Page 266 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 14: Introduction to Recent Development in Cost Management

14.4 Summary Notes

Activity-based Costing (ABC) is a costing model that identifies activities in an
organization.
It assigns the cost of each activity resource to all products and services according to the
actual consumption by each: it assigns more indirect costs (overhead) into direct costs.
In this way an organization can establish the true cost of its individual products and
services for the purposes of identifying and eliminating those which are unprofi table and
lowering the prices of those which are overpriced.
In a business organization, the ABC methodology assigns an organization’s resource costs
through activities to the products and services provided to its customers.

It is generally used as a tool for understanding product and customer cost and
profi tability.
As such, ABC has predominantly been used to support strategic decisions such as pricing,

outsourcing and identification and measurement of process improvement initiatives.

Target costing is a simple, straightforward process that can have significant impact on the

health and profitability of many, if not most, businesses.
It doesn’t require an army of specialists, large-scale software implementations, or complex
management structures and procedures.
It’s mostly logical, disciplined common sense that can be imbedded into a company’s
existing procedures and processes.

14.5 Keywords

Constraint: A constraint is a restriction on the degree of freedom you have in providing a
solution.
Cost Object: A cost object is a tangible input for a product manufactured/service provided, like
labor or material.
Experience Curve: Graph that depicts the ‘experience effect’ (increases in productivity) as refl ected
in reduced average and marginal costs.
Resource Driver: Activity based costing measure of quantity of resource consumed or required
by an activity.

14.6 Review Questions

1. How does Activity Based Costing differ from traditional cost accounting systems?
2. How will you suggest to analyse the activities?
3. Analyse the activity-based costing and enumerate its associated pros and cons.
4. Examine the concept of target cost. How do you think it to be useful for fi nance
specialists?

5. What do you think are the potential benefits of target costing for a firm that want to launch
its product in the market through
(a) invention
(b) innovation
(c) imitation
6. Is activity based costing an inventory valuation method or a cost accumulation method?
Support your answer with reasons.

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