Students of management accounting are faced with a whole new language which surrounds costing and managerial finance methods and techniques. Terms such as cost and value management; cost reduction, value analysis, quality assurance processes and activity based costing all add to the students’ financial vocabulary.
In this article I wish to focus on activity-based costing or as it is more commonly referred to ‘ABC’. This technique re-examines the problem that has faced accountants and accounting technicians for decades — that of the allocation and absorption of overhead.
Traditional pricing method has been based upon absorption costing principles and the treatment of overhead usually followed a set procedure:
cost centres are identified and established within the business;
cost centres may be producing or service centres;
wherever possible a direct charge is made to a cost centre i.e., allocated overhead;
where overhead is jointly incurred, it is apportioned to the cost centres on some equitable base;
the overhead cost for the service centre is then transferred to producing centres;
the total overhead cost for each producing centre is then divided by, for example, machine or labour hours per cost centre;
overhead recovery rates are then determined;
these are then used to absorb the overhead to products;
in the short-run, if planned activity levels are actually achieved, then overhead may be fully recovered.
Such techniques may be used successfully where there is a limited product range and predetermined rates are well planned on achievable production volumes.
Cuecraft is an SME which manufactures high quality snooker and pool cues. For a number of years the accountant has dealt with the recovery of overhead in a traditional manner following the procedure outlined earlier.
The business has three major producing cost centres; Machining, Finishing and Packing.
The process of allocation and apportionment for period end March 2000 had been complete and the predetermined figures were:
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