Efficiency based absorption costing

Efficiency-based absorption costing (EBAC) is the discipline of accounting, which is concerned with establishing methods or techniques to allocate fixed costs to each product or service an organization produces. EBAC (Samuel et al. 2009) is an alternative or even improved technique of absorption compared to previous established techniques as it takes into account the different level of overhead use efficiency of products. EBAC highlights the problem with use of the single standard absorption rate to allocate fixed costs to products. The single standard absorption rate was used for simplicity purposes (Steve R. and Ken 1994; Gunasekaran et al. 1999). However, it ignores the different level of efficiency of each product or service in incurring the fixed cost and as a result, a high degree of cross subsidization occurs between more efficient and less efficient products and services. In a nutshell, EBAC focuses on the efficiency aspect by identifying the products’ different level of overhead utilization efficiency.

The EBAC first coined by Samuel et al. (2009) uses efficiency as the main determinant to calculate the absorption rate. Efficiency is defined here as the ratio of input required to produce an output. An output or product or service is efficient if it requires lesser input to produce a given number of outputs. For example if Product A needs 200 set ups to produce 100 of its units and Product B needs 50 set ups to produce 100 of its units, Product B is more efficient. This is because Product B needs lesser input or drivers to produce a given number of outputs.

EBAC is a methodology that is both easy and convenient to apply. Firms using ABC could instantly explore the alternative and improved EBAC as no new data collection effort is required. The use of EBAC as compared to earlier established methods results in key changes in host of pertinent cost control and decision making scenario business face like to make or buy, to accept or reject a special order, to continue or shut down a cost/revenue centre, how much to price products and services and how much resources to allocate to different products and establish output volume levels.