Activity-Based Costing

Abstract

In Chapter 11 we looked at some of the ways in which common costs can be attributed to production departments. In practice, the direct costs of production departments, together with these attributed common costs, are allocated to individual products using some measure of volume, frequently based on direct labour. Such allocations are needed for, amongst other things, inventory valuations, especially in the financial accounts. But it is argued by writers such as Cooper and Kaplan (eg., 1988) that they also have an impact on management decisions. Indeed, it is the impact of such allocations which led to the claims, mentioned in Chapter 3, that management accounting information is not relevant to the needs of managers in the modern production environment. In this chapter we will look at some of the issues concerning the relevance of accounting information and explore the nature of a proposed alternative which is currently receiving much attention in the professional literature — activity-based costing. We will focus largely on the role of activity-based costing in the determination of product costs. But as will be discussed below, activity-based costing is a response to a wider set of issues.