Activity Based Costing Vs Full Costing Method - Free Solution

Question: Explain how activity-based costing differs from the full costing method. How can activity-based costing be applied to the service sector when the activities that it seeks to analyse tend to be related to manufacturing? Answer: Introduction The given assignment provides about activity based costing and how it differs from Full Costing system. Also, the application of ABC is discussed for service sector and manufacturing Activity based costing is a powerful tool for performance measurement. Activity based Costing; assigning indirect cost (overhead) into direct cost, this is what defines the ABC. It can also be defined as approach to monitor activities which involves tracing resource consumption and costing final outputs. Discussion Under the full costing method, the cost of the finished goods is calculated as the sum of the cost of the direct materials, cost of direct wages, variable overheads and the fixed manufacturing overheads. Under full costing the total cost is allocated among the product units. The full costing method is also known as the absorption costing method. It is the traditional method of accounting which focuses on the assigning of the cost of various resources to the products and services directly. Under the absorption costing method the cost of the various fixed overheads is distributed equally on the basis of number of unit of the goods produced. The method of fixing of the prices is dependent on the inventory. The higher level of inventory leads to lower level of product cost and the lower levels of inventory leads to higher levels of cost. The absorption costing complies with the rules and regulations that are provided in accordance with the generally accepted accounting principles, financ ial accounting standards board. The absorption costing method helps to calculate the overall profitability of manufacturing system. The full costing method is suitable for the small firms and the firms that are producing the homogenous products. (N. Nayab Jean Scheid, 2010) Under the activity based costing, the various activity centers are identified in the organization and after that the various cost are assigned on the basis of the identified activity centers. Under this the activity is properly evaluated and thus the purpose of the activity is identified and the cost is assigned on the basis of the demand of each activity by various units. Under the activity based costing the various incurred cost is traced in order to allocate them. It is the modern system of allocating cost and it is based on the concepts that the various activities are consumed by the products and the services and resources are required for those activities. The method of fixing the prices does not change with the levels of the inventory. Activity based costing requires two types of cost systems to be prepared one is the cost system and the other is the accounting books of records. It provides information in relation to the cautioning of the enterprise and thus helps in the proces s of decision making. It is beneficial in large companies and companies with multi product operations. (Dr. Carl Marx, 2009) The activity based costing can be applied to the service sectors where the activities that it seeks to analyze tend to relate to manufacturing can be implemented after the execution of the various provided steps: 1. The cost needs to be properly classified by classifying the drivers in accordance with the respective groups. 2. After the classification of the cost, the various identified cost drivers need to be aggregated and grouped into different activities that are to be analyzed. 3. The proper reporting need to be done in relation to the aggregated costs. 4. The various activity centers need to be identified. 5. The various cost drivers are selected on the basis of the first and the second stage and thus the total cost is calculated. (Ruhl, J.M., B.P. Hartman, 1998) Conclusion ABC costing and full costing method are differentiated and the above mentioned steps should be followed for application of Activity-Based Costing to the service sector where the activities that it seeks to analyze tend to relate to manufacturing. References: 1. Nayab Jean Scheid, 2010, Absorption Costing vs. Activity Based Costing. 2. Rose Johnson, 2014, Traditional Costing vs. Activity Based Costing. 3. Carl Marx, 2009, Activity Based Costing (ABC) and Traditional Costing Systems. 4. Horngren, Charles T., Gary L. Sundem, and William O. Stratton. Introduction to Management Accounting. 11th ed. Upper Saddle River, NJ: Prentice Hall, 1999 5. Ruhl, J.M., B.P. Hartman, 1998, Activity-Based Costing in the Service Sector Advances in Management Accounting, pp. 147-161. 6. Ashford C. Chea, 2011, Activity-Based Costing System in the service sector: A strategic approach for enhancing managerial decision making.