MODULE TITLE:  BUSINESS MANAGEMENT TECHNIQUES

TOPIC TITLE:  COSTING TECHNIQUES

LESSON 5:  ACTIVITY BASED COSTING

INTRODUCTION - Overheads are often charged to cost units passing through the cost centres. However, distortions can arise if the company has a mixture of low volume and high volume products. Low volume throughputs will attract low overheads when in fact short production runs can have high unidentified costs. For example, short runs of special steels will need heating requirements, roll changes and other labour intensive activities compared to a long production run of standard steel girders of the same tonnage. The effect of this is to make the selling price of the steel girders higher than it need be and therefore less competitive. Activity Based Costing (ABC) was developed to try and overcome this and, by focusing on the activities of cost centres that generated costs, to reflect more accurately the overheads that should be assigned to a particular cost centre.

YOUR AIMS

At the end of this lesson you should be able to:

• understand the basic nature of Activity Based Costing (ABC)
• understand some of the terms used in ABC
• distinguish between the traditional allocation of overheads to cost centres and that by ABC
• appreciate some advantages and disadvantages of ABC.

QUESTIONS -

1. Indicate the resource, resource driver, activity, activity driver and possible cost drivers for the activity in a Decoration Department of a pottery company in which a painter is painting a prototype piece of pottery.

2. Describe briefly a disadvantage of ABC.

3. For the following categories of activities assign an appropriate cost driver from the list provided below against each activity in the following table.

Cost Drivers:

• Cost of Inspection/Test
• Number of Machine hours
• Direct Labour Hours
• Number of Purchase Orders
• Number of Production Runs
• Material Delivery/Invoices