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  Activity Based Costing

Introduction to Activity Based Costing

This method is of recent origin and is basically concerned with apportionment of overheads in an organisation having results that different in complexity and volume of production. The crux of activity based costing is in precisely assigning the overhead cost to the end result. The conventional costing system does not provide effective reasons of pricing decisions and product costing. Charging overhead to the products on the basis of labour hour rate and machine hour rate might give faulty data as to costs that should be correctly attributed to a product. If the direct labour cost is occupied like the base for charging overhead cost, high volume products might be apt to get larger share of overhead cost than the low volume complex products. Each overhead cost does not directly change with the volume of production. The illegal cost attribution would provide a distorted picture of the cost information that is resultant in a wrong decision. Activity based costing is a technique of cost attribution to cost units on the basis of advantages received from indirect activities. The performance of specific activities and demands made through the activities on the resources of organisation are connected together that is why the cost of product is inwards at as per the quantum of activities performed to produce a product or make a service.

The cause for such a basis is that products itself do not consume resources directly rather various activities are needed to be performed for them, and these activities take the resources of the organisation as driven through cost drivers, (activities generating cost). Cost centres pay for these resources, relies on the number of activities needed for a product.

So, the overhead costs of organisation are recognized with each activity that is acting like a cost driver that is the cost for incurrence of the overhead cost. The number of these activities in an organisation relies on the complexity of operations. The more complex an organisation's operations are, the much more cost driven activities it is similarly to have.

After making out the overhead cost along with each cost centre, the cost per unit of cost driver can be determined and cost assigned to jobs (cost objects) on the base of number of activities needed for their achievement. So, ABC serves like a basis for product costing besides purposing for managing overhead cost. Activity based costing might be described like a method which includes identification of costs with each cost driving activity and making it like the basis for apportionment of costs over dissimilar products or jobs.

The Chartered Institute of Management Accountants describes it as a method of cost attribution to cost units on the base of advantages received from indirect activities example setting up, ordering, and assuring quality."

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