Identification of Several Activities:
Under activity-based costing method, the activity hierarchy should be considered with utmost care. The activity hierarchy helps to classify the costs into different segments. There are some activity costs, i.e., rent, licensing, rates & taxes etc., which can be directly allocated to the school. On the other hand, the costs, related to activities, like greeting or helping students, can be categorized under organization-sustaining cost activities. Interacting with parents are almost same kind of activity. However, as it is not conducted on daily basis or frequently like student related activities and does not depend on the number of students or classes. Hence, it can be referred as facility-sustaining cost activities.
Cost Pools for Different Activities:
In the stated organization, the students of each class use to involve in same kind of activities. Hence, each class can be considered as a batch. Art & craft activities, learning and music activities involve same numbers of teachers and outside suppliers. Therefore, all these activities can be jointly formed to a batch-level cost pool. The free play and resting require few teachers and no supplier. So, these two activities can be grouped to a second batch-level cost pool. As snacks and meals can be measured in units, the meal activity should be grouped as a unit-level cost pool. The parent meeting helps to gather information about each student and so, it should be classified under another unit-level cost pool.
Cost Drivers for Different Cost Pools:
There should be different cost drivers for allocating costs related to different activities. The cost pool for resting and free playing activities can be measured as per the time or days, spent for these activities. Hours, spent by the teachers for art and craft, music and learning activities, should be the cost driver for another batch-level cost pool. Number of students or number of plates served can e used to allocate the cost of meals. As the main purpose of parent meetings is to collect information about every student, this activity can be measured in accordance to the number of students (DRURY 2013).
Activity-based costing method is one of the most widely used and popular methods, used for allocating various types of overheads amongst different products, manufactured, or services, rendered by the manufacturers. It is a process, which allocates the overheads to the items, which are actually responsible for incurring such overhead expenses. The costing method is most beneficial for the large production systems, where the manufactures produce multiple products or incorporate complex manufacturing processes. It has been observed that Activity-Based Costing method often provides more accurate outcomes in comparison to other overhead allocation methods.
Benefits of Activity-Based Costing:-
The benefits of activity-based costing are discussed below:
- Accuracy and Reliability:
Under activity-based costing method, the overheads are allocated on the basis of related cost drivers. Therefore, the cost allocation uses to be more realistic and accurate in comparison to other methods. It reduces the possibility of inappropriate overhead allocation. Thus, the production cost, determined under this method, use to be more accurate and more reliable.
- Fixation of Appropriate Selling Prices:
It is very difficult for multiproduct manufactures to allocate various general expenses amongst different products. Hence, it often faces issues to fix the selling prices of the individual products at such level, which can cover all the expenses. Activity-based costing can effectively allocate the general overheads to each product by using proper cost drivers. Thus, it provides more reliable production cost, which can be used as the base for determining the selling price of each product, and helps the management to cover all the expenses through the total sales revenue.
Activity-based costing method determines each cost driver by relating the activities with overhead costs. Thus, it can be beneficial for managers to identify the factors, which can be used for controlling the overhead expenses.
As the activity-based costing method determines the product costs more efficiently, the managers can use the information, provided by the method, for taking better decisions (Groot and Selto 2013).
Cost of Implementing Activity-Based Costing:-
The activity-based costing requires analysis of every overhead expense, identifying individual cost drivers and implementation of various measuring processes to measure the units of cost drivers. The whole implementation process requires huge amount of resources and funds. The small firms, therefore, often face problems to implement the activity-based costing due to fund crisis. It is one of the major limitations of this costing method.
DRURY, C.M., 2013. Management and cost accounting. Springer
Groot, T. and Selto, F., 2013. Advanced management accounting. Pearson Higher Ed.