Activity Based Costing Harvard Business Press

Question: Discuss about theActivity Based Costing for Harvard Business Press. Answer: Introduction There are many ways to find out the cost drivers and various activities that associated with the production of products in the organization. In activity based costing there are certain steps that need to follow while estimating the cost drivers and activities associated with them (Kaplan, Steven and Anderson, 2013). In the case of Browns Bakery Mr. Knight has to first evaluate the various costs that took up in the mixing department. These costs are wages, building cost, depreciation, consumables, energy and other indirect cost. As all these costs have been identified it is easy locate the cost driver for each cost. In is explained below: Wages are paid to labor therefore this percentage of labor time will be appropriate cost driver for division of cost in each activity. Consumables are used in each activity and it is divided according to the labor time used in each activity. The indirect cost that is left over will be allocated in each activity as per labor time as no other cost driver can be applied. Building cost is related to floor area occupied by each activity in mixing department, so this cost divided on basis of floor area occupied by each activity in the mixing department. Depreciation and energy is related to use of machine and machine is only used in operate mixers activity of mixing department, therefore whole cost of depreciation and energy is allocated to operate mixers activity directly (Goektuerk, 2007). Following steps must be taken by the Knight to ensure that information is reliable: Knight must collect information on various costs that are incurred in the mixing department so that value of each cost can be calculated. After identification of each cost, Knight must make efforts to find out the different activities that have been taken place in the mixing department. It can be assured by asking by the department manager of mixing department (Kaplan, Steven and Anderson, 2013). Identification of cost driver is the most important task and in order to ensure it is reliable Knight have to check applicability of each cost according to the resources they used. For example, wages cost used labor resources therefore wages cost must be allocates through use of labor time by each activity. Lastly to ensure that whole cost have been allocated, Knight must ensure that overall profit in activity based costing and tradition costing are same. In activity based costing method, all indirect costs are allocated according to the activity used in processing of each product. Apart from indirect cost there are some direct costs like material used and labor cost that have also to be allocated in the product cost to drive at the product cost in each case. Actually direct cost is based on any activity as it is simply put for use for each product process and various activity are performed on it to make it a finished product (Kaplan, Steven and Anderson, 2013). While drawing the cost pool for allocation of cost in the various activities direct material cost are leftover and it is essential to add them while estimating the whole cost of the product. Direct labor cost is also a part of product cost and it also not taken in cost pool as it is divided directly into product while estimating total product cost. The main reason for division of labor cost directly in statement of product cost is because they are associated to products and th ey are involved in all the activities. In case of Browns Bakery various activities have been found and costs associated to activities are divided as per activity driver of that activity. Certainly some costs like direct material and direct labor are not listed in the list of activities and these must be added while estimating the cost of Meat pie and Vegetarian Quiche. Activity based costing system is more accurate cost division system and it helps to allocate the various indirect cost more precisely into the products according to the different activities used by them. In case if product A consume more resources as compare to product B than certainly the cost of product A will be more as compare to cost of product B. In activity based costing the all the indirect cost are first identified and their cost drivers are assigned according to the resources they have used. While in case of conventional costing system or traditional costing system all the indirect cost are taken all together and divided using the most appropriate cost driver like labor hour or machine hour (Goektuerk, 2007). Therefore activities that have not been used in the particular product have been allocated the part of that activity cost. So, conventional costing system does not support appropriate allocation of cost. In this costing system cost of product A can be lower than produc t B but in actual it is totally opposite. This led to misappropriation of profit in each product and provides wrong information of the costing of products. In case of Browns Bakery the cost of Vegetarian Quiche is certainly more because it has used more resources than meat pie and in activity based costing system costs have been divided as per the resources used by each activity. In tradition costing system all indirect cost are divided on the basis of one cost driver. Activity-based costing (ABC) is a costing method that is used for allocating the overhead costs to each activity of an organization in a more logical manner as compared to the traditional approach of assigning costs to the products. The method identifies all the activities of an organization and then assigns indirect costs to products. Thus, ABC system can be regarded as an approach of establishing the relationship between costs, activities and products. The indirect costs such as office staff salaries is rather difficult to identify attributed to each of the product with the traditional method of cost accounting (Goektuerk, 2007). Thus, activity-based accounting is used as a technique for aligning the indirect costs related with manufacturing of products. The approach to costing is most commonly used in the manufacturing sector as it helps in gaining the actual costs incurred by an organization in its manufacturing process. It also facilitates organizations to develop much better co rporate strategies by recognizing the costs in advance. Advantages: ABC system provides more realistic information about product costs as it places more emphasis on its cause in context of manufacturing goods It helps organizations to identify and implement effective strategies for controlling their overhead costs ABC technique also provides sufficient information regarding the profits realized from its various product lines ABC approach facilitates organizations to determine the selling prices of the products as overheads are allocated on the basis of cost drivers Limitations: The major limitation of this approach exist in the difficulty of identifying the various activities in an organization that impacts costs The evaluation of cost on the basis of activities is also very difficult The method is not effective for identifying overhead costs related with small manufacturing of products So it can be concluded that activity based costing system take into account all the indirect cost as per the resources used by the products while traditional costing approach misses this division of cost. But in ABC costing system it is very difficult to locate the different activities and misidentification of activities will lead to wrong allocation of indirect cost. References Goektuerk, H. 2007. Activity-Based Costing (ABC) - Advantages and Disadvantages. GRIN Verlag. Kaplan, R., Steven, R. and Anderson, R. 2013. Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. Harvard Business Press.