MAS 1 (2019) Essay: Activity-Based Costing and Its Applications

This essay provides a comprehensive overview of Activity-Based Costing (ABC), a management accounting method used by businesses to enhance processes and boost productivity. It explains how ABC classifies activities, allocates costs to products and services based on resource consumption, and uses cost drivers to link activity costs to outputs. The essay highlights the benefits of ABC, such as improved cost data consistency and better overhead cost allocation, while also acknowledging its disadvantages, like being expensive and time-consuming. The analysis includes a practical example of calculating the cost driver rate. The essay concludes that ABC is an effective cost accounting method in today's competitive environment, aiding in waste reduction and accurate cost assignment. It references key sources like CIMA, ICMAB, and academic publications to support the discussion.

[Management Accounting]
2019

MAS 1
Activity-Based Costing
The aim of this paper is to present a short essay on Activity-Based Costing which is
one of the most successful approaches of management accounting system used by the
businesses to improve process and increase productivity.
Activity-Based Costing is the costing method that classifies activities in a business
and allocates cost from every activity to every service and product as per the actual
consumption of the resources by all. This model allocates overhead and indirect costs to the
related service and product. CIMA has defined this approach as the method of costing and
monitoring of the activities that is comprised of tracing the consumption level of the
resources and costing the final outputs (CIMA, 2008). In the business, this method is applied
by allocating the resources to every activity and activities to the cost objectives depending on
the estimates made related to the consumption. In the last, it use cost drivers to link activity
cost to the output. According to the ICMAB, ABC is the method of accounting that
recognizes the firm activities and allocates indirect costs to the cost objects (Moudud & Huq,
2015).
Activity based costing mostly work in the manufacturing industry as it helps in
improving the cost data consistency, hence generating true costs and superior categorization
of the costs that is incurred by the firm in the procedure of production. The activity based
costing can be calculated by applying the specified formula that is: cost pool divided by cost
driver, which produces the rate of the cost driver. The rate of the cost driver is then used for
the calculation of the overhead amount and indirect costs linked to specific activity (Kim,
2017). For instance, the electricity bill of ABC Company is $50,000 per year. The labour
hour number has direct influence on the bill. For the considered year, the worked labour

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hours were 2,500 that is the cost driver. The rate of cost driver can be calculated by dividing
the electricity bill per year that is $50,000 by the 2,500 as the labour hours. The rate of the
cost driver that can be yield is $20. For the product PQR, the firm consume electricity for 10
hours. The product’s overhead cost is $200.
Activity Based Costing provides number of benefits to the business by improving the
costing procedure. It helps in increasing the cost pools number that could be utilized to
assemble the cost of overhead. It also creates the new bases for allocating the costs of
overhead to the products in a way that cost is assigned depending on the activities that are
involved in generating costs in place of on volume measures, like cost of direct labour.
Further, the ABC approach changes the nature of different indirect costs. Apart from these
benefits, Activity based costing has some disadvantages too. The major disadvantages of this
approach are that it is expensive as well as time consuming method to implement (Goektuerk,
2007).
The above essay has provided a brief analysis of the activity based costing approach
of management accounting that is used by business to allocate the cost to business activities
by identifying the consumption level of the resource by every activity. In the conclusion, it
can be said that ABC method in today’s competitive environment is one of the most effective
method of cost accounting as it helps in reducing wastage and assigning true cost to the
activities of the business.

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References
CIMA. (2008). Activity Based Costing. Retrieved from
http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_c
osting_nov08.pdf.pdf
Goektuerk, H. (2007) Activity-Based Costing (ABC) - Advantages and Disadvantages 2nd ed.
Germany: GRIN Verlag.
Kim, Y.W. (2017). Activity Based Costing for Construction Companies 1st ed. U.K: John
Wiley & Sons.
Moudud, R.T., & Huq, Z.T. (2015). The Cost Management. The Institute of Cost and
Management Accountants of Bangladesh, 43(4), 1-62.