ACCA F5 - Performance Management
Activity Based Costing is focus on allocating overhead based
on activity. It starts with identifying the activity, and then the cost driver,
which drives the overhead. In global business environment overhead forms a
significant part of product (goods and services) cost. When a single
organisation devotes to deliver range of product to its widespread customer
base in a competitive price, it will be difficult to allocate appropriate share
of overhead to each of the products. ABC tries to simplify the complexity
involved in identifying cost in this type of complex situation and helps to
allocate justifiable share of overhead to each product offered by the
organisation.
First step to understand activity based costing is to identify
activities. Overhead identified under traditional absorption costing system are
grouped into activities. One and more type of overhead forms a group called
cost pool. Activities within a cost pool are driven by cost drivers. In some
cases, identifying cost driver can be difficult and cumbersome. After
identification process ends next task is to calculate overhead absorption rate
(OAR). It is calculated by dividing specific total pool overhead by total cost
driver of same poll. Then, each OAR is used to allocate the overhead cost of the
pool to given products.
ABC has many advantages and some disadvantage too. The
bright sight is that it increases accuracy in costing and aids pricing the
product in a competitive environment. It gives clear picture of overhead costs
and force that drives the cost. Despite their importance, some large organisations
may find hard to implement ABC in business because of difficulty in identifying
drivers. Unlike big organisations, for small firms operating in local level
where overhead are small part of total costs ABC can be unjustified, complex
and costly.
Today ABC has widespread implications. ABC management, ABC
budgeting, aid on pricing, support to implement sales strategy and decision
making are some of widely discussed topics in present business world.
CIMA Article: Activity Based Costing
ACCA Article: Activity-Based Costing
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