Introduction to Activity Based Costing Techniques
There are a lot of financial techniques and measures that are used in realizing cost data. These include product costing, product line profitability analysis target costing, service pricing amongst others. However, activity based costing techniques perform the duties of all these other techniques and measures. Activity based costing techniques can also be used to complement the others. For the purpose of this article, we will be looking into how to get accurate cost data with activity-based costing techniques.
Activity based costing techniques are measures used in having an excellent understanding of the true cost of a particular company. Having a better understanding of this will help the company map out a suitable pricing strategy. This will help prevent or avoid irrelevant expenses that are not necessary.
What is Activity based Costing (ABC)?
Activity based costing (ABC) is a very direct way of assigning running costs or indirect costs for a business as a result of the operations (that is ‘activities) that are the causes of the running costs. When it comes to variance analysis, the running costs are put in as a result of a particular cost driver. These cost factors may be the machine hours or the work hours. This not only happened in variance analysis, it is also a part of job order costing.
In general, activity based costing is adapted in the manufacturing sector. Since it gives a more correct data concerning costs, giving rise to numbers that are almost as the real cost. These number values can be spotted out in the stage of production. When we refer to activity based costing techniques, there’s one word driving the process. That word is ‘activity’ or ‘activities’. The word activity is one of the crucial factors that serves as the basis of this topic. Now let us take a quick look at what it means and merge it with the activity based costing techniques.
What is an activity?
An activity is an action, occurrence, job or any kind of work that is carried out for a particular reason. There is a reason or an aim that drives the process of an activity. Activities may range from the process of sketching out a product, assembling the equipment to be used, to the point of actually using the equipment and disseminating or spreading the products to the final users. For that reason, activity based costing will just not depend on one varying factor like the labor hours, machine hours. Activity based costing puts into consideration all the estimated activities that will be involved in the whole process.
The advantages of activity based costing
There are three ways in which activity based costing can have an impact on the process of cost distribution. Let us take a look at them:
Accuracy
The activity based costing gives a more factual and correct data of the overhead cost. The distribution of the running cost is more detailed and can be relied on. Since they are divided and segmented into different groups depending on the amount of activities. Note that these activities encompass the total number of tasks involved in the process. In simpler terms, in place of joining all of the company’s costs together and coming about all the indirect overhead costs of the company, activity based costing groups the costs depending on the activity.
Builds a basis for untraceable costs
Another advantage of activity based costing is that it gives you a clue to the exact cause of some activities that were initially not evident. For instance, in a case where there is depreciation, you are able to track down the cost data. As a result of this, of course, you will be able to rectify the problem in the situation.
Balance Unit Cost
The activity based costing technique will also help to balance the unit cost of products with low volume and higher volume. This can be achieved by removing the running cost from the high volume products. This will in turn help the unit cost of the low volume products.
A breakdown of the activity cost based calculation
(By Investopedia)
- List out all the activities that are needed to manufacture that product.
- Separate all activities under cost pools, this consist of every individual costs that are involved in one activity—for example, the process taken to manufacture the product. Now do a calculation of the total running cost of all cost pools.
- Allocate cost drivers to every cost pool activity, for instance, the time.
- Now calculate the cost driver rate by doing a division of all running cost in every cost pool with the overall cost drivers.
- To arrive at the cost driver rate, you do a division of the overall overhead of all cost pools by the overall cost drivers.
- When you get your value, you multiply this value by the total cost drivers.