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  Working of Activity Based Costing

Introduction to Working of Activity Based Costing

The working of Activity Based Costing is described below.

• Understanding and analyzing manufacturing process:-

Study of manufacturing process is necessary for installation of any costing system. For Activity Based Costing system as well as, it is essential to study the manufacturing process and ascertain several stages included in similar so that 'activities' included in similar can be identified.

• Study of the Activities involved:-

The next step is to study the activities included in the manufacturing process. This step is extremely crucial because the complete Activity Based Costing is based on identification of activities. In this step, the activities included in a process are recognized. For instance, in a bank, opening of an account is one of the services presented to customers. In this service, activities included are studied. It might be revealed that opening of a new account includes activities such as issuing the application form, verification of similar and accepting the initial amount needed for opening of an account. Likewise in case of a manufacturing company, purchase procedure might include activities such as receiving of purchase requisition for concerned department or the stores department, inviting quotations from several suppliers, placing of an order, follow up of similar and at last receiving and inspection of the goods. In case of an educational institute, activities within a library might involve activities such as issue of books, giving accession numbers, stock taking, receipt of books, ordering new books, removing obsolete and outdated books, and fast moving items, identification of slow moving etc. In this way, either in manufacturing or in service sector, activities are recognized or the next step is to spit the activities into value adding and non value adding. The aim behind this is that attention can be determined on the value adding activities when non value adding activities can be removed in the future.

• Activity Cost Pool:-

Cost pool is described by CIMA like, 'the point of focus for the costs that are relating to a specific activity in an activity based costing system.' For instance, in case of a library, cost of ordering, the cost of issue and receipts, stock taking costs etc. can be recognized with 'Library Cost'. Other words, 'Library' will the cost pool where all the costs mentioned above might be clubbed. In case of a manufacturing organization, like concern to stores, cost of classification, inspection costs, cost of issue of stores requisitions,  etc. can be pooled within the heading 'stores'. So cost pool concept is identical to the concept of cost center. The cost pool is the point of focus or in other words, it is the entire cost that is assigned to an activity. It is the addition of all the cost elements that are assigned to an activity.

• Cost Drivers:-

As per to CIMA, 'cost driver is any factor that causes a change in the cost of an activity, example the quality of parts received through an activity is a considering factor in the work needed through that activity and so affects the resources needed. An activity might have multiple cost drivers related with it.' Other words, cost driver mean the issues that determine the cost of an activity. For instance, if we repeat the instance of library, the number of receipts and issue of books will be cost drivers, in a stores, no. of stores demands will be cost drivers, in customer order processing the number of customers ans no. of orders will be cost drivers. So a cost driver is an activity that generates cost. Activity Based Costing is relies on the belief that activities cause costs and so a link should be established among activities and product. So the cost drivers are the link among the activities and the cost.

• Identification of costs with the products:-

The final stage in Activity Based Costing is to make out the cost along with the final products that can also be termed as cost objects. Cost objects involve, products, services, customers, contracts and projects. As described before, direct costs can be identified simply with the products but the indirect costs can be related with the products through identifying activities and cost drivers. Thus Activity Based Costing is the process of tracing costs first from resources to activities and then from activities to particular products.

• Conclusion:-

It could be concluded that the Activity Based Costing is a costing system that tries to charge the indirect costs to the services and products quite accurately. Though for effective implementation there is a requirement of involvement of the staff and their training on continuous basis.

Likewise there is a requirement to review the working of the system at periodic intervals and keep a record of the feedback received. These actions will make sure effective implementation of the system. Support of top management is also needed for effective implementation of this system. Activity Based costing system is certainly a better system but very much relies on the implementation of the same.

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