The activity-based costing (ABC) system is a bookkeeping technique that distinguishes activities and assigns specific costs. However, indirect costs cannot be assigned using the traditional costing technique. Indirect costs are classified with the ABC technique. Indirect costs, for example, administration and staff salaries, are difficult to assign under the traditional costing system. Therefore, the ABC technique has discovered its niche in the assembling division.
The ABC system allocates fabricating overhead expenses for items better than the conventional approach, which apportions costs on the premise of machine hours. Activity-based costing consigns expenses to exercises that cause an overhead cost. This discussion will concern the process of ABC using two items produced by one organization. “Item A” is a low-volume product that requires certain exercises, for example, specialized engineering, specialized testing, and numerous machine setups since it is produced in small amounts. A comparable product called “item B” is a high-volume item that requires little consideration without exercise. A company using traditional costing could spread its overhead costs to items based on machine hours. This will cause the minimal overhead cost to be assigned to “item A” because it did not demand machine hours. Interestingly, “Item B” will be allotted huge overhead costs because it requires huge machine hours. However, “item B” did not demand as much activity as “item A.” Based on these assumptions, the result will be computed wrongly for each item’s actual overhead cost. Using ABC techniques, managers overcome such issues by assigning multiple overhead costs of activities and machine hours.
Based on the above case, ABC recognizes the firm’s activities such as specialized engineering, specialized testing, and machine hours because they allow the organization to allocate resources and inputs. Under the ABC technique, the organization will ascertain the cost of assets utilized as a part of its operations. Consequently, the costs of each overhead will be allocated to items that requested exercises. As a result, “Item A” will be assigned part of the organization’s expenses for specialized engineering, specialized testing, and machine hours. It should be noted that exercises or activities will be allotted part of their expenses. Thus, the ABC technique is accepted generally because overhead expenses have expanded fundamentally. Secondly, overhead costs are separated from machine hours and labor costs. Thirdly, this technique covers different manufactured items, and customers’ demands have expanded. Finally, few items are created in extensive groups, while others are manufactured in small quantities.