Page 9 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Activity-based costing and activity-based management

Basics revisited

In traditional absorption costing, overheads are charged to products using
a pre-determined overhead absorption rate (OAR). This OAR is based
upon the volume of activity.

A full unit cost is then computed, in order to satisfy financial accounting
requirements.

However, full product costs are not suitable for decision-making purposes.
Instead, decisions should be based on a decision-relevant approach using
relevant/incremental cash flows.

Within this approach, decisions such as introducing new products and
special pricing decisions should be based on a study of only those
incremental revenues and expenses that will vary with respect to the
particular decision.

Cooper and Kaplan have developed a more refined approach for
assigning overheads to products and computing product cost: activity –
based costing (ABC). ABC provides product-cost information that is useful
for decision-making purposes.

Stage 1 Stage 2
Activity cost pools Cost driver rates

Cost per
Material
material
handling movement
Overhead costs Cost per Product
Procurement purchase lines
order

Cost per set-
Set-up up

3