ACTIVITY BASED COSTING – A TOOL OF ACCURATE COSTING

Activity based costing is a system of allocating overheads to jobs, processes or products on the basis of activities responsible for such expenses, instead of the traditional system, so that true and logical cost is obtained. According to traditional system, firstly the overheads are apportioned over various departments on some basis and then they are absorbed to the individual product on the basis of direct wages or direct labour hours or direct machine hours etc. Suppose factory overheads are absorbed on the basis of machine hours, this is not logical, because all factory overheads are not dependent on machine hours and so the overheads allocated are incorrect and consequently the total cost and selling price based on such costs are all incorrect and illogical, which may put business into trouble. The overheads are absorbed under Activity Based Costing on the basis of activities giving rise to overheads, e.g. to allocate the expenses of procurement of goods, it can be divided into three activities like placing an order, receipts and inspection, storage etc. The total overheads of all three activities are ascertained and are absorbed to various jobs, processes or products in proportion to the services which they received from these activities, e.g. the inspection cost is absorbed on the basis of number of times the product is inspected, cost of placing an order is allocated on the basis of number of times the orders were placed etc.