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Traditional Costing Systems Versus Abc Systems Accounting Essay

Cost systems:

Harmonizing to Bhimani, Horngren, Datar and Foster ( 2008 ) , directors understand the demand for a cost accretion system in determination devising to reply their inquiries about merchandise merchandising monetary value, profitableness of the merchandise, the measure to do net income. Furthermore, the jobs which are many indirect cost are relevant for determination devising, merchandise determinations are non independent are besides the chief grounds ( Drury, 2008 ) . There are three typically cost system: direct cost systems ; traditional soaking up bing systems, activity-based bing systems.

Traditional bing systems versus ABC systems:

Drury ( 2008 ) indicated that both traditional and ABC systems use a two-stage allotment procedure. In the first phase, traditional bing systems allocate the operating expense cost to all sections and so reapportion service section costs to production sections. In term of ABC systems, it assigns operating expenses to major activity instead than section. Consequently, many activity-based cost Centres ( or cost pools ) are created and ABC systems will usually hold more figure of cost Centres.

In the 2nd phase, overhead allotment rates are used to follow operating expenses to merchandise by traditional bing systems whereas ABC systems use the term ‘cost driver ‘ ( Soin, Seal and Cullen, 2002 ) .

We can sum up the chief difference of ABC to Traditional Systems are: ABC systems have greater figure of cost Centre and greater figure and assortment of 2nd phase cost drivers. Therefore, as a more advanced bing systems, ABC systems can mensurate the resources consumed by cost objects more accurately.

ABC systems and its design:

Drury ( 2008 ) proposed that ABC systems use both volume-based and non-volume-based cost drivers whereas traditional systems use lone volume-based cost drivers. This thought is supported by Garrison and Noreen ( 1994 ) , Volume-based cost drivers assume that the merchandise ‘s ingestion operating expenses related straight to figure of unit produced and it is merely appropriate with activities which are performed each clip a unit of the merchandise or service is produced. Example of “ figure of set-ups and technology orders ” are non-volume-based cost drivers and they are besides needed for cost allotment.

Bhimani, Horngren, Datar and Foster ( 2008 ) defined ABC systems is the bing systems focused on single activities as the cardinal cost objects. ABC systems calculate the costs of single activities and allocate costs to be objects on the basic of activities undertaken to bring forth each merchandise or service. An activity can be an event, undertaking, or unit of work with a specific intent. Another definition was given by Innes & A ; Mitchell ( 1993 ) ; the cardinal rule of ABC is that overhead costs should be identified with cost objects every bit accurately as possible. Costss are caused or ‘driven ‘ by the assorted activities that take topographic point within the concern environment. Activities focused are divided into four classs: unit-level activities ; batch-level activities ; product-sustaining activities ; and facilities-sustaining activities.

We are now traveling to look at ABC systems in more item by looking at Drury ‘s position and Garrison and Noreen ‘s position about ABC systems design. Drury ( 2008 ) suggested that ABC systems are designed by four stairss:

Identifying the major activities that take topographic point in an organisation ;

Delegating costs to be Centres for each activity ;

Determining the cost driver for each major activity ;

Delegating the cost of activities to merchandises harmonizing to the merchandise ‘s demand for activities.

He indicated that the first two stairss are in the first phase and the concluding two stairss relate to the 2nd phase.

To get down with the first measure, activities are composed of the collection of units of work or undertakings and are described by verbs associated with undertakings. Activities are identified by transporting out an activity analysis. Innes and Mitchell ( 1993 ) stated that administrations should star from analyzing a physical program of the work topographic point to indentify how all work infinite is being used and the paysheet listings to guarantee that all relevant forces have been taken into history. A series of interviews with the staff involved or a clip sheet for staff to finish explicating their clip spent. Many elaborate undertakings are likely to be identified in the first case, but after interviews, the chief activity will look. The activities chosen should be at a sensible degree of collection based on costs and benefits. The concluding pick of activities must be a affair of judgement but it is likely to be influenced by factors such as the entire cost of activity Centre and the ability of a individual driver to supply a satisfactory determiner of the cost of activity. Activities with the same merchandise ingestion ratios can utilize the same cost driver to delegate costs to merchandises.

