers, such as, direct labor, direct material along with transaction-based drivers. In this way, long-term variables overheads, traditionally considered fixed costs, can be traced to products (AICPA, 2014). The process used when applying the ABC method is as follows:
Advantages of AbsorptionBasedCosting
ABC is a great method to accurately assign product/service costing to assist in pricing decisions. Pricing accuracy is due to the utilization of unit cost rather than just total costs. Absorptionbasedcosting mirrors how production is done which can help facilitate benchmarking. The ABC method can help Ideal Manufacturing’s management better understand the overhead incurred due to production. “ABC...
...1a) Activitybasedcosting is a relatively new type of procedure that can be used as an inventory valuation method. The technique was developed to provide more accurate product costs. This improved accuracy is accomplished by tracing costs to products through activities. In other words, costs are traced to activities (activitycosting) and then these costs are traced, in a second stage, to the products that use the activities. Another way to express the idea is to say that activities consume resources and products consume activities. Essentially, an attempt is made to treat all costs as variable, recognizing that all costs vary with something, whether it is production volume or some non-production volume related phenomenon. Both manufacturing costs and selling and administrative costs are traced to products in an ABC system. In traditional full absorptioncosting and direct (or variable) costing systems, indirect manufacturing costs are allocated to products on the basis of a production volume related measurement such as direct labour hours. Thus, the fundamental differences between traditional systems and activitybased systems are:
1) How the indirect costs are assigned (ABC uses both production volume and non-production volume related bases) and
2) Which costs...
...between Absorptioncosting and MarginalCosting
The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term.
To begin with, MarginalCosting which is formally defined as the cost accounting in which variable costs are charged to cost units (product costs) and the fixed costs of the period are written-off in full against the aggregate contribution (thus, the difference between sales and marginal costs). Its special value is in decision making. In view of this, MarginalCosting distinguishes between fixed costs and variable cost. Again, the marginal cost of a product is the summation of all variable cost incurred on the product. Thus, it normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads. Mathematically, MARGINAL COST= VARIABLE COST DIRECT LABOUR + DIRECT MATERIAL + DIRECT EXPENSES + VARIABLE OVERHEADSMarginalcosting can be defined as the technique of presenting cost data...
The management of costs remains pertinent to the successful operation of any company. To achieve a competitive edge a company must consistently improve their service or product quality, lower their service or product costs, and eliminate services or products that incur profit losses. Using a traditional costing system the portion of overhead costs allocated to the production of a service or product is determined by the total of direct labor hours used in production of the service or product. Companies implement refined cost allocation systems such as the activitybasedcosting method with the intention of helping management strategically plan because these systems provide quality information to help management make informed decisions. In this essay, I will examine the use of cost allocations, the activitybasedcosting method, and how companies can implement and benefit from activitybasedcosting.
The allocation of costs serves four primary purposes throughout a company. The first is to present the information management needs to make an informed decision. The second is the reduction of non-essential uses of common company resources. The third is to encourage management to assess the efficiency of services provided internally. Finally, the fourth reason is the calculation of...
A Discussion on Activity-BasedCosting
ACC-532 Graduate Paper
A Discussion on Activity-BasedCosting
When we think of cost of accounting it is easy to come up with numerous different cost accounting methods which is because over the year’s cost accounting has developed in numerous ways to accommodate different types of situations. While every type of cost accounting is important and has its own benefit and disadvantages this paper will focus on what I believe is one of the most important cost accounting methods. The method that this research paper will focus on is the activity-basedcosting method, more commonly known as the ABC method. “A costing method that first assigns costs to activities and then to goods and services based on how much each good or service uses the activities” (Hilton, 2014), this is the definition of the ABC method according to the textbook Advanced Cost Accounting. While I believe that this definition gives us a good idea of the general idea of what the ABC method is it does not even begin to crack the surface of how important this costing method is and how essential it is to the companies that utilize it. In order to get a broad understanding of the ABC method this research paper will focus on three focus...
...ActivityBasedCostingActivity-BasedCosting (ABC) was developed as a practical solution for problems
Associated with traditional cost management systems. In the early 1980’s many
Companies began to realize that their traditional accounting systems were
generating inaccurate costing information. Traditional cost accounting systems
that were designed to address the issues of inventory valuation for external
audiences have two deficiencies. The inability to accurately determine actual
total product and service costs and the inability to provide useful information to
management for purposes of making operating decisions.
Users of ABC
Businesses want to know which of their products and services make or lose
money so they can remain competitive. To get a handle on this information, some companies have embraced activity-basedcosting/management (abc/m) to help them tract product and customer profitability and reduce operating costs. armed with the facts from, the abc/m data, managers can make better decisions about how they can use resources and can improve business processes.
Activity-basedcosting is an accounting methodology that links the following
elements; costs, which are the expenditures are classified as product costs. That resources are costs that are...
...ActivityBasedCosting can be defined as an accounting methodology that assigns costs to activitiesbased on their use of resources, rather than products or services. This enables resources and other associated costs to be more accurately attributed to the products and the services which they use. It doesn’t change or eliminate any costs; it provides detailed information about how costs are consumed. (Online manager-net.com).
Traditional cost accounting looks at what is spent, while ABC methods look at what is done in terms of activities. In ABC it is much easier to identify opportunities to reduce costs and improve performance, while maintaining the quality of care provided.
Traditional Cost Systems use cost allocation methods, do not focus on where or why costs occur, Report information that is accounting oriented and inaccurate. These systems are also not easily understood by operational managers, since the focus is fiscal.
Whereas ActivityBasedCosting assigns costs to activitiesbased on the resources they consume. ABC provides insights into the sources of costs and the possible impact of different decisions. It also provides the information required to take action and realize performance breakthroughs.
Implementation of ActivityBasedCosting...