Activity+Based+Costing

8/9/2019 Activity+Based+Costing

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What?

Why?How?

7/31/2010Chandrakant@SOM,KIIT University1

Activity Based Costing


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Requirement of Cost Systems

Valuation of inventory and measurement of the cost of

goods sold for financial reporting.

Estimation of the costs of activities, products,services, and customers.

Providing economic feedback to managers andoperators about process efficiency.

7/31/2010ACHAL ABHAY,KIIT University

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Todays businesses are working in an increasingly complex

environment.

Use of Advanced Technology

Product Life Cycle

Product Complexity

Channels of Distribution

Quality Requirements

Product Diversity



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0

100

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Composition of Cost

Direct Material Labour Overheads



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Conventional Costing Total Cost = Material + Labour+ Overheads Overheads are allocated to the products on volume based

measures e.g. labour hours, machine hours, unitsproduced

Will this not distort the costing in the new

environment?

ABC provides an Alternative.

7/31/2010Chandrakant@SOM,KIIT University

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Conventional Costing

Expenses

Cost Objects

AB Costing

Resources

Activities

Cost Objects

Economic

Element

WorkPerformed

Product orservice

7/31/2010Chandrakant@SOM,KIIT University

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Basics of A B C 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

Money is spent on activities

Activities are consumed by product/services



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Basics of A B C (contd.) 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 thatreflect/mirror the physical dynamics of the business



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Basics of A B C (contd.) Provides ways of assigning the costs of indirect support

resources to activities, business processes, customers,

products. It recognises that many organisational resources are

required not for physical production of units of productbut to provide a broad array of support activities.



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ABC systems addresses the following

Questions:


y What activities are being performed by theorganisational resources?

y How much does it cost to perform activities?

y Why does the oranisation need to perform thoseactivities?

y How much of each activity is required for theorganisations products, services, and customers?


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Basics of A B C : How?Steps:

1. Form cost pools

2. Identify activities

3. Map resource costs to activities

4. Define activity cost drivers5. Calculate cost

Cost pools are groups orcategories of individual expenseitems



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Activity Cost Pools


y Under ABC, costs are grouped into pools, according to theactivities which drive them e.g. cost pool may be ofprocurement of goods, in this all costs associated withordering, inspection, storing ,etc would be included in this cost

pool.y Cost pools are similar to cost centers in traditional cost

systems.


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Identify Activities


In developing an ABC system, the organization

identifies the activities being performed. An

aggregate of closely related tasks is called as an

Activity.

Move material

Schedule production

Purchase material

Inspect items

Respond to customers

Improve products

Introduce new products

Explore new markets

Activity Dictionary


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Map resource costs to activities


y Financial accounting categorises expenses by spending code;salaries, fringe benefits, utilities, travel, communication,computing, depreciation etc.

ABC collects expenses from this financial systemand drive them to the activities performed.


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Activities: Types Unit level: Performed each time a unit is

produced. E.g. Energy, Repairs.

Batch level: Performed each time a batch isproduced. E.g. Setup-hours, Procurement costs

Product level: Performed to support production of differenttype of product. E.g. Design cost, engineering cost.

Customer Level: Performed to support servicing customers

Facility level: Residuary head. E.g. rent, building security



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Define activity drivers


y The linkage between activities and cost objects, such asproducts, customers,, is accomplished by using activitydrivers.

y Any factor which causes a change in the cost of an activity.

y ABC system is based on the belief that activities cause costsand a link should therefore be made between activities andproducts by assigning costs of activities to products based onan individual products demand for each activity.


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Building an ABC Model

Identify

Resources

Identify

Activities

Identify

Cost Objects

Define

Resource

Drivers

Define

Activity

Drivers

Enter

Resource

Costs

Enter

Resource

Driver Qty.

Enter

Activity

Driver Qty.

Calculate

Costs



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ABC: Where to Use?


y High Overheads

y Product Diversity or Multiple Products

y Customer Diversity

y Service Diversityy Stiff Competition

Activity+Based+Costing

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