Question

Critically evaluate the use of activity based costing as an approach to the calculation of product costs. As part of your critical evaluation, explain the information that Quebec plc will need to produce in order to apply the activity based costing technique to the calculation of product costs for product Y and product Z.

Answer 1

Use of ABC (Activity Based Costing) as an approach to the calculation of Product costs:

• In Traditional Costing, Indirect costs i.e. Overheads are allocated evenly to all the products based on a cost driver like Machine Hours, Labour Hours, etc.
• But, practically all the products do not use overheads equally.Some products use more overheads than others. Thus, the product cost determined in such way is inaccurate.
• ABC recognises that different products require different overheads.
• For Activity Based Costing,first all activities are identified to create a product. (Eg: Production Run,Product Management)
• Then, All overheads are apportioned to the Activities based on the Cost Pool. (Eg: Maintenance expense, Factory Rent)
• Thereafter, Cost Driver (Eg: Machine Hours, Square Feet) is identified for each activity and total activity cost is apportioned among the products based on Cost Driver of activities used.
• Thus, Direct as well as Indirect Costs are are assigned to each product based on its usage of expense. Thus, the product cost determined by ABC is more appropriate.

The information that Quebec plc will need to produce in order to apply the activity based costing technique to the calculation of product costs for product Y and product Z are:

• Activities to produce Y and Z
• Cost Pools used by such activities
• Cost Drivers required for both Y and Z.