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Strengths and weaknesses of activity based costing
Strengths and weaknesses of activity based costing
Factors that led to the emergence of activity based costing
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Introduction
Activity Based Costing (ABC) refers to an accounting method that enables businesses to gather information about their operating costs and assign them to specific activities such as planning, engineering or manufacturing. Therefore, ABC enables businesses decide which products, services and resources to employ in order to increase profitability and cut down unnecessary wastage. Unlike the traditional costing methods, ABC emerged in the 1980’s as a way to more accurately measure all business costs while at the same time associating them to the goods and services produced.
Application of ABC in Pratt & Whitney
Pratt & Whitney; one of the world leading firms in the designing and production of gas turbine engines (small and medium) for helicopters, military trainers, business crafts and marine applications utilizes the ABC method. According to the then CEO, Claude Levesque; manufacturing costs were killing the company operations. Claude terms the traditional costing methods as systems that allot huge pieces of overhead to the processes of
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For instance, ABC might identify a distribution channel as non-remunerative or non-value adding. Such channeling might however be non-profitable, but aid in achieving some other strategic objectives. Conclusively, the review of activity based costing benefits and shortcomings suggests that although ABC has many uses and has aided in renovating many firms, the establishment of lean accounting methods such as Economic Value Added and Balanced Scorecards that focus on eradicating cost allocations and permit thorough accounting, measurement and control systems, has made activity based costing tend to become obsolete. However, ABC still has many supporters, notably in some business-intelligence software applications and the US Marine
The engineering section of aircraft manufacturing is quite old. It is characterized by a few firms that keep Rolls-Royce on its toes in terms of competition, like General Electric. The small number of firms can be justified by the high cost of starting of...
If done right, I believe that all of the costs can be allocated to each of the three products through both direct and overhead costs. The only direct costs that are being included currently are labor and manufacturing costs. I broke up overhead into overhead based off direct labor and overhead based on units sold.
With the demands of keeping up with competitors and customers these conditions will help them to stay on top of the economy. Even though ABC cost system is a managerial cost tool, e-commerce companies can use EAD (expense activity dependence) and APD (activity product dependence) matrix. These are two tools associated with ABC costing will allow Groupon to use the data provided from the company to trace overhead expenses such as: web design and maintenance, order processing, product marketing, telephone support, product handling and product shipping. The main activities identified to trace Groupon’s overhead will be determined by the level of accuracy and reliability
Life-cycle cost analysis (LCCA) is a method for assessing the total cost of facility ownership. It takes into account all costs of acquiring, owning, and disposing of a building or building system. LCCA is especially useful when project alternatives that fulfill the same performance requirements, but differ with respect to initial costs and operating costs, have to be compared in order to select the one that maximizes net savings. For example, LCCA will help determine whether the incorporation of a high-performance HVAC or glazing system, which may increase initial cost but result in dramatically reduced operating and maintenance costs, is cost-effective or not. LCCA is not useful for budget allocation.
Moving from a traditional cost accounting system to ABC can reveal hidden costs and hidden profits on the basis of the identified activities (i.e. customers, orders, etc.).
Process costing System is an accounting expression which describes one method to determine the manufacturing costs to the units manufactured . Processing is typically used when similar units are mass produced. Also process costing system is a type of accounting process costing which is used to determine the cost of a produced inventory. Chartered Institute of Management Accountants (CIMA) defines process costing as " The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are average over the units produced during the period, being initially charged to the operation or process "( College Accounting Coach, 2007). Process costing is more important and appropriate for all businesses producing identical products during which production is an ongoing flow. Toyota is on the of the major companies in the world that used well-known new philosophic management to produce identical products using process costing system.
The overall purpose of cost accounting is to advise top administration and the management team on the most suitable and cost effective methods and actions to employ based on cost, capability and efficiencies of a given product or service. It can be defined as the method where all the expenditures used during execution of business activities are gathered, categorized, examined and noted down (Horngren & Srikant, 2000). Once these numbers are gathered and recorded the information is used to determine a selling price and/or to identify possible investment opportunities. Although the principal aim or function of cost accounting is to help the business administration with their decision making and business planning process, the cost accounting data
Cost control and management. The study also identifies several other advantages of using the ABC
In accounting terms, operating expenses (OE) and cost of goods sold (COGS) are both considered expense accounts. In short, they measure different ways in which resources are spent in the process of running a business. They are segregated on an income statement in part to see how much a product’s resources cost versus how much it costs a business to turn those resources into a consumer good.
1.What is the ABC cross model? Define what is meant by the product costing, process costing, and the “what-if” cost-modeling perspectives of ABC.
Others feel that ABC would be more widespread in industry if it were marketed better by the cost accounting profession itself [1]. As the dust has settled, ABC has turned out to be less a revolutionary technique than a useful refinement to proven systems. The costs of products and services must be accurate, or management can be misled. Decisions... ...
Life cycle costing is a process of estimating and accumulating costs over a product’s entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre- and post- manufacturing stages. Identifying the costs incurred during the different stages of a product’s life cycle provides an insight into understanding and managing the total costs incurred throughout its life cycle. In particular, life cycle costing helps the management to understand the cost consequences of developing and making a product and to identify areas in which cost reduction efforts are likely to be most effective.
Cost accounting system has two types, job order costing, and process cost system. These two cost systems are very different, almost every company uses order costing or process costing. Starbucks, is a coffee shop where citizens congregate to drink there morning coffee, study, and or socialize. Starbucks is one of the oldest and largest privately held specialty coffee retailer in the United States. (Starbucks) Their passion is to discover the flavors you love and always bring it home, delivering the look, taste and aroma of the world’s best coffee and teas. Job order costing is a very easy way in order to help Starbucks managers to know how much profit their company (Starbucks) made.
Firms today are trying to introduce activity-based costing into their system, however, some firms are unsuccessful in the implementation, which later result in abandoning the ABC system. According to research, the reason of failure ABC implementation in People’s Bank of China is due to lack of a clear business purpose about the implementation, lack of education about ABC, poor ABC model design, lack of participants, individual and organizational resistance to change, and few outsourcers available. To solve these problems, top management support and cross-functional involvem...
A job order cost system is one in which costs are accumulated by individual products. Furthermore, a job-order costing system is utilized for assigning manufacturing costs to an individual product or batches of products. Generally, the job order costing system is used only when the products manufactured are adequately different from each other. In contrast, when products are identical or nearly identical, the process-costing system will likely be used (Averkamp, 2016). In addition, a job-order costing system is generally used by companies that manufacture a number of contrasting products.