Activity based costing Essay Example | Topics and Well Written Essays - 1500 words

Activity based costing - Essay Example With this new era of cost reduction and resource utilization,managers always have to come up with ways to maximize their bottom-line One of the newest ways how companies can get increased cost-savings is by using a technique called Activity Based Costing (ABC). The main objective of this type of system is proper identification of all cost categories and using basing decisions on this information. Most organizations that use ABC systems have two costing systems – the official costing system that is used for preparing external financial reports and the Activity Based Costing system that is used for internal decision making and for managing activities. Table of Contents Executive Summary 1 Table of Contents 2 Introduction 3 Recent Studies in ABC 3 Role of ABC in Industries 4 Role in Manufacturing 5 Role in Financial Services 6 Role in Health Services 7 Role in Retail 8 Role in Government 9 Limitations of ABC 10 Conclusion 11 Bibliography 12 Introduction The main objective of Acti vity Based Costing is to understand the various types of overheads that are affecting the business. In comparison, normal accounting attempts to separate the different type of costs and the focus is on the cost of goods sold (or cost of services rendered in case of service companies). In this section, analysis of the various aspects of Activity Based Costing will be done, and how it is used effectively by managers in order to create the maximum value for the company. A number of examples will also be looked into when it did not prove to be very effective for the organizations. The basis of Activity Based Costing is simple, non-manufacturing as well as manufacturing costs may be assigned to products. Moreover, some manufacturing costs may be excluded from product costs. All overhead costs are attached to a product and activity is used as a measure of all the costs involved. The overhead rates or activity rates may be based on the level of activity at capacity rather than on the budge ted level of activity. To compensate for the deficiencies of the conventional information systems, ABC requires firms to collect costs in specially constructed â€Å"activity pools† rather than service departments or overhead cost centers. Each of the pools corresponds to a group of similar business processes or activities that are homogeneous in that all costs assigned to the pool are influenced or driven by a common factor (Rafiq & Garg 2002). Recent Studies in ABC A study in the year 2005 concluded that nearly half (55%) of respondents suggested within their entirety that their companies were at that time making use of the Activity Based Costing either in an active fashion or in a pilot with another 32% considering use. Only one in ten which amounted to around 11% did not contemplate using the ABC. The manufacturing industry had the highest representation with 24%, followed by financial services at 18%, public sector at 16%, and communications at 8%. Other industries accou nted for less than 5% each. The same study found out that out of all the industries being considered, the communication industry is the most aggressive in adopting the ABC system (Timlin 1998). The primary reason for this being that the Activity Based Costing uses various activities to trace overhead directly to cost objects, such as products, processes, services, etc., avoiding the distortions of traditional costing systems. In order for the ABC system to be affective large investments will have to be made in IT to support this need for categorical information. Role of ABC in Industries Now taking a look at the different industries and trying to analyze how ABC system is used to achieve different goals according to the company. While company goals may vary greatly, the purpose here is to identify how Activity Based Co