activity based costing Flashcards
cost pools
COST POOLS are groups of overheads that are caused by the same activity.
Examples of cost pools are indirect costs such as maintenance, administration and canteen expenses.
cost drivers
COST DRIVERS are activities that influence the level of costs.
Examples of cost drivers for each batch of goods produced are:
• The number of machine setups
• The number of quality inspections
• The number of production runs
• The number of orders that need to be processed for customers or suppliers
attribution
ATTRIBUTION means relating overheads to units of output.
activity based costing
ACTIVITY BASED COSTING (ABC) means that the overheads are attributed to output on the basis of relevant activities, which are called cost drivers.
it is a alternative to absorption costing
benefits of abc compared to marginal
ABC ensures full cost recovery, because, unlike marginal costing, it does include overheads.
The mark-up percentage for the selling price when using ABC will be lower than when using marginal costing.
ABC is acceptable under International Accounting Standards for a valuation of inventory.
benefits of abc compared to absorption costing
It produces more accurate cost information as the cost driver which causes the cost is used to attribute the cost on a more objective basis.
It does not require an arbitrary apportionment of overheads based on labour hours or machine hours.
More accurate unit costs can lead to a more accurate establishment of selling prices.
It enables management to have a greater understanding of why costs are incurred and therefore how to control costs.
It takes into account the fact that batch sizes influence indirect costs (e.g. set-up costs per unit are more expensive for small batches)
It is more accurate than absorption costing for capital intensive businesses where overheads are complex in nature
limitations of activity based costing
Not all expenses can be related to cost drivers (e.g. rent, insurance and business rates), so there will still have to be some arbitrary apportionment of overheads.
It is more time-consuming than absorption costing because of the need for detailed record keeping.
It is doubtful whether a single cost driver can explain the cost behaviour of an activity.
