The third step in the process is to calculate activity costs. This is accomplished by assigning specific drivers to the activities based on interviews and logical associations. The forth step in the process is to identify cost objects. The next step is to how activities are related to cost objects in terms of time invested for these cost objects. The last step is to calculate cost object costs.
Traditional and Activity-Based Costing Accounting Methodologies
In the past, armed only with traditional management accounting information, managers were forced to achieve their efficiency goals by engaging in "slash-and-burn" or "cut-and-cope" approaches to cost cutting. Traditional cost accounting methodologies were of little use to organizations in managing unit cost, since they did not provide timely and accurate information on what changes were necessary to reduce cost.
Joseph Naughton-Travers (2001) believes that the challenge when attempting to analyze cost lies in the calculation of indirect costs. The difficultly lies in determining how these costs, often known as overhead, administrative or support costs, relate to the services being offered. Traditional systems use simple formulas to allocate these costs. Indirect expenses are usually divided into categories, such as salaries, fringe benefits, supplies and depreciation. These do not provide information on why costs occur.
The advantage of activity-based costing is that this system traces costs to the products that cause them, providing a much more accurate picture. Under this system indirect costs are driven first to the activities and processes that occur in an organization, and then to the actual service themselves. ABC thus allocates these indirect costs more...
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