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Trine highlights the importance of both full costing and activity-based costing (ABC) to an organisation in a bid to effectively deal with global competition. He further brings out the differences between the two whereby full costing suggests that indirect costs be divided and charged to a unit while activity based costing views indirect costs as being “caused by activities”.
Activity based costing assumes that the overhead cost is driven by various activities in the organisation. Products are priced according to the capacity they utilise hence idle capacity cost is not charged to products according to Kaplan & Cooper 1998. All the costs that can be reasonably linked to a product, whether manufacturing or non- manufacturing are assigned to the product.
The managers of Euclid Engineering, an automobile manufacturing company, after carrying out an ABC study discovered that the company was spending less on direct labour expenses than launching new products to produce the existing products. They further realized that by attacking the costs of production launch directly they could have a major cost reduction opportunity. The information produced by this study also helped the company in its customer relations by creating trade- offs in that the customers would often ask for the skipping of certain activities whose benefits were less than costs.
Tata consultancy services of India, serving both local and international clients, in its software development business identified problem areas through ABC. They found out that the overall effort was a factor of quality assurance, error correction and testing activities and so the managers set better priorities and monitored the costs of error correction activities which eventually led to client feedback within the scheduled time.
Reference
Kaplan, R. & Cooper, R. (1998) Cost and effect: Using integrated cost systems to drive profitability and performance, Boston: Harvard Business School Press.