Traveling to 2nd measure, after activities have been indentified, the cost of resources consumed over a specific period must be assigned to each activity. The purpose is to find how much the administration is passing on each of its activities. Many of the resources will be straight attributable to specific activity Centres but others such as labor and lighting and warming costs may be indirect and jointly shared by several activities. These costs should be allocated to activities on the BASIC of ‘resource cost drivers ‘ . At this measure, there is no reallocation of support costs.

In term of 3rd measure, in order to delegate the costs of each activity cost Centre to merchandises, it is necessary to choose a cost driver for each activity Centre. These cost drivers are ‘activity cost drivers ‘ . The administration should be able to explicate costs in each activity cost pool. Furthermore, a cost driver should be easy to mensurate, informations should be easy to obtain and indentify with merchandises. In ‘activity cost driver ‘ , there are dealing and continuance drivers. Transaction drivers count the figure of times an activity is performed. However, if the sum of resources required by single cost objects is non great, dealing drivers will mensurate accurately activity resources consumed. If this status does non use, continuance cost drivers should be used. Duration drivers show the sum of clip it takes for an activity.

The concluding measure purposes to use the cost driver rates to merchandise. Therefore the cost driver should be able to mensurate to be identified with each merchandise. In add-on, mechanism needed to supervise the usage of one activity to the merchandise, easier for dealing drivers and Duration drivers.

However, in a different point of position, Garrison and Noreen ( 1994 ) argued that four stairss involved in the design of ABC systems are:

Process value Analysis ( PVA ) ;

Identifying activity Centres ;

Tracing costs to activity Centres ;

Choosing cost drivers.

Process Value Analysis ( PVA ) is systematic analyse in activities required to do a merchandise or execute a service. It identifies all resource-consuming activities involved in a merchandise or functioning a client and indicates these activities as either value-added or non-value-added in nature. To finish a PVA, the undermentioned actions should be taken. First, directors should fix a flow chart detailing each measure to finish a merchandise. Second, they should analyze each activity on the flow chart and determine whether it is value-added or non-value-added. Finally, they need to indentify how to extinguish the non-value-added activities documented on the flow chart.

Indentifying Activity Centres: The definition of Activity Centre is proposed by Garrison and Noreen ( 1994, p.194 ) as “ a portion of the production procedure for which direction wants a separate coverage of the cost of activity involved ” . As we mentioned supra, there are four general degrees of activities: unit-level activities ; batch-level activities ; product-sustaining activities ; and facilities-sustaining activities. Unit-level activities are those that arise as a consequence of entire volume of production traveling through a installation. Some companies put all activities at the unit degree into a individual activity Centre, while other usage two or more unit-level activity Centres ( labour activity and machine activity ) . Batch-level activities are undertakings such as the arrangement of purchase orders, apparatuss of equipments, cargos and grosss. Costss of batch degree are independent of the size of the batch. ABC systems recognise batch construct be the creative activity of a separate activity Centre for each batch-level activity that can be identified. Product-level activities are activities associating to specific merchandises. A batch activity Centre is needed for each product-level activity that can be identified. Facility-level activities are normally combined into a individual activity Centre.

Tracing Costss to Activity Centres: where possible, administrations are likely to delegate costs straight to activity Centres to avoid any deformation in costing.

Choosing Cost Drivers: we should see two factors when choosing a cost driver: the easiness of obtaining informations associating to the cost driver ; the grade to which the cost driver measures existent ingestion by merchandises of the activity involved

Benefits and Restrictions of ABC systems:

ABS systems help administration to better the costing systems which leads to more accurate merchandise costs ( Drury, 2008 ) . ABC systems increase the figure of cost pool to roll up overhead costs. Furthermore, ABC systems change the base used to delegate overhead costs to merchandises. ABC besides changes a director ‘s perceptual experience of many overhead costs. To reason, by holding more accurate merchandise costs, ABC leads to break costs control and more accurate determination devising ( Garrison & A ; Noreen, 1994 )

However, ABC systems besides have some restrictions. Two recognized restrictions of ABC systems are that it is necessary to do some arbitrary allotments based on volume and ABC systems are sometime dearly-won with multiple activity Centres and cost drivers.

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