Activity-based costing (ABC) system is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore 鈥榝ixed鈥 costs.Activity-based costing is also used as an element of activity-based management,an approach to management that focuses on activities (Willie Seal et al,2006,p298).It helps to identify inefficient products,departments and activities; allocate more resources on profitable products,departments and activities; control the costs at an individual level and on a departmental level and find unnecessary costs
In this way an organization can precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and lowering the prices of those which are overpriced.In a business organization,the ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers.It is generally used as a tool for understanding product and customer cost and profitability.As such,ABC has predominantly been used to support strategic decisions such as pricing,outsourcing and identification and measurement of process improvement initiatives.
Due to changes in manufacturing technology and processes that have arisen in recent years.In modern manufacturing environment,the impact of Business Process Re-engineering (BPR),shorter production runs,increased flexibility,and increased investment in facilities have led to a significant increase in overhead expenditure.This is that large proportion of total costs is overhead costs,and direct labour costs are relatively small.Thus marginal costing provides only limited information for management,because it does not analyses fixed overhead costs.
Traditionally cost accountants had arbitrarily added a broad percentage of expenses into the indirect cost.However as the percentages of indirect or overhead costs had risen,this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products.For example,one product might take more time in one expensive machine than another product,but since the amount of direct labor and materials might be the same,the additional cost for the use of the machine would not be recognized when the same broad 'on-cost' percentage is added to all products.Consequently,when multiple products share common costs,there is a danger of one product subsidizing another.Robin Cooper and Robert S.Kaplan,proponents of the Balanced Scorecard,brought notice to these concepts in a number of articles published in Harvard Business Review beginning in 1988.Cooper and Kaplan described ABC as an approach to solve the problems of traditional cost management systems.These traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services.Consequently managers were making decisions based on inaccurate data especially where there are multiple products.
Because overhead costs large,ABC system is appropriate to trace costs as accurately as possible to the products that create the cost.More activity-related costs are variable at the product-sustaining level than:at the product or batch level.Even more activity-related costs are variable at the facility-sustaining level than at the product-sustaining level.Therefore it is not accurate to allocate the overhead costs based on direct labour hours.Because many of the overhead costs are attributable to activities,such as purchasing ordering,material handling,quality control,roasting,blending and packaging in CBL.
ABC provides information that about the activities that drive overhead costs.And ABC therefore provides information that could be relevant to long-term cost control and long-term product selection or product pricing.However,we cannot get these information in traditional costing system.ABC can provide the basis for management of CBL information system to manage and control overhead costs.
As indicated earlier,activity-related costs can be attributed to markets,channels of distribution and customers,giving management of CBL more information with which to make their decisions.The CBL鈥檚 new marketing manager can make better decisions bases the ABC data.In highly competitive markets,management of CBL needs much more information than information about the profitability of products.They need to know about the profitability of particular markets,or distribution channels,and the profitability of different categories of customer.
In a conclusion,the CBL Company use ABC system can help the marketing manager make better decision than traditional costing system.By relating costs to activities,ABC can be used to provide information about market profitability,channel profitability and customer profitability rather than using direct labour as the base for assigning manufacturing overhead cost to products.