In direction accounting there are three method/techniques of ciphering a cost per unit that a concern may utilize. The company can take any type of method to utilize depending on a concern. These are Absorption bing, Activity based costing, Variable or Marginal costing. Absorption costing is besides known as traditional costing which was designed and developed in 1870 to 1920. In 1970 ‘s and 1980 ‘s Activity Based Costing was developed as the method of soaking up costing, before ABC was developed most companies used soaking up bing and fringy costing. Cooper and Kaplan conceptualized the thoughts behind these systems as a manner of seeking to better the truth of the charge made to be objects in complex concern environments
In this study will cover with the advantages and disadvantages of activity based costing and soaking up costing and why the company demand to utilize either of these methods, but will besides look at the chief difference between allotment, allotment and soaking up rates.
“ In soaking up bing the cost of a merchandise or service is established by adding a portion of fixed production operating expenses ( indirect costs ) to direct costs. ” Absorption costing is consistent with demands for stock rating in fiscal coverage. For fabricating system, it is usual to absorb production overheads merely into merchandise cost. Administration, gross revenues and distribution operating expenses are normally written off as an disbursal of the period in which they arise. Overhead soaking up is besides known as overhead recovery ” . ( CIMA )
“ Under soaking up bing method a full production cost per unit is calculated by including in the cost of the cost unit a proportion of the production operating expenses from each of the production and service cost centres. This is done by apportioning, allotment and absorbing the operating expenses ” . ( AAT )
When you compare these two definitions CIMA definition is the best because it explains more in inside informations. It explains the procedures involved in soaking up costing, which gives an thought of what it is. The other definition from AAT is besides good but non batch of information is given.
Phases in Absorption Costing
An allotment it ‘s one of the first phases in soaking up costing. It ‘s the method of delegating costs into the cost Centres, the appropriate footing demands to be used when apportioning operating expenses.
An allotment is the 2nd phase in soaking up costing. In this phase the sum of each service section is used to distribute the costs into the production sections by utilizing the appropriate footing.
An soaking up rates is the last phase in soaking up costing in which the sum of each production section is divided by either direct labour hr or machine hr.
Using the information given in illustration 1.1 is to delegate all operating expenses to production and service Centres. Exhibit 1.2 shows all three phases of soaking up bing get downing from allotment to soaking up rates.
Advantages of Absorption bing
Ideal for smaller concerns because they do n’t hold many operating expenses to administer.
Most suited for the companies that makes merchandises instead than services.
This method is used to fix fiscal histories.
The soaking up will demo less alterations in net net income when production when gross revenues alterations but production corsets constant.
Used for revenue enhancement grounds in order to value the stock so it reflects the true rating.
Disadvantages of Absorption Costing
Not suited for the company that does services because soaking up bing based more in merchandises.
Not ideal for direction to utilize for doing determination, planning and control as its highlighted on entire costs both fixed and variable cost and it is non accurate.
Not suited for the larger companies as it can be deceptive.
In soaking up bing the cost of production can be determined after the service or merchandise have been produced
Activity Based Costing
“ Activity based costing is an alternate attack to merchandise costing. It is the signifier of soaking up bing but its attack is to associate overhead costs to the merchandises or services that cause them by absorbing overhead costs on the footing of production volume. ” ( CIMA )
“ Activity based costing is the method of soaking up bing which uses more sophisticated methods of apportioning operating expenses to be unit than the normal methods of overhead allotment and allotment. ” ( AAT )
Between these two definitions, once more CIMA definition explains more about ABC, they explain the rudimentss things that its attack is to associate overhead costs to the merchandise or service on the footing of production volume. The AAT definition merely defined partly which if reading first clip will be difficult to understand.
The diagram below illustrates in outline how ABC works:
Cost pool 1
Cost pool 2
Cost driver 1
Cost driver 2
Cost pool 1 entire / no. of cost driver
Cost pool 2 entire /no. of cost driver
Use of cost driver *cost driver rate
Use of cost driver *cost driver rate
Identifying activity doing operating expenses
Gather all costs for each activity
Identify what causes the cost
Calculate cost driver rates
Apply to single cost unit
Activity cost is the first thing that needs to be worked out, illustration of these activities is having goods, inspecting, and hive awaying goods. Using information given in illustration 1.1, Exhibit 1.3 it shows measure by measure on how ABC is worked out. All the phases shown on the diagram above are calculated.
Advantage of Activity Based Costing
In ABC the cost of production can be steadfastly decides through client feedback before the product/service is produced
ABC technique helps either to raise or lower activities to win clients.
It is more accurate than soaking up bing
ABC can be applied to production and other operating expense costs
Easy to be used in service bing than merchandise costing
ABC can be applied to acquire realistic costs in a complicated concern environment
It is suited for bigger companies.
Suitable for future planning
Disadvantages of Activity Based Costing
ABC is designed for larger companies because of many operating expenses included.
May be hard to run
Time consuming, takes clip in roll uping informations and its got long procedure.
Many cost drivers needed so ABC would be excessively complex and expensive
I recommend that the company should alter from soaking up bing to ABC system because the company is based on services instead than merchandises so this is best method for the company. Not merely that but besides it ‘s a medium sized company, a batch of operating expenses are involved, if the soaking up costing is to go on be used so it will be so difficult for direction to do determination, planning and control.
The company can present ABC system by puting up a squad that will be covering in placing which activities are required for the service. Experts from different country of the company and outside adviser must be included in that squad.
After the squad is joined together and all stuffs and information are collected, so can make up one’s mind the rudimentss of each activity that costs money. It is really of import to hold attending to inside informations in this phase because a batch of these costs may non be clear and non easy to see.
As shortly after the costs are determined and good known, all the collected facts must be saved into a computing machine ( ABC package, informations base or customized package ) . This will eventually assist the company make up one’s mind whether to increase the net income borders and do the activity more organized.
After the company had examine the informations obtained utilizing ABC and make up one’s mind which activities are officially in force, it can so take what ways to utilize to increase net income. All activities that are considered to be really expensive can so be reduced or rejected to do them more profitable.
The company needs to utilize these methods/ techniques because of the three chief things, these are determination devising, planning and control and merchandise costing. It is really of import for the company to place if they are doing net income or loss. For them to do determination whether to drop the service or maintain making, they need to cognize which services are more profitable and which one are non. After the determination is made the company must be after and command their disbursement.
Taking into history everything that is explained in this study, the ABC system is the best. The company needs to cognize what is traveling on within a concern, whether is traveling up or down. ABC system will assist direction to do determinations of whether to go on making the same service or supply another that can do the concern more profitable. It is really of import to hold accurate figures for doing determinations be aftering and control. The soaking up bing method is non accurate particularly if a concern has many operating expenses, merely ABC system is accurate.