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An activity-based costing (ABC) system first traces costs to activities and then to products.
Under the system cost are not assigned to the products directly but are assigned to the activities and charged to the products on the basis of the activities utilized by them.
Cost Driver is the activity that proves cause and effect the relationship with the overhead cost and the cost pool.
The cost pools are assigned to the products on the basis of the cost driver.
Thus the indirect costs are allocated to the products on the basis of the activities required for their production.
The costing approach relates the cost to the activity.
Second and the most importantly, TDABC uses simpler procedure to estimate cost.
As mentioned previously, TDABC avoids the costly, time consuming and subjective activity surveying tasks.
Besides allocation of cost to the product accurately ABC also helps in managing cost by providing detailed information about the cost and its behaviour (Thorne, H. The use of ABC helps the management in making decisions regarding the production of the products and quantity produced.
Thus ABC helps in developing the detailed and successful Decision support system (DSS), we can say that ABC costing will be suitable for both manufacturing as well as service organizations. At the same time, we can also say that ABC in service sector is applied only in typical service industries such as banking sector, health care and logistics and that too in a modified version which is Time Driven Activity Based Costing, TDABC which unlike ABC which usually collects the proportion of time, TDABC is more interested in actually time spend for particular activities.