Activity Based Costing

Introduction

Nowadays, every profit-making company wants to achieve the most common goals which are to gain the maximum and to beat their competitors in order to lead the market. It is believe that cost is one of the factors which will affect the success of the companies. Therefore, it is important for a company to choose what costing method it is going to use.

The purpose of this essay is going to explain what activity based costing (ABC), Theory of Constraints (TOC), Overhead Absorption Costing (OAC) and Marginal Costing (MC) are, and examine the assertion that ABC and TOC are, respectively, OAC and MC in a different guise.

Activity Based Costing

The concept of activity based costing (ABC) was exploited in the manufacturing sector of the United States during the 1970s and 1980s. It is a popular costing method which assigns costs to activities rather than products or services. In fact, ABC was build up to solve the problem that traditional costing systems had. It is because that those traditional costing systems did not frequently carry out the actual costs of production.

Cooper (1990) has pointed out five steps that need to be identified for an ABC system: Step 1, to assemble actions and turn them into activities. Step 2, report the cost of activities. Step 3, point out what the activity centres are. Step 4, choose first-stage cost drivers. Step 5, choose second-stage cost drivers. In the first-stage cost drivers, the costs of inputs will be traced into cost pools and in the second-stage cost drivers, the costs of cost pools will be traced into product costs.

Activity based costing gives companies a clear view of how much the costs are when they produce units of production. By doing this, companies can easily set up the price for the products and making the product mix decisions in order to get the maximum profit they can. ABC can also facilitated identify the radical causes of poor financial performance and trace costs of activities and work...