ACKNOWLEDGEMENT

We have taken effort in this project. However, it would not have been possible without the
kind support and help of many individuals and organization. We would like to extend our
sincere thanks to all of them. We thank god for providing us with everything that we required
in completing this project. We are highly indebted to the lecturer in charge for his guidance
and constant supervision as well as for providing necessary information regarding the project
and also for his support in completing the project.
1.0 INTRODUCTION OF ABSORPTION AND ACTIVITY BASED COSTING (ABC).
ABSORPTION COSTING
Absorption costing, sometimes called full absorption costing, is a managerial accounting
method for capturing all costs associated with manufacturing a particular product. The direct
and indirect costs, such as direct materials, direct labor, rent, and insurance, are accounted
for using this method. Absorption costing is required by generally accepted accounting
principles (GAAP) for external reporting. Absorption costing includes anything that is a direct
cost in producing a good in its cost base. Absorption costing also includes fixed overhead
charges as part of the product costs. Some of the costs associated with manufacturing a
product include wages for workers physically working on the product; the raw materials used
in producing the product; and all of the overhead costs, such as all utility costs, used in
production.

- Absorption costing differs from variable costing because it allocates fixed overhead
costs to each unit of a product produced in the period.
- Absorption costing allocates fixed overhead costs to a product whether or not it was
sold in the period.
- This type of costing means that more cost is included in the ending inventory, which
is carried over into the next period as an asset on the balance sheet.
- More expenses are included in ending inventory, expenses on the income statement
are lower when using absorption costing.

Absorption costing means that ending inventory on the balance sheet is higher, but
expenses on the income statement are lower.

ACTIVITY BASED COSTING

Activity based costing (ABC) assigns manufacturing overhead costs to products in a more
logical manner than the traditional approach of simply allocating costs on the basis of
machine hours. Activity based costing first assigns costs to the activities that are the real
cause of the overhead. It then assigns the cost of those activities only to the products that
are actually demanding the activities.
Activity based costing recognizes that the special engineering, special testing, machine
setups, and others are activities that cause costs—they cause the company to consume
resources. Under ABC, the company will calculate the cost of the resources used in each of
these activities. Next, the cost of each of these activities will be assigned only to the
products that demanded the activities. In our example, Product 124 will be assigned some of
the company's costs of special engineering, special testing, and machine setup. Other
products that use any of these activities will also be assigned some of their costs. Product
366 will not be assigned any cost of special engineering or special testing, and it will be
assigned only a small amount of machine setup.
Activity based costing has grown in importance in recent decades because (1)
manufacturing overhead costs have increased significantly, (2) the manufacturing overhead
costs no longer correlate with the productive machine hours or direct labor hours, (3) the
diversity of products and the diversity in customers' demands have grown, and (4) some
products are produced in large batches, while others are produced in small batches.
2.0 ABSORPTION OR ABC
2.1 COMPARISON BETWEEN ABSORPTION AND ACTIVITY BASED COSTING (ABC)

ABSORPTION ACTIVITY BASED COSTING

Absorption costing assigns costs to Activity-based costing focuses on
individual units company activities as a central cost and
then attempts to assign indirect costs to
units.
Overheads are first related to the various Overheads are first related to the
production and services departments. activities or grouped into cost pools.
Overhead rates are used to ascertain Activity cost drivers can be used to
cost of products only. determine the cost of the cost objects.
Since the overheads are related to the It portrays more realistic cost behaviour
cost centre, a realistic picture of the cost since the overheads are related to the
behaviour is not portrayed. cost drivers.
Only two levels of activity. All levels of activities in the
manufacturing cost hierarchy.
Example: facility level and level are
identified. Example: unit level, batch level, product
level and facility level are identified.

2.2 EXAMPLE OF FINANCIAL OR NON FINANCIAL INFORMATION

The absorption and activity based costing, financial and non-financial information that could
help in decision making is the asset such as inventory and the remainder on the entity’s
balance sheet at the end of the period. This is because the absorption costing allocates fixed
overhead cost to the both cost of goods sold and inventory, the cost associated with the item
that is still in the inventory and it will not be captured in the expenses on the current periods
income statement. Absorption costing reflects more fixed cost attributes to ending inventory.

Other than that, the absorption ensures more accurate accounting for ending inventory
because the expenses associated with that inventory are linked to the full cost of the
inventory still on hand. In addition, more expenses are accounted for in unsold products,
which reduces actual expenses reported in the current period on the income statement. This
results in a higher net income calculation when compared to variable costing calculations. At
The same time it could make the decision making of the company more clear and accurate
for the future.
 Furthermore, for the activity based costing financial information that could support the
decision making is due to it being useful in arriving at more realistic product cost information
for the financial reporting. At the same time it also could control the cost in all areas of the
business so this means that it can be used to help managers develop successful strategies
in running the business and the planning to improve the business. Other than that the
product cost also being the financial information which are routinely calculated for inventory
valuation, a critical element of externally published financial statements, from this information
this can be used to the future planning which the item that using the most expenses can be
deduct which can make the decision making possible.

Beside these, the other financial and non-financial information that can support the future
decision making include environmental impact, your relationship with your vendors, diversity
in the workplace and social responsibility. They may have financial impacts, but it's
impossible to quantify them purely by assigning them a dollar figure. It also brings out the
benefit like measuring whether sales revenue rises or falls between this quarter and the last
is simple. Measuring customer loyalty, employee commitment or environmental impact takes
more work, but it offers rewards like improved management decisions, better stakeholder
confidence, increased credibility within the community and lower the risk of problems at the
same time improved operation. On the financial information side the item that can support
the future decision making is advertising cost, sales revenue employee compensation and
the value of assets.
3.0 RECOMMENDATION/ ADVICE/ OPINION
In our opinion, Jola Publishing Co should change from the absorption costing to activity
based costing (ABC) for its company to calculate all the overhead calculation. An important
component in determining the total production costs of a product or job is the proper
allocation of overhead. For some companies, the often less-complicated traditional method
which is absorption costing, does an excellent job of allocating overhead. However, for many
products, the allocation of overhead is a more complex issue, and an activity-based costing
(ABC) system is more appropriate. Activity-based costing can help marketing people by
providing more accurate product cost numbers for decisions about pricing and which
unprofitable products the company should eliminate. In this case, if Jola Publishing Co
change the method to activity-based costing (ABC), the company can detect that their
product which is a comprehensive technical journal (TJ) should be eliminate as it shows that
the possibility for TJ to become unprofitable products are higher. This is because the paper
used for the production of TJ are relatively poor quality and is not subject to any
governmental controls and consequently only a small number of inspections are carried out.
The TJ also uses far more machine hours than the children’s book (CB) in its production
while it is not profitable if compare to CB.

The difference between the absorption costing (using one cost driver) and the ABC method
(using multiple cost drivers) is more complex than simply the number of cost drivers. The
use of the single cost driver does not allocate overhead as accurately as using multiple cost
drivers. It may overallocate overhead to one product and underallocate overhead to another
product, resulting in erroneous total costs and potentially setting an incorrect sales price.
Jola Publishing Co used absorption costing where overhead costs tend to be consistently
driven by only one cost driver, which is machine hours. This will lead to the possibility of
incorrect overhead calculations and will affect production costs. Calculating an accurate
manufacturing cost for each product is a vital piece of information for a company’s decision-
making. For example, knowing the cost to produce a unit of product affects not only how a
business budgets to manufacture that product, but it is often the starting point in determining
the sales price. Production also benefits because activity-based costing provides better
information about the cost of each activity. In practice, ABC helps managers identify cost-
causing activities. To manage costs, production managers learn to manage the activities that
cause costs. ABC also traces costs to areas of managerial responsibility, processes,
customers, departments besides the product costs.

4.0 CONCLUSION

Activity Based Costing (ABC), as a management accounting tool, offers a remedy for
accurate costing as well as improvement in efficiency, effectiveness, and quality of the cost
information on organisations. ABC is hence a better costing system for services to improve
profitability, achieve organizational goals, target growth, sustainability and development. For
the absorption costing model is also ill-fitted to professional service firms because the
overheads are allocated proportionally as additional fixed parts of the calculation to single
products (services). This is only valid at only one volume and cannot provide information
concerning a short-term price floor, especially at low or falling utilization, or with enhancing
direct costs.

5.0 REFERENCES

1. https://www.fool.com/the-blueprint/activity-based-costing-vs-absorption-
costing/#:~:text=Absorption%20costing%20and%20activity%2Dbased,assign%20indirect
%20costs%20to%20unit

2. https://writepass.com/journal/2012/12/why-does-the-company-need-either-absorption-
costing-or-abc/
3. https://opentextbc.ca/principlesofaccountingv2openstax/chapter/compare-and-contrast-
traditional-and-activity-based-costing-systems/