Activity-Based Costing

Arun Varghese
S3 MBA
MACFAST
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Introduction
 ABC developed in the manufacturing sector
of the United States during 1970s & 1980s.
 First time Clearly defined in 1987 by Robert s.
Kaplan & W. Bruns.
 Activity based costing is an accounting
methodology that assigns costs to activities
rather than products or services .
 This enables resource and overhead costs to
be more accurately assigned to the products
and the services that consume them.
Meaning & Definition

 “A method of measuring the cost and

performance of activities and cost objects”
 “It may be defined as a technique which
involves identification of cost with each cost
driving activity and making it as the basis of
absorption of costs of over different products
or job”

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Overview of ABC

 Identifies activities required to produce the

product or service
 Determines the cost of the activities
 Allocates costs to the cost object based on
the object’s consumption of activities

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Significant Terms

 Cost objects: products ,customers, services

or location
 Activivities:aggregate of different task that are
concerned with functions associated with cost
objects
 Cost pools :an activity cost centre
 Cost drivers:the cost of incurrence of
overhead cost is known as cost drivers
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Steps in ABC
1.Identify activities and resources
2. Measure the costs of resources used to
perform each activity.

3. Determine cost drivers and resource-

consumption rates .

4. Assign activity costs to products by

multiplying the use of the cost drivers by the
resource-consumption rate
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Steps in ABC

5.Determining activity hierarchies

 Unit level activities
 Batch level activities
 Product sustaining activities
 Facility sustaining activities

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Steps in ABC

7. Identifying outputs
8.Selecting suitable cost drivers
9.Computing cost driver rates
10.Identifying cost of the products
11.Test Run

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 Building an ABC Model
Identify Identify Identify
Resources Activities Cost Objects

Define Define
Activity Resource
Drivers Drivers

Enter Enter Enter

Calculate
Resource Resource Activity
Costs
Costs Driver Qty. Driver Qty.
Advantages of using ABC
 Activity based costing brings accuracy and reliability in
product cost determination by focusing on cause and effect
relationship in the cost incurrence.
 Managers manage activities and not products. The changes in
activities leads to changes in costs. Therefore if the activities
are managed well ,costs will fall and resulting product will be
more competitive.
 ABC highlights the problem areas that deserves the
managements attentions and more detailed analysis.
 ABC system is used in setting priorities for action.
 Makes “Indirect” expenses “Direct”.
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Drawbacks of ABC
 ABC fails to encourage managers to think about changing work processes
to make business more competition.
 ABC is not conformed to generally accepted accounting principles in same
area.
 Using ABC for short run decisions may sometimes prove costly in the long
run.
 ABC does not encourage the identification and removal of constraints
creating delays and excesses.
 An over emphasis on cost reduction with out regard to the constraints does
not create an environment for learning about the problems and
management.

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Activity-Based Costing

 Traditional allocation method

Costs Products

 Activity-based allocation method

Costs Activities Products

First stage Second stage

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Traditional
 use cost allocation methods
 do not focus on where or why costs occur.
 provide little insight into the causes of variances.
 report information that is accounting-oriented, inaccurate, not flexible
and not timely.
 are not easily understood by operational managers, since the focus
is fiscal.
 do not associate the cost of a product or service with the actual
effort expended

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Abc
 is based on ACTUAL performance, consumption and expense data
extracted from the organization’s existing information systems and
combined with the knowledge of those directly involved in the
delivery of the product or service.
 assigns costs to activities based on the resources they consume.
 provides insights into the sources of costs and the possible impact
of different decisions.
 provides the information required to take action and realize
performance breakthroughs.

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THANK YOU

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