History of ABC System or How did Activity Based Costing emerge?
Activity Based Costing (ABC System) is the latest development of Cost Accounting System. Under ABC system, the overheads are absorbed on a more realistic basis than just equitable basis.
Today, many manufacturing companies are forced to using advanced manufacturing technology. Under this type of environment, overheads are increased and direct costs are decreased especially direct labour cost. In this way, out of total cost of a product, the proportion of direct labour cost is very less and proportion of overheads is high.
In olden days, there is a sellers market. When, most of the companies are manufacturing a narrow range of products. In this case, direct materials and direct labour were the dominant factors of production. Overheads is very less. The cost of processing the costing information was very high.
Today, single company manufacture many products at a time. Overheads are very high since the production is carried out through automatic system. Under the intensified global competition, there is a need of correct costing of products to avoid misleading in decision-making.
Some expenses like material handling and machine setup are incurred in the manufacturing concern. These expenses are added with volume rated costs such as purchase expenses and manufacturing expenses. This is not correct method. These expenses are separately calculated on activity basis and apportioned on the end products to get correct cost of product.
Activity Based Costing system has the potential, to provide more useful information to managers for costing purposes.
The main focus of activity based costing is over an activity rather than over the department, section or division. A department, section or division has number of activities which are either value adding activities or non-value adding activities. The non-value activities are eliminated for the allocation of indirect costs with the help of activity based costing.