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Compare the uses of both variable and activity based costing as managerial decision making tools in business providing both examples and applications. Be specific on how service products must have good cost measures to access both profit accuracy and proc

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Introduction

Compare the uses of both variable and activity based costing as managerial decision making tools in business providing both examples and applications. Be specific on how service products must have good cost measures to access both profit accuracy and process adjustments to remain competitive. Review of subject Both variable and activity based costing are valuable management tools in business. In this paper, we will discuss how variable and activity based costing used in an organization and explain how these two methods differ. Variable costing is method of determining unit product cost and it is used internally for planning and control purposes only. Whereas, activity based costing (ABC) is a costing method based on activities that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity. We will also be looking to find the answer how service products must have good cost measures to access both profit accuracy and process adjustments to remain competitive. Discussion Variable and activity based costing are managerial decision making tools. Variable costing identifies contribution margins of individual products, helps managers make decisions on what products to develop and what product to improve while ABC identifies profitability of individual products and from individual customers, helps managers make decisions on what products or customers' relationship to develop and what products or customers' relationship to improve. ...read more.

Middle

Companies that use variable costing for internal reporting must convert to absorption costing for external reporting. Activity Based Costing (ABC -- also called transaction cost analysis) starts by apportioning an organization's expenses to a set of cost pools, usually classified by activity rather than by organizational unit or department. Cost analysts then use statistics to determine which transactions cause these pools to vary in size. These are called activity drivers, resource drivers, or cost drivers. Examples of cost drivers in a manufacturing environment include the number of inspections, raw materials receipts, the number of components in inventory, machine setups, or change orders. In many organizations, ABC is a by-product of quality management. Under quality management, ABC is used to distinguish between activities that add value (to final products) and those that do not -- like inspection, rework, and scrap, which arise out of defects in the service delivery process. Because quality management pushes significant operating decisions down to the lowest levels of the organization, cost measures and cost estimates are needed at the lowest levels, as are measures of rework, activity cycle time, customer satisfaction, etc. Standards are also needed for cost/performance measures. Standards can be based on the best an organization has achieved over time (base lining), the best practice currently being achieved somewhere (benchmarking), or an engineering standard -- in target costing, for example, price targets are set by the market (price less planned markup equals allowable cost) ...read more.

Conclusion

Regardless of its reliability, however, it is all we have or can have. In the second instance, cost is measured after decisions have been made and implemented. Only the measurement method and its consequences are conveyed prior to the decision. In this second case, measured costs are used to evaluate managerial performance, with the purpose of influencing management choices. Consequently, managers must be informed as to how their performance will be measured and how performance measured will affect outcomes they care about -- promotion pay, esteem, etc. Conclusion Planned costs must take account of cost behavior if they are to provide a reliable basis for control. In addition, the link between sales and profit performance, under variable costing, ensures a performance measure that managers understand easily. With the need to identify fixed and variable cost, and their importance to the production or service, as well being needed for managerial decisions these all interlink and are useful in identifying the needs of methods of use. The purpose of the various costing classification are dependent upon what type of project is being undertaken and what the intended outcome is. However, I feel that ABC fits in to the uses of various different. This method can be a more appropriate way of classification of costs as it recognizes that in the long run most costs are not fixed, and it seeks to understand the forces that cause overhead costs to change overtime, and what activities cause costs and create demand. ...read more.

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