ACTIVITY BASED COSTING(ABC)

VALUE CHAIN ANALYSIS

TARGET COSTING
LIFE CYCLE COSTING
 Activity based costing(ABC) is a technique of
apportionment of overhead incurred for production produce
to the cost centre using suitable basis. This system allocates
the overhead cost at a uniform rate on the basis of labor hour
or machine hour worked. It doesn’t consider those activities
which are involved in the production process. It focuses on
analysis, recording, controlling and reporting on the cost and
wider performance of activities rather than the traditional
system.
ABC is defined as “Cost attribution to cost units on the
basis of benefits received from indirect activities e.g.
Ordering, setting-up, assuring quality.
-------------- CIMA
• Thus ABC can be defined as a method of charging
overhead to cost centers or cost units on the basis of
benefits received from the particular indirect activity
.Under ABC, overhead are attributed to products on
an activity base. It also attempts to show relationship
between overhead costs and the activity that cause
the costs.
 OBJECTIVES OF ACTIVITY BASED COSTING
1. To identify value added activities in transactions.
2. To focus high cost activities.
3. To distribute overheads on the basis of activities.
4. To identify the opportunities for improvements
and reduction of costs.
5. To validate the success of the quality drive with
ABC.
6. To ensure accurate product costing for decision
making.
7. To use information to improve product mix and
pricing decisions.
LEVELS OF ABC
1. Unit level activity

2. Batch level activity

3. Product level activity

4. Facility level activity

 STEPS IN ABC SYSTEM
The major steps in ABC system are;
1. STEP 1------ Process specification
2. STEP 2------ Identify main activities
3. STEP 3------ Identify non value adding activity
4. STEP 4------ Identification of activity cost pools.
5. STEP 5------ Selection of activity cost drivers
6. STEP 6------ Tracing of cost with cost objects
7. STEP 7------ Staff training
8. STEP 8------ Review and follow up
 ADVANTAGES OF ABC SYSTEM
1.It is more flexible and can be change immediately if
needed.
2.It shows the cause and effects of relationship
between cost and activity which is useful in
controlling the cost.
3.By adopting ABC, it is possible to asvertain most
accurately and realistic product cost.
4.It helps in fixing of competitive selling price.
5.Information regarding capacity utilisation is
available for decision making.
 LIMITATION OF ABC SYSTEM
1. It is a complex system which consists of various cost
pools and cost driver rates
2. It is difficult to attribute cost to single activities,
some cost support several activities.
3. ABC requires total commitment and support from
top level management.
4. Implementation of ABC requires bulk amount of
time and money.
5. ABC requires positive attitudes and employees
support for successful implementation.
 VALUE CHAIN ANALYSIS(VCA)
• Value chain analysis is a strategic managerial tools to
assess and review the various business functions in which
utility is added to the products or services. The various
business functions include research and development,
product design, services or process, production,
Marketing, distribution, customer service and strategy
and administration.
• The chain of activities that is performed to add value
to inputs in order to arrive at the final outputs is referred
to as value Chain. The value chain is a tool developed by
DR. MICHEAL PORTER. The value chain is concentrating
on the activities starting with raw materials till the
conversion into final goods.
PORTER classified value chain into two activities. They
are :
1) Primary Activities
a. Inbound logistics
b. Operations
c. Outbound logistics
d. Marketing & sales
e. Services
2) Secondary activities
a) Infrastructure
b) Human resource management
c) Technology development
d) Procurement
 ADVANTAGES OF VALUE CHAIN ANALYSIS

1. Helps to stay out of the “No profit zone”

2. Presents opportunities for integration
3. Aligns spending with value process
4. Helps to examine the activities of a firm’s and how
they interact with one another and affect each
other’s cost and performance.
 LIMITATION OF VALUE CHAIN ANALYSIS
1. Finding the costs, revenues and assets for each
value chain activity gives rise to serious difficulties.
2. Value chain analysis is very difficult to understand
by all the employees and hence may face
resistance from employees as well as managers.
3. For a long term strategic decision making in cost
structure, market price and capital investment may
not be available because data of company
provided is of a single period financial information.
 TARGET COSTING
• Target costing is the cost that can be incurred
while still earning the desired profit.
Target cost = Selling price – desired profit
“The Target costing is a disciplined process for
determining and achieving a full stream cost at which
a proposed product with specified functionality,
performance and quality must be produced in order
to generate the desired profitability at the products
anticipated selling price over a specified period of
time in the future.”
• METHODS IN ESTABLISHMENT OF TARGET COSTS
1. Subtraction methods
2. Addition methods
3. Integrated methods
• ADVANTAGES OF TARGET COSTING
1. Proactive approach to the management
2. Break down barriers between departments
3. Minimize non value added activities
4. Reduced time to market
5. Foster partnerships with suppliers
• DISADVANTAGES OF TARGET COSTING
1. Target costing requires many meeting for
coordination.
2. It’s implementation requires willingness to
cooperate
3. May reduce the quality of products due to use
cheap components which may be inferior quality
4. Effective implementation and use requires detailed
data.
 LIFE CYCLE COSTING
• Life cycle costing is defined as the total cost
throughout its life including planning, design,
acquisition, support cost and other cost directly
attributable for owing the assets.
• In other words the process of identifying and
documenting all the costs involved over the life of an
assets is known as life cycle costing.
• The cost under life cycle cost are:
1. Acquisition cost
2. Operating cost
 •Cost of failures
•Cost of repairs
•Cost of spares
•Loss of production
3. Maintenance costs
*Cost of corrective maintenance
*Cost of preventive maintenance
*Cost of predictive maintenance
4. Disposal costs
 IMPORTANCE OF LIFE CYCLE COSTING
1. Helps to make decisions for capital and investment
based on least life cycle costs.
2. Rank each of the projects based on total costs of
ownership
3. Makes more informed decisions.
4. Allow better reporting to key stakeholders.
5. Higher level of yields from the project.
 LIFE CYCLE OF AN ASSETS
1. Plan
2. Acquire
3. Operate
4. Maintain
5. Renew
6. Dispose
• ADVANTAGES OF LIFE CYCLE COSTING
1. Improved forecasting
2. Improved awareness
3. Performance trade off against cost
• DISADVANTAGES OF LIFE CYCLE COSTING
1. Time consuming
2. Costly
3. Technology