| INTRODUCTION: | | | | individual activity as well as underlining the exact unit |
| Allocation of costs are important as they give value of | | | | cost of every activity. More so, it doesn't precisely |
| inventory or stock for external reporting reasons, for | | | | allocate costs to assorted activities and processes |
| planning and scrutinizing the cost of activities and | | | | involved. Therefore, unsophisticated allocation method |
| procedures, and for several short term and long term | | | | produces inappropriate and incorrect data for planning |
| policy decisions. It tries to identify costs related to | | | | and monitoring the performance of a company. |
| design, production and distribution of products and | | | | However, the ABC costing has a number of benefits. |
| services. | | | | These include: establishing the most and the least |
| Activity based costing is a system that first | | | | profitable clients, products and channels, and establish |
| accumulates overhead costs for each activity of an | | | | the factors that contribute or detract financial |
| organization and proceed to allocate the costs of | | | | performance. It also gives exact forecast of costs, |
| activities to the products, services or other cost | | | | margins resource demand related with variance in |
| objects that caused that activity. The link between an | | | | production quantity, company composition and the |
| activity and the cost object must be established | | | | supply expenditures, as well as providing administrators |
| through identifying the cost drivers for each activity. | | | | with cost acumen to achieve improvements and |
| The number of transactions involved in the activity | | | | enhance the negotiating strength with the customer. |
| measures the cost drivers. Each of the products or | | | | Managers can also expand their market share by |
| services defines them as the measure of the use of a | | | | placing their products well in the market. |
| shared activity. The system identifies parts of high | | | | However, ABC system is mostly concerned with |
| overhead costs per unit and so directs attention to | | | | conversion of indirect costs into directs so that they |
| finding means to minimize the costs or to charge more | | | | can be easily distributed over various processes and |
| for costly products or services. | | | | products, this criterion treats fixed costs as if they |
| Traditional cost systems allocate overhead costs to | | | | were variable. This is wrong as in computation of |
| products or services mainly to distribute the costs for | | | | gross margin you need to classify costs as either |
| financial reporting costs. It usually allocates indirect | | | | being fixed or variable. This implies in calculating profits, |
| costs to the products or services in two stages: firstly, | | | | there are no fixed costs as they have been translated |
| the indirect costs of the individual production process | | | | into variable. |
| are established and secondly, the indirect costs of the | | | | Therefore, this will interfere with accurate planning as |
| different production processes are assigned to the | | | | fixed they have to be incurred whether there is an |
| individual products. | | | | additional unit of a product has been produced or not. |
| ANALYSIS: | | | | In a way we can conclude that the ABC system can |
| Steinway piano is entirely formed by hands of | | | | also be misleading in a way and great caution should |
| craftsmen and technicians, with locally available raw | | | | be taken when masking decisions after using the |
| materials but no machine or modern technology used | | | | system, for its results should be clearly understood and |
| like wood, rims, wires etc. The production process is | | | | interpreted. |
| simplified and the costs associated are materials and | | | | In addition, the traditional system assigns costs to |
| labor costs i.e. the amount charged by technician and | | | | products using the predetermined unit based output |
| the craftsmen. There are no machines used or | | | | rates, while the ABC system assigns overhead to |
| technology applied; hence the piano is not a good | | | | activity cost pools and assigns costs to products using |
| candidate of the ABC system as the direct costs can | | | | cost drivers. The cost drivers must accurately |
| be easily allocated to the product. Therefore, traditional | | | | measure the resources used by a certain activity and |
| systems of cost allocation can be easily applied, as the | | | | should have the associated information readily |
| direct labor costs form a greater percentage of the | | | | available. |
| total production cost. | | | | CONCLUSION: |
| The ABC systems are mostly applied where | | | | ABC is not a replacement of the existing cost system |
| technology is highly used, hence the productivity | | | | rather it acts as supplement, and it has its own |
| advancements have greatly minimized the direct costs | | | | limitations such as its expensive and there are arbitrary |
| of labor and materials, and instead the indirect costs | | | | allocations made. However, in terms of its results it's |
| have increased. For instance, increased automation | | | | highly recommended. Its application depends on |
| has minimized the labor costs, but depreciation has | | | | whether the products vary mostly in quantity and |
| increased which is an indirect cost. More so, where the | | | | whether the products are plentiful, diverse and require |
| total amount of labor has greatly decreased and | | | | various sustaining services. |
| significant increase in total overhead costs, as well as | | | | Therefore, before a company decides which system |
| the manufacturing industry is complex demanding | | | | to execute it should put into consideration the |
| double allocations foundations. | | | | complexity of their production process and the |
| However, in Steinway piano indirect costs are few and | | | | overhead costs involved. For a complicated process |
| can be easily identified, as mostly it deals with the | | | | implies double allocations of costs, while a simple |
| direct costs of materials and labor, which can be easily | | | | production process calls for a single costing system so |
| allocated through traditional systems. At the same time, | | | | as to cut on the costs. The traditional system takes |
| the number of pianos can be easily known, without | | | | direct labor hours to be the relevant activity base while |
| having to use ABC system to identify the cost drivers | | | | machine hours are the appropriate activity base for |
| putting into consideration that the system is expensive | | | | ABC system. |
| and complicated in simplified production process, with | | | | In our case of Steinway piano, though the production |
| most of the costs being direct. | | | | process is not complex as most of the direct labor |
| Similarly, the system doesn't treat fixed costs as if | | | | costs form a large portion of total manufacturing costs |
| they were variable hence it's a bit beneficial to | | | | as there is need to use the ABC system at least |
| managers when planning , but great care should be | | | | once, so as to know the amount of resources each |
| taken as the method omits so many factors | | | | activity consumes and the cost drivers behind each |
| ABC VERSES TRADITIONAL COSTING. | | | | activity. |
| Traditional costing systems fail to acknowledge that | | | | Hence, one can clearly know the number of pianos to |
| the number of activities performed in an industry are | | | | manufacture so as to maximize the margin while |
| the main causes of costs and there are unique cost | | | | reducing the total costs. This is recommended |
| drivers behind them, rather than being general. | | | | because there are other kinds of pianos being |
| However, ABC systems focus on the activities | | | | manufactured, therefore creating a competition in the |
| executed to produce a given result i.e. it tries to | | | | market implying that there is need to check on the |
| establish the cost drivers behind each activity. It tries to | | | | customer bargaining power to expand the market |
| determine the amount of resources used by an | | | | share. These issues are not addressed when using the |
| individual product as well as by the activities and | | | | traditional system making it difficult to know the |
| processes that distribute the products and services to | | | | distribution costs of the pianos and other related costs. |
| clients, to establish the cost and the performance of | | | | REFERENCE: |
| an industry. | | | | Kaplan, Robert S. and Bruns, W (1987), Accounting and |
| Traditional systems do not clearly reveal the total cost | | | | Management: A Field Study Perspective, Harvard |
| of each activity and identify the cost drivers of each | | | | Business School Press, Harvard. |