Page 256 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 14: Introduction to Recent Development in Cost Management

14.1.1 Important Factors of Selecting the Cost Drivers Notes

The following are the important factors:
Degree of Correlation: The degree of correlation between the consumption of activity and
consumption of cost drivers shows the trend of the cost assignment in the context of cost drivers.

If the firm requires regular inspection of the quality standard of the products during the
production for every batch, the number of inspections per hour and per shift will be subject to
the previously mentioned norms. If the number of inspection is more and more in line with the
volume of production, it means the firm has a positive high correlation between the cost of the

activity and cost object.
Trade off in between Cost and Accuracy: Undoubtedly, ABC is the only system able to extend

the business intelligence for the firms’ survival over the other combatants with the help of more
amount of accurate costs for every level of activities, but they are very expensive in the process
of implementation as well as in maintenance.

Effects in the Behaviour of ABC Analysts: It not only influences the decisions of the fi rm which
are taken by the ABC analysts but also their behaviour.
The third most important assumption is information about the activities. It only helps to determine

the quality customers who generate greater profitability to the fi rm.
Now the entire structure of assumptions of ABC are over. ABC is considered to be predominant
tool of analysis in the manufacturing firm. Why? The following are reasons:

1. Dominance of Overheads: Nowadays, due to cutthroat competition, every firm is expected

to meet the needs and demands through value addition at cheaper cost. These objectives are
mutually contradictory. Normally, the process of value addition warrants more and more
research and development cost requiring the firm to charge higher price for the absorption

of overheads. But the cost cutting is aimed at bringing down the cost on one side as well
as to supply the products/services at lower price to attract the buyers through the pricing
strategy. This is the only reason for greater volume of overheads over the direct costs.
2. Different kinds of Product Range: Due to acute competition, every firm is required to meet

the varied needs and demands of the ultimate consumer. To supply the car to the tune
of the consumer preference, the car has to be painted accordingly. It involves some more
activities than the routine supply of a car. It requires the firm to price the value addition

appropriately through an appropriate pricing which neither overcharges the customer nor
undercharges the fi rm.
3. Varied Overhead rate for Divergent Products: Different products use different overheads
wherever they incur according to various needs and demands of the market.
4. Consumption of Overheads driven by an Activity not by Volume: The consumption of
overheads is not driven by the volume of output but by the number of activities which are
involved in the process.

14.1.2 Objectives of ABC

1. To establish the linkage between the amount of cost and the cost drivers, which are nothing
but resource and activity drivers.

2. To determine the cost of every activity and fi nally to find out the cost of the product or
service.
3. To apportion the overheads in accordance with the activities involved in the process only
in order to ascertain the accurate cost.
4. To evade the bottlenecks of the traditional cost system through the destruction of charging
the overheads on the functional basis.

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