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ACTIVITY-BASED ACCOUNTING
Activity Based Costing (ABC) Method

1) INTRODUCTION.

This method is fundamentally different from the traditional method, which is the full cost method.
This traditional method has been criticized for adopting a new approach based on costs, no longer centered on...
the costs specific to the different activities of businesses.
For now, this method is used in Tunisia, in the majority of large companies such as Unilever, Coca Cola, Délice.
Danone, Nestlé, Henkel...

2) ORIGINS OF THE ABC METