Activity Based Costing

Requirement of Cost
Systems
Ø Valuation of inventory and
measurement of the cost of goods
sold for financial reporting.
ØEstimation of the costs of activities,
products, services, and customers.

ØProviding economic feedback to

managers and operators about process
efficiency.
Activity Based Costing.
vABC developed in the manufacturing
sector of the United States during
1970s & 1980s.
vFirst time Clearly defined by Robert s.
Kaplan & W. Bruns.
vActivity based costing is an accounting
methodology that assigns costs to
activities rather than products or
services .
vThis enables resource and overhead
costs to be more accurately assigned to
the products and the services that
consume them.
Today’s businesses are working in
an increasingly complex
environment.
Use of Advanced Technology

Product Life Cycle

Product Complexity
Channels of Distribution
Quality Requirements

Product Diversity
ABC systems addresses the
following Questions:

Ø What activities are being performed

by the organizational resources?
Ø How much does it cost to perform
activities?
Ø Why does the organization need to
perform those activities?
Ø How much of each activity is
required for the organization's
products, services, and customers?
Building an ABC Model
Identify Identify Identify
Resources Activitie Cost
s Objects

Define Define
Activity Resourc
Drivers e
Drivers

Enter Enter Enter

Resourc Resource Activity Calculat
e Driver Qty. Driver Qty. e
Costs Costs
 ABC Steps
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 rates.
A B C Steps : How?
Cost pools are groups
Steps: or categories of
individual expense
1.Form cost pools items

2.Identify activities
3.Map resource costs to
activities
4.Define activity cost drivers
5.Calculate cost
A B C Steps Cont…….
q ABC assigns Costs to Products by
tracing expenses to “activities”.
Each Product is charged based on
the extent to which it used an
activity.
q The primary objective of ABC is to
assign costs that reflect/mirror the
physical dynamics of the business
Activities: Types
vUnit level: Performed each time
a unit is
produced.
vBatch level: Performed each time
a batch is
produced.
vProduct level: Performed to support
production
of different type of
product.
v Customer Level: Performed to
Define activity drivers
 The linkage between activities and
cost objects, such as products,
customers,, is accomplished by using
activity drivers.
 An activity driver is a quantitative
measure of the output of an activity.
 The selection of an activity driver
reflects a subjective trade-off
between accuracy and cost of
measurement.
.
 Advantages of ABC
Ø More accurate .
Ø Understand how costs are actually consumed .
Ø Support Strategic Decisions.
Ø Identify cause and effect relationship to objectively
assign cost.
Implementation restrictions

Ø Require proper planning and a commitment from

upper management.
Ø Run the risk of spending too much time, effort, and
even money on gathering and going over the data
that is collected .
ABC: Where to Use?
ü High Overheads.
ü Product Diversity or Multiple
Products.
ü Customer Diversity.
ü Service Diversity.
ü Stiff Competition
Thank you.