ACTIVITY BASED

COSTING

What is A B C
Innovative method against the conventional system of
costing.
Used for accurately allocating overheads to products and
services.
In ABC multiple activities are identified in production
process that is associated with the incurrence of costs.
Cost of a product is the sum of the costs of all activities
required to manufacture and deliver the product.
Products do not consume costs directly.

Basics of A B C
ABC assigns Costs to Products by tracing expenses to
activities. Each Product is charged based on the extent to
which it used an activity
The primary objective of ABC is to assign costs that
reflect/mirror the physical dynamics of the business
Provides ways of assigning the costs of indirect support
resources to activities, business processes, customers,
products

OBJECTIVES OF ABC
To Improve Product Costing
To identify non-value adding activities in the production
process
To provide required information for decision making
To reduce the nonessential use of common resources
To encourage managers to evaluate the efficiency of services
To calculate full cost of products for financial reporting
purpose

Steps in Activity Based Costing

Identify activities
Activities are the major tasks or group of tasks involved in
the production process. These are associated with the cost of
operation or job.

Relating costs to activities

Costs are related to cost pools for different activities. Cost
driver trace the cost in two stages
a) The activity that generate cost
b)Cost driver trace the cost pools into product costs

Determine cost driver for activity

Cost drivers are identified for activities called activity
drivers. There are events within activities that cause costs
E.g. For purchasing materials, inviting quotations, placing
orders, receiving, inspection etc.

Estimate application rate

A predetermined rate is calculated for each activity driver
by dividing the cost pool by the estimated level of activity.

Applying Cost to Products & Jobs

It is done by multiplying the application rate by the usage
of the activity driver for producing the product.

ABC: ADVANTAGES

It helps in detailed analysis of activities

Helps to reorganize activities and reduce those activities that do

not add value to the product

To ascertain product costs more accurately

Provides comprehensive cost data to management for decision

making

Help management in strategic planning, decision making and

control of costs.

helps better performance evaluation of managers.

ABC: DISADVANTAGES

It is based on historical costs and is not helpful for future

planning.

No classification of cost into fixed and variable, which is

relevant for short run decisions

More lengthy and costly compared with the traditional costing

system

Cost allocation will be arbitrary if the cost drivers selected are

not associated with the factors that cause costs.

ABC: WHERE TO USE?

High Overheads

Product Diversity or Multiple Products

Customer Diversity

Service Diversity

Stiff Competition

THANK YOU