Conventional cost systems can report seriously distorted product costs when the products that are manufactured are diverse. In particular, size and batch-size diversity can affect the accuracy of reported product costs. Activitybased costing (ABC) is the answer. It is a development in product costing that has attracted much attention in the last few years.
Conventional cost accounting systems focus on units of particular products. Costs
are allocated or “traced” to a product because each unit is assumed to consume resources.
Therefore, conventional allocation bases measure only attributes of a unit, for example, the number of direct labour hours, machine hours or material costs consumed in making the product.
By contrast, ABC systems focus on the activities performed to produce products in the manufacturing process. Costs are traced from activities to products based on each product’s consumption of the activities performed (Cooper, 1990a). ABC acknowledges that products or services do not directly use up resources; they use up activities. ABC systems differ from traditional cost accounting systems in the nature of cost drivers used to trace costs.
Traditional, unit-based cost accounting
systems use only second-stage allocation bases, which are based on unit-level characteristics
of the product. Typically, direct labour hours, machine hours…
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