Activity Based Costing Peers Posting1 Tamara Marquis

Activity Based Costing Peers Posting1 Tamara Marquis Posted Oct 21

Activity Based Costing (ABC) involves allocating manufacturing costs based on activities that drive costs, providing a more accurate picture of product costs. For example, in manufacturing digital scales, costs such as testing tempered glass and calibration are considered. These costs vary based on product size and accuracy requirements. Larger scales require more tempered glass, thus more testing costs assigned to them, while scales demanding higher precision incur more calibration costs. Implementing ABC reveals the true cost of manufacturing different sized scales, aiding managers in identifying which products are more profitable by understanding specific cost contributors at various production stages. Without ABC, understanding the true cost structure is limited, potentially obscuring areas where expenses are disproportionately high, ultimately affecting pricing, profitability, and operational efficiency.

Similarly, assessing the costs involved in a division, such as rent, utilities, employee wages, and raw materials, offers a comprehensive view of manufacturing expenses. Accurate costing of goods and understanding the associated operational costs enable better resource allocation and decision-making. In the context of manufacturing automobiles, costs involve direct materials like steel, rubber, and glass; direct labor such as assembling and painting; and manufacturing overheads including machinery maintenance, utilities, depreciation, and supervision. Appropriately allocating these overheads is crucial; the most effective method might involve using departmental machine hours because it correlates strongly with production activity levels. Alternative methods, like direct labor hours, are less suitable in highly automated settings, as they may not accurately reflect resource consumption, potentially skewing cost estimates and affecting profitability analysis.

Paper For Above instruction

Activity Based Costing (ABC) is a costing methodology that assigns manufacturing costs to products based on the specific activities involved in production. Unlike traditional costing methods, which often allocate overhead costs uniformly, ABC recognizes that different products consume resources differently based on the activities they require. This approach allows managers to gain a clearer understanding of the true cost drivers and profitability of individual products, which is essential for strategic decision-making in today's competitive manufacturing environment.

Introduction to Activity Based Costing

ABC originated as a response to the limitations of traditional costing systems that tend to oversimplify overhead allocation. Traditional systems often rely on volume-based measures such as direct labor hours or machine hours, leading to potential distortions in product costs, especially when products vary significantly in their complexity and resource requirements (Cooper & Kaplan, 1991). ABC assigns costs based on activities such as purchasing, machine setup, inspection, and material handling, providing a nuanced view of how resources are consumed in manufacturing processes (Kaplan & Anderson, 2004). This methodology enhances decision-making and cost control, making it increasingly relevant amidst the complexity of modern manufacturing operations.

Implementation of ABC in Manufacturing

Implementing ABC requires identifying the key activities involved in production, estimating their costs, and determining cost drivers—these are measurable factors that directly influence activity costs. For digital scales, activities such as tempered glass testing and calibration at the production stages are prime examples. Costs associated with these activities are allocated proportionally based on scale size and required accuracy, respectively. Larger scales utilize more tempered glass, leading to higher testing costs, whereas scales demanding higher calibration precision incur greater calibration expenses (Drury, 2013). Accurate activity cost pools and drivers ensure that costs are allocated most effectively to reflect actual resource consumption.

Benefits of Activity Based Costing

One of the primary advantages of ABC is the provision of accurate product costing, which directly impacts pricing strategies and profitability analysis. Managers can pinpoint high-cost activities and identify opportunities for process improvement or cost reduction (Garrison et al., 2010). Furthermore, ABC facilitates better product mix decisions by revealing which products contribute most to overhead absorption and profit margins. This detailed understanding enables manufacturers to prioritize efficient products and reconsider unprofitable ones. Additionally, ABC supports the development of more accurate cost-based budgeting, performance measurement, and resource allocation, fostering continuous operational improvement.

Challenges and Limitations

Despite its advantages, ABC implementation can be resource-intensive, requiring significant data collection and analysis. Smaller firms or those with less complex manufacturing processes might find the costs of implementation outweigh the benefits. Also, maintaining updated activity cost pools and drivers can be challenging in dynamic environments where processes frequently change (Horngren et al., 2013). Nevertheless, the insights gleaned from ABC often justify these efforts, especially in industries with diverse product lines and complex processes.

Impact of ABC on Decision-Making

Adopting ABC allows managers to make more informed strategic decisions, such as product pricing, discontinuation, or process improvement initiatives. For example, an understanding of the true costs associated with producing different sizes of scales enables targeted investments in automation or quality control where needed. It also helps identify products that may be subsidizing less profitable items, thereby guiding resource reallocation. In a manufacturing context, where overhead costs are a significant component of total costs, ABC provides the transparency necessary for leaner, more profitable operations.

Conclusion

In sum, Activity Based Costing offers a sophisticated approach to understanding the true costs of manufacturing products. By focusing on activities and their respective resource consumption, ABC enhances managerial insight, supports strategic decision-making, and promotes operational efficiency. While implementing ABC can be challenging, its benefits in providing detailed, accurate product costing make it a valuable tool for modern manufacturers aiming to optimize profitability and sustain competitive advantage.

References

• Cooper, R., & Kaplan, R. S. (1991). The design of cost management systems: Text, cases, and readings. Prentice Hall.
• Drury, C. (2013). Management and cost accounting. Cengage Learning.
• Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2010). Managerial accounting. McGraw-Hill Education.
• Hyer, N., & Wemmerlöv, U. (2002). Reorganizing the factory. Productivity Press.
• Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard Business Review, 82(11), 131-138.
• Rasheed, K. (2012). Oracle JD Edwards EnterpriseOne 9.0: Supply Chain Management Cookbook. Packt Publishing.