INTERNATIONAL JOURNAL OF ARTIFICIAL INTELLIGENCE
ISSN: 2692-5206, Impact Factor: 12,23
American Academic publishers, volume 05, issue 05,2025
Journal:
https://www.academicpublishers.org/journals/index.php/ijai
page 978
ABSORPTION COSTING AND ACTIVITY-BASED COSTING METHODS IN
MANUFACTURING AND SERVICE SECTORS
Bazarbayeva Umida Gulmirzayevna
Tashkent university for applied scinces
Annotation.
This thesis is about cost management systems which play a crucial role in
organizations by providing a structured approach to monitor, control, and optimize costs.
These systems are researched to track and analyze expenses across various departments and
activities, enabling businesses to make informed decisions and improve their financial
performance. From a strategic perspective, cost management systems help
organizations identify cost drivers, understand cost behavior, and allocate resources
effectively. They also facilitate budgeting and forecasting processes, allowing businesses to
set realistic financial targets and monitor their progress. When it comes to the importance of
cost management systems, different stakeholders have varying perspectives. From the
perspective of top management, these systems provide valuable insights into cost structures
and help identify areas of inefficiency or waste. This enables management to take proactive
measures to reduce costs, enhance profitability, and gain a competitive edge in the market.
For finance departments, cost management systems streamline financial reporting and
enable accurate cost allocation, ensuring compliance with accounting standards and
regulations.
Key words
. Accountants, traditional costing, indirect costs, cost driver, cost estimates,
activity-based costing, cost behavior, business operations.
Introduction.
Traditional costing is a method of cost allocation popular in the business for
many decades. It originated in the early 20th century and was developed by accountans who
were looking to allocate indirect costs to products and services in a systematic way. The
method involves allocating indirect costs, like overhead, to products based on a
predetermined cost driver, such as direct labor or machine hours. The cost driver choice
depends on the assumption that the cost of producing a product or providing a service is
directly proportional to the volume of resources available. While the traditional costing
method is already popular in business, its limitations have become more apparent in the
modern business environment. One of the main limitations is that it needs to consider the
complexity of contemporary production processes. And the diverse range of activities
involved in producing goods and services. This can lead to inaccuracies in cost estimates,
particularly for products that consume different levels of resources. Many companies use
complex costing methods like activity-based costing (ABC). This provides a more
comprehensive and accurate view of cost behaviour. And thus is better suitable for modern
business operations complex and diverse nature.
Materials and methods.
Absorption costing is based on the principle that production
overheads are driven by the level of production. This the because the activity level in the
OAR calculation can be units, labour hours or machine hours. These all increase as the level
of production increases. This was true in the past, because businesses only produced one
single product or a few single and similar products.
INTERNATIONAL JOURNAL OF ARTIFICIAL INTELLIGENCE
ISSN: 2692-5206, Impact Factor: 12,23
American Academic publishers, volume 05, issue 05,2025
Journal:
https://www.academicpublishers.org/journals/index.php/ijai
page 979
Graph 1. Using overheads systems in tradidional manufacturing and modern
manufacturing
The nature of manufacturing has changed. Many companies must now operate in highly
competitive environment and, as a result, the diversity and complexity of products has
increased.
Traditional systems measure accurately volume-related recources that are consumed in
proportion to the number of units produced of the individual products. Such resources include
direct materials, direct labour, energy, and machine-related costs. However, many
organizational recources exist for activities that are unrelated to physical volume. Non-
volume related activities consist of support activities such as, materials handling, material
procurement, set-ups, production scheduling and first item inspection activities. Traditional
product-cost systems, which assume that products consume all activities in proportion to their
production volumes, thus report distorted product costs.
Activity-based costing establishes separate cost pools for support activities such as material
handling. As the costs of these activities are assigned directly to products through cost driver
rates, reapportionment of service department costs is avoided. The use of cost drivers is the
main idea behind ABC as they highlight what causes costs to increase – for example, the
number of orders to suppliers each product incurs. Overheads that do not vary with
volume/output, but with some other activity, should be traced to products using ABC cost
drivers. Traditional costing, on the other hand, allows overheads to be related to products in
more arbitrary ways- therefore producing less accurate product costs
Table 1.
Calculating the full production cost per unit using ABC (there are five basic steps):.
Step 1
Identify the organization`s major activities.
Then can group the production overheads incurred into cost pools according to
INTERNATIONAL JOURNAL OF ARTIFICIAL INTELLIGENCE
ISSN: 2692-5206, Impact Factor: 12,23
American Academic publishers, volume 05, issue 05,2025
Journal:
https://www.academicpublishers.org/journals/index.php/ijai
page 980
how they are driven. A cost pool is a collection of overheads costs assoiated
with each of the specific activities identified.
Step 2
Identify cost drivers for each activity, i.e. what causes the costs related to this
activity to be incurred.
A cost driver is a factor that influences the level of cost.
Step 3
Calculate a cost driver rate for aech activity
The cost driver rate is calculated is the same way as the absorption costing
OAR. However. A separate cost driver will be calculated for each activity, by
taking the activity cost and dividing by the total cost driver volume.
Step4
Absorb the activity costs into the product.
The activity costs should be absorbed back into the individual products.
Step 5
Calculate the full production cost and/or the total profit or loss
To measure the cost of a service and take into account resource costs, the resource used must
be measured-which often means recording time spent. Timesheets allow accountability for
what people are actually doing and for this cost then to be allocated to services. This is a
challenge for the public sector, and for those that wish to use ABC or take a similar approach,
a culture change is definitely required.
Analysys and result.
Absorption-costing, or full costing, has for years been the most
common method of allocating manufacturing overhead. This approach takes the full amount
of manufacturing overhead and spreads it equally across the production volume of all
products. It does not consider that certain products may be responsible for more or fewer
costs from specific activities. Activity-based costing, also known as ABC, deals with this
problem. This methods, actually, have both merits and demerits, such as:
Advantages of Activity-Based Costing:
Provides realistic costs of manufacturing for specific products
Allocates manufacturing overhead more accurately to products and processes that use
the activity
Identifies inefficient processes and target for improvements
Determines product profit margins more precisely
Discovers which processes have unnecessary and wasted costs
Offers better understanding and justification of costs in manufacturing overhead
Disadvantages of Activity-Based Costing:
Collection and preparation of data is time-consuming
Costs more to accumulate and analyze information
Source data isn't always readily available from normal accounting reports
Reports from ABC don't always conform to generally accepted accounting principles
and can't be used for external reporting
Data produced by ABC may conflict with managerial performance standards
previously established from traditional costing methods
May not be as useful for companies where overhead is small in proportion to total
operating costs
Conclusion.
Activity-based costing is a comprehensive cost allocation method. It helps the
management identify cost activities and cost drivers. ABC method serves several purposes
including product costing, pricing, profitability, and customer profitability analysis.
INTERNATIONAL JOURNAL OF ARTIFICIAL INTELLIGENCE
ISSN: 2692-5206, Impact Factor: 12,23
American Academic publishers, volume 05, issue 05,2025
Journal:
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page 981
On the other hand, absorption costing is the conventional costing approach. It adds fixed
overhead costs to the variable costs of production.
The absorption costing method can be suitable for production facilities with little
customization needs. It is ideal for production facilities where a large volume of products is
manufactured for similar products. ABC method is costly, complex, and time-consuming.
Thus, it is only suitable for large production facilities with a lot of customization needs.
Absorption costing takes conventional costing approaches such as marginal costs one step
further. However, it does not help the management in the decision-making.
ABC approach is a comprehensive method of cost allocation. The management can identify
cost drivers and activities that are not direct to product manufacturing. Thus, it can help the
management in product pricing, costing, and product profitability analysis.
The absorption cost method is a widely used and accepted method. It is in compliance with
the accounting standards such as US GAAP rules.
The ABC method is also a widely used method. However, it is not required under accounting
standards such as the US GAAP rules.
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INTERNATIONAL JOURNAL OF ARTIFICIAL INTELLIGENCE
ISSN: 2692-5206, Impact Factor: 12,23
American Academic publishers, volume 05, issue 05,2025
Journal:
https://www.academicpublishers.org/journals/index.php/ijai
page 982
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