Abc Costing Essay

Activity Based Costing (ABC)

Firstly the case analyzes the two hypothetical factories i.e. single factory making one million pens, all the same color blue and Multi Factory also makes one million pens but of many different colors, sizes and varieties. It shows how the multi factory is benefitted by the use of ABC.

ABC systems extend traditional systems by linking resource expenses to the variety and complexity of products produced, not just the physical volumes produced. ABC basically tries to answer following questions:

1) Why is the organization spending money on indirect and support resources?

The spending on indirect and support resources is necessary because of the activities performed or the capabilities being supplied by these resources. Therefore, it is necessary to define how to allocate costs and why is the organization spending money. Here, ABC project teams use the rules of thumb, such as to ignore activities that use less than 5% of an individual’s time or a resource’s capacity.

2) How much is the organization spending on each of its activities? ABC system maps resources expenses and activities using cost drivers. The cost drivers link spending and expenses based on company’s financial or general ledger system.

Hierarchy of Activities

After identifying activities and cost drivers, manufacturing activities forms hierarchy:

Unit level activities are activities performed for every unit of product or service produced. The quantity of unit level activities performed is proportional to production and sales volume.

Batch level activities are those performed for each batch or setup of work performed. It includes setting up a machine for a new production run, purchasing materials, and processing a customer order.

Product sustaining activities are performed to enable the