Module 11

ACTIVITY BASED COSTING

Dr. Varadraj Bapat

Activity Based Costing
(ABC)
2

Concept of ABC
Traditional Costing V/s ABC
Treatment of cost under ABC
Steps of ABC
Benefits
Limitations
Activity Based Management: ABM
Relation between ABC & ABM
Dr. Varadraj Bapat
Reasons to choose the
right way of costing
3

In business, arriving at the

correct cost is very important,
because it:
identifies money-makers and
money losers;
finds an economic break-even
point;
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4

facilitates opportunities for cost

control.
permits comparison of different
options; and
enables strategic decision
making.

Dr. Varadraj Bapat

The Concept of ABC
5

Activity-Based
Costing
Departmental
Overhead i ty
Rates ex
pl
o m
Plant-wide fC o
Overhead e l
v
Rate Le
Overhead Absorption
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The Concept of ABC
6

Overhead Absorption
Departmental Department D1 OH
Overhead Rate = Overheads
Rates Apportioned /
Machine Hours

Plant-wide Plant OH Rate =

Overhead Overhead Cost /
Rate Machine Hours
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 Introduction
7

ABC is a costing system,

which focuses on activities
performed to produce
products.
ABC relates cost (resources
consumed) to work
accomplished (outputs
produced).
Dr. Varadraj Bapat
8

ABC is a management tool that

provides better allocation of
resources.
The ABC or unit cost goal is a
benchmark that represents an
expectation of the cost
incurred for the production of
an output.
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9

ABC aligns costs to outputs

thereby increasing cost
visibility, and is useful in
forecasting financial
baselines.
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 Traditional
Costing V/s ABC
10

ABC Traditional

Resources Everything in Resources

Organization

Consume Traced by Resource Allocate

Drivers
What is actually
Activities being done Cost Centre

Consume Traced by Activity

Drivers
-Products/Services - Products
Objects Objects
- Customers - Services
- Etc
 ABCs Basic Premise
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Cost objects consume activities.

Activities consume resources.

This consumption of resources is

what drives costs.

Understanding this relationship is

critical to successful budget

management.
Dr. Varadraj Bapat
 Treatment of
12
Costs under ABC
In ABC, products are assigned the
overhead costs that are supposed to
be related to the allocation base.
Non-manufacturing costs

Manufacturing costs

Plant wide Overhead Rate

Departmental Overhead Rates

Costs of idle capacity

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 ABCs Basic Steps
13

1 . Analyze activities.
2 . Gather cost data.
3 . Trace costs to activities.
4 . Establish output measures.
5 . Analyze costs.

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 ABCs Basic Benefits
14

Makes it possible to determine

production cost traced to
outputs.
Targets areas needing
management attention.
Encourages the consideration of
alternative methods of
production.
Highlights operational efficiency.
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15

Identifies financial benchmarks

for activity performance.
Generates more information to
measure and reward
performance, and prioritizes
activities for cost reductions.
Provides a common managerial
framework among support
activities.
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 Limitations of ABC
16

Trade-off between expense and

accuracy.
Need for more precise data

Need of full support of top level

management, and support of

ABC based performance review.
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17

Cases of overstated costs and

under-stated margins and
mistakes in pricing and other
critical decisions.

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 18

Activity Based
Management
18

Activity based management involves

any use of ABC information to support
the organizations strategy, improve
operations, or manage activities and
their resulting costs.

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 19

19

Activity Based Costing

establishes relationships between
overhead costs and activities so that
we can better allocate overhead
costs.
Activity-based management
focuses on managing activities to
reduce costs.
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 20

Relation ABC and ABM

20

Cost Assignment View

Resource ABM
Resource costs
costs
Process View
Activity Analysis Activity Evaluation

Root
Root Activity
Activity Performance
Performance
Causes
Causes Triggers
Triggers Measures
Measures
Activities

Cost
Cost Objects
Objects
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 21

Eliminating non-
21
value added costs
using ABM

Identifying Activities
Identifying non-value added activities
Understanding activity linkage, root
causes and triggers
Establishing performance measures
Reporting non value added costs
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 22

22

ABM seeks to satisfy

following customers needs
Lower costs
Higher quality
Faster response time
Greater innovation

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 23

23

Customer
Profitability Analysis

Customer profitability analysis

uses activity-based costing to
determine the activities, costs and,
profit associated with serving
particular customers.
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 24
Customer Profitability
Analysis
24

A costly customer is one:

Demands
Orders faster
small service
quantities
Requires
special
packaging

Often
changes Orders
orders frequently

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