"INTRODUCTIONProcessador Company is a manufacturer of processed meats which was producing only threeproduct lines since twenty years, namely Mettwurst, Bologna Sausage and Saveloys, throughlabor intensive techniques of production. It has recently started manufacturing low volumes ofspeciality lines namely, Clobassy, Csabai etc. These new products are complex to produce andrequire usage of extra labor and machine hours. The company has deployed computer operatedmanufacturing techniques so as to increase quality and customer satisfaction. However,profitability seems to be sinking for the company. The management accountant is of the opinionthat conventional costing system of using a single plantwide rate for allocation of overheads isleading to distorted cost calculation for various product lines. Activity based costing is proposedto estimate accurate costs for all the products so as to determine the most profitable productlines.Activity Based CostingActivity based costing is a technique wherein overhead costs are absorbed on the basis ofactivities which drive or cause those costs. Such activities are called cost drivers. This method isan improvement over traditional costing systems which assumed overheads are driven by thelevel of activity or production.Activity Based costing involves dividing production process into a number of activities and totaloverheads into a number of similar cost pools. Then the cost drivers of each activity aredetermined and the overhead absorption rate for each activity is calculated. Finally the activitycosts are absorbed into each product based on the volume of activities used by them.Benefits of Activity Based CostingActivity based costing uses cost drivers to allocate costs instead of relating them to productionvolume so it gives a better insight to what actually causes the costs. In today’s business scenario,overheads constitute a significant proportion of total manufacturing costs. Activity based costinggives detailed understanding of overheads and their drivers leading to determination of expensiveand non-value added activities. This helps as control tool for wasteful and expensive activities.Also, profitable product and customer lines can be easily found with the help of Activity BasedCosting.As we can see in the case of Processador company, when we calculate overhead costs per unit byconventional plantwide rate, it allocates costs in an equal manner over the entire range ofproducts, rather than according to the resources and activities, a product is using. As oppose tothis, Activity based costing system provides us with correct allocation base for overhead costspertaining to different activities used by a particular product line. The difference in the cost perunit of Mettwurst and Csabai is over 100%. The cost of Mettwurst comes out to be $8.36 per unitand Csabai as $19.15 per unit (refer appendix). On the other hand plantwide rate was giving costof both the products as $6.25 per unit. It signifies that cost of many other less expensive productlines was being averaged out while using a single plantwide rate based on annual level ofproduction. With the help of these findings, company can single out its most profitable or lossmaking product lines.Another benefit of Activity based costing is that it can be easily used in all types of businessenvironments, whether it be product sector or service sector. Costs and Limitations of Activity Based CostingThe basic premise of employing any new system or process in a business is that its benefitsshould outweigh its cost. Activity based costing is definitely more complex and time consumingthan conventional costing systems and requires more resources and efforts. The advantage ofincreased accuracy in allocation of overheads might not outweigh its cost. Also, Activity basedcosting might not be much of use where overhead costs are less in proportion to overallproduction costs. Moreover, managers might show resistance in employing new system whenthey have become accustomed to the traditional costing system.Analysis of case studyAs stated above, there is a vast difference in the cost of Mettwurst and Csabai as calculated withthe help of activity based costing. This difference of approx $10 would not be reflected in theconventional costing system using a plantwide rate for all product lines. The existing systemshows the cost of both the products as $6.25 where as Activity based costing brings out the costof Mettwurst as $8.36 per unit and that of Csabai as $19.15 per unit. Clearly, traditional costingsystem understates the cost of both the products. The implication of this could be that the otherproduct lines are less costly to produce and their low costs are being averaged out while using asingle plantwide rate.The company has undergone a lot of changes in the past 20 years. Apart from introduction ofnew complex product lines, computer aided production techniques have also been employed. Thefocus has shifted from labor intensive methods to complex machinery. As in accordance to thegrowing competition, the company lays more stress on customer satisfaction through quality control. Side by side, in order to maintain profitability, company needs to single out loss makingproduct lines and most profitable ones to obtain a perfect product mix. The effect of this on coststructure is that proportion of indirect costs has increased over the years due to reduction ofdirect man hours and use of automated processes.Activity based costing can help in overcoming the limitations of traditional costing system. Asdirect costs like direct labor and direct machine hours have become less in quantum as comparedto the overheads incurred due to automated complex production process, it is important that asingle plantwide rate based on labor hours or machine hours should not be used to allocateoverheads. Computerised manufacturing process involves many activities that incur costs at alllevels. Activity based costing identifies such activities and their cost drivers, and the volume ofactivities consumed by each product to estimate costs. This method is definitely an improvementover conventional costing system.Factors to be considered when implementing Activity based costing1) Managers should keep in mind that activity based costing is fruitful only in the long runfor complex business procedures where indirect costs are high in proportion.2) Small businesses with mainly direct costs should not incur so much time and efforts on it.3) Different feasibility studies should be done like economic feasibility, technical feasibilityetc to assess the benefits and costs of implementing the system.4) The willingness of personnel to undergo the change should be considered and condusiveenvironment for successful implementation should be harnessed. References? Activity Based Costing, 2012, can be accessed fromhttp://www.accountingformanagement.org/predetermined-overhead-rate/? Activity Based Cost Management, 2013, can be accessed fromhttp://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s02? Activity Based Costing, 2013, can be accessed from http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Activity%20Based%20Cos ting%20(ABC).aspx?mode=none? Management Accounting, can be accessed fromhttp://www.businessdictionary.com/definition/activity-based-costing-ABC.html? http://www.cgma.org/Resources/Tools/essential-tools/Pages/activity-based-costing.aspx? https://www.inkling.com/read/managerial-accounting-for-managers-noreen-2nd/chapter- 7/the-limitations-of-activity "