Activity Based Costing

Identification of problem:

The problems present in the Community Healthcare Centre case concerns the limitations of the traditional, volume-based costing and the ABC systems of assigning costs. Since the use of different systems to determine costs will yield different results, a discussion of both systems is required to justify whether CHC should adopt the ABC system.

Under the traditional, volume-based costing system, costs are assigned to products based on a single activity base that is related to volume. A potential problem with this costing system is that costs may be distorted since only a single, volume-based cost driver is used. It should be noted that the costs of the programs might not be accurate because the consumption ratios of costs differs widely between programs. For instance, ÐŽ§general overheadЎЁ is allocated on the basis of direct total labour cost, but not all staff devotes an equal proportion of their time to patient.

While on the other hand, the ABC system, overhead costs are assigned to products by following a two-stage procedure. The most significant activities are identified and categorized to activity cost pools first, and then allocating costs from each activity cost pool to each product line in proportion to the amount of the cost driver that is consumed by the product line. According to Community Healthcare Centre, at the first stage, activity cost pools are established. Moreover overhead costs are assigned to activity cost pools in accordance with the way resources are consumed by activities. In stage two of the ABC costing project, cost drivers are identified for each activity pool indicated above. By allocating the costs for each activity and calculating a cost per driver and allocate to products for each driver separately, a database showing how the cost drivers are distributed across products is created. However, this approach still has deficiencies. It entails the cost-benefit trade-offs, since the more activity cost pools are identified in ABC system, the greater will be the accuracy of the cost assignments, which also results in greater costs of implementing and maintaining the system. In addition, the relevant period inconsistency with each cost per driver per period and activity costs per period can have an impact on the cost analysis accuracy as well.