Activity Based Costing Analysis

ABC is one of the costing techniques that are applied by many firms in order to establish the costs incurred by the firm in the course of its production. The method makes use of cost objects to assign direct overhead costs. It pools overhead costs into homogenous cost pools with the allocation of the cost driver on the pool being based on the cause effect relationship between the cost object and the ability of the firm to incur overhead costs. According to Institute of management Accounting (2006, p. 21), ABC is beneficial in employing a two stage allocation strategy for overheads as the allocation of the costs to intermediate pools is done in the first stage while the second stage entails allocation of the costs from the intermediate pools to the products.

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Many scholars have argued that the method of allocating costs of ABC is implemented by firms no because it provides additional information to management, but because it is fashionable. It is true that ABC does not provide any additional information to the management since it establishes the costs incurred by the firm in a different way from the traditional costing method. While the traditional costing technique pools all costs of an organization together and thereafter allocating them to the manufactured product basing on the labor hours incurred directly for every manufactured product, ABC focuses on the activities that are executed before a product is fully produced. In ABC, the costing activity is an intermediate step undertaken by an organization to allocate overheads to the goods so that accuracy is established regarding the cost information of the good. In some cases, the cost activity ends up being the activity. In all these cases, ABC does not provide any new information. But it rather breaks down the entire process of costing to ensure accuracy of provided cost information for each unit or product produced.

Accounting is based on transparency and accuracy of information. Traditional cost techniques allocate all type of overheads such as batch level, product level and facility basing on the allocation that best suits the unit level. However, ABC exploits the cost hierarchy in order to bring out the accuracy in the cost information. This is the convenient reason why it is commonly applied by many firms.

Nolan (2004, p. 18) argues that ABC focuses on activities that are involved in the production of goods in a firm. The involvement of activities cuts across various departments in an organization and therefore calls for participation of managers from all departments in the firm. Therefore, implementing ABC in firms improves the level of communication and therefore cooperation within an organization. ABC technique of costing has become a significant consulting product for many firms since many accounting firms are hired by firms to conduct costing using the technique. However, the accuracy provided by the ABC technique does not reduce costs. Due to the use of the technique a consulting product, the popularity of the method has increased and therefore proving the fact that the increased use of the technique is not due to its provision of additional information for managers, but it is because it is fashionable to use the technique and accounting firms use the technique as a tool to being hired.

List of References

Institute of management Accounting, 2006, ‘Implementing Activity based costing’, Web.

Nolan, PM 2004, ‘Critical Success Factors for Implementing an Enterprise-wide ABC Solution’, Journal of Performance Management, vol. 17, no. 3, pp. 15-22.

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