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Subject: Management Accounting
Activity based costing methodology in operational management focuses of allocation of cost. Activity based costing allow segregation into overhead cost, fixed cost and variable cost. Cost splitting helps in the identification of drivers of cost, if achieved. While tracing of costs relating to a product can be relatively easier for direct material and direct labor, it becomes difficult to allocate the indirect costs to the product. Some type of weighting is required for the process of cost allocation in case of resources that are used commonly by products. The factors that drive or create the cost of any activity are called cost drivers. For example, in the case of running machinery (activity) the machine running hours (cost driver) give birth to expenses related to maintenance, labor and power (cost).
Applications in routine business
Activity based costing is not just a topic of discussion for the students of commerce but it has its applicability in the real life business as well, which can be in accounting, costing as well as financing.
It is a modeling process which could be applicable partially or fully.
It helps in the identification of inefficient departments, activities and products.
It allows allocation of greater number of resources on profitable departments, products and activities.
It helps controlling per unit cost of products and also on the cost incurred in each department.
It identifies unnecessary costs which can be eradicated to eliminate them.