how activity-based costing differs from the full costing method: application in service sectors

Author: Iloka Benneth Chiemelie

Published: 20th February 2014

Explain how activity-based costing differs from the full costing method.

Nayeb (2010) presented a clear distinction between activity based costing (ABC) and full costing. It is also important to understand that full costing is also known as absorption costing. The differences between these two kinds of costing methods s based on their approach, methodology, and scope in the accounting systems. 

In terms of their approach, the main different is that absorption costing allocates costs to product units, while activity based costing traces the cost of product units. Absorption costing is more of a traditional cost accounting method which focuses on products or services when fixing costs, while activity based costing is more of a modern cost accounting approach that focuses on activities as the bases of its costing method (Nayed, 2010).

In terms of differences in their methodology, absorption costing divides the fixed overhead of costs equally with the number of product units, while activity based costing makes identifications based on the actual number of fixed overhead costs that has been incurred by the product units. Activity based costing adopts more of a scientific approach, while price fixation in absorption costing depends on the inventory.

Another areas where these two forms of costing differ is in their scope. Absorption costing helps in ascertaining the overall profitability or efficiency of the manufacturing system but doesn’t actually provide the real costs of individual product units. Activity based costing on the other hand highlights the functioning of the enterprise and contributes significantly towards strategic decisions-making processes.

How can activity-based costing be applied to the service sector when the ‘activities’ that it seeks to analyse tend to be related to manufacturing? 

The process of implementing activity based costing in organizations where the activity to be analyzed is based on manufacturing following numerous steps as:

Cost classifications – the cost drivers need to be classified into their respective groups.

Cost aggregation – once classified, the cost drivers will them be aggregated into different activities that they seek to analyze.

Activity cost reporting – the cost of all aggregated activities will then be recorded and reported.

Identification of activity centers – this is the segment of product process that the management wishes to report cost of activities involved separately.

Selection of first and second stage cost drivers – following success of other steps above, the stages of cost drivers are selected as the point at which the total cost can be calculated.

A case example of BOSK

The case analysis is based on documentations presented by Gunasekaran, A., Marri, H. B., and Yusuf, Y.Y. (1999). BOSK is a company based in Belgium that focuses more on the production of exhaust systems, with over 3 thousand products. At present, it has an European market share of 30% but wishes to expand such share to 50%.

In order to improve the market share, the management has been in search of new cost system that will be used to replace its volume-based system. Following an extensive automation, overhead costs became an increasingly important aspect of the company costing system while the direct cost measures also decreased at a considerable rate. The company carried out an extensive research with the purpose of examining the possibility of implementing an ABC system, as the decision is that implementing an ABC system will result in decrease of its distortions of product costs. In any case, the decrease will be a sort of balance for the increase in complexity of its cost system. Thus, the company successfully implemented ABC costing and it helped it to move close to its business objectives by reducing overhead and costing the production process more accurately. Its services and after sales options also experienced reduced costing measures and the company performed with more precision in its costing system.

Conclusion

From the above analysis, it can be seen that while ABC and AC seems to be related as a kind of costing method, all indications show that there are differences in their approach, methodology and scope. Additionally, it has been proven that ABC can help companies improve their overall performance by analyzing individual approaches activities independently and aggregating such activities to reduce overhead costs.

References

Nayed, N. (2010), “Absorption costing-vs-Activity based costing.” Available at: http://www.brighthub.com/office/finance/articles/86649.aspx [Accessed on: 21/12/2013].

Gunasekaran, A., Marri, H. B., and Yusuf, Y.Y. (1999), “ Application of activity based costing: some case experience.” Managerial Auditing Journal, Vol 14, No 6, pp 289-293.