Activity-Based Costing System in the Service Sector: A Strategic Approach for Enhancing Managerial Decision Making and Competitiveness Chea International Journal of Business and Management

The defendant’s expert witness, an accounting professor, used activity-based costing to dispute the allegation. Figure 3.9 „The Three Methods of Overhead Allocation” presents the three allocation methods, using SailRite as an example. Notice that the three pie charts in the illustration are of equal size, representing the $8,000,000 total overhead costs incurred by SailRite. As you can see in Figure 3.6 „SailRite Company Product Costs Using Activity-Based Costing”, overhead is a significant component of total product costs. This explains the need for a refined overhead allocation system such as activity-based costing.

In this way, ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs https://www.bookstime.com/ or to charge more for more costly products. First, it expands the number of cost pools that can be used to assemble overhead costs.

Flexible Budgets & Overhead Analysis Solutions in Managerial Accounting

It would probably be unwise to eliminate tax services because of the connection they have with audit services (i.e., audit clients may appreciate the convenience of also having tax services available to them). However, management can look for ways to make the process more efficient by focusing on costly activities identified in the ABC analysis.

Below are the production details that have been derived from the production sheet. The common ‘top-down’ management style and organisational culture among SOEs worked well when instigating innovative ideas and inducing corporate-wide learning. Top management’s commitment to trying out new management ideas and investing in new technology has been the unique feature. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years. This way the calculation process will be coherent because it will represent a cause and effect relationship between the cost source and destination.

The Purpose of Activity-Based Costing

If the customer were new, 15 more minutes would be required to set up the customer in the company’s computer system. The potential problem with ABC, like other cost allocation approaches, is that it essentially treats fixed costs as if they were variable. This can, without proper understanding, give some people an inaccurate understanding which can then lead to poor decision making.

The Cost PoolsA cost pool is a strategy to identify the company’s individual departments or service sector costs incurred. It determines the total expenses incurred in manufacturing goods and allocates them to different departments or service sectors based on valid identifiers known as cost drivers. ABC focuses attention on cost drivers, the activities that cause costs to increase. Traditional absorption costing tends to focus on volume-related drivers, such as labour hours, while activity-based costing also uses transaction-based drivers, such as number of orders received.

Step-by-step breakdown

However, some indirect costs, such as management and office staff salaries, are difficult to assign to a product. Nowadays companies face strong competition at a global level, so there is a lot of pressure to increase productivity and lower production costs. Thus, obtaining a method of estimating the costs of the various products produced in the same company in a rigorous and precise way has turned into a really strategic objective . To address this issue, the ABC methodology has been proposed, which establishes that resources are consumed by the activities and these are consumed by the products and services. The distribution of resources by activities and the subsequent allocation to the products is done through cost drivers .

This approach takes the full amount of manufacturing overhead and spreads it equally across the production volume of all products. It does not consider that certain products may be responsible for more or fewer costs from specific activities. Traditional costing adds an average overhead rate to the direct costs of manufacturing products. The overhead rate gets applied on the basis of a cost driver, such as number of labor hours required to make a product. At this point, we have identified the most important and costly activities required to make products, and we have assigned overhead costs to each of these activities.

Virtually all organizations—including service, nonprofit, retail, and governmental—can benefit from implementing some form of ABC and ABM. Although unit product costs do not change significantly for the inkjet printer when activity-based costing is used activity based costing (from $147.50 to $153), the cost increases enough to result in a $3 loss for each unit. Conversely, the laser printer costs decrease significantly from $285 to $269 per unit when using activity-based costing, resulting in a profit of $81 per unit.

• It determines the total expenses incurred in manufacturing goods and allocates them to different departments or service sectors based on valid identifiers known as cost drivers.
• Conversely, the laser printer costs decrease significantly from $285 to $269 per unit when using activity-based costing, resulting in a profit of $81 per unit.
• Identify and assess ABC needs – Determine viability of ABC method within an organization.
• This provides the overhead rate calculations for the Company for each activity.
• When you divide the total overhead in a cost pool by your total cost drivers, you get a cost driver rate.
• Activity based costing will overcome this shortcoming by assigning overhead on more than the one activity, running the machine.
• For simplicity, let’s assume that the remaining $1,800,000 of manufacturing overhead is caused by the production activities that correlate with the company’s 100,000 machine hours.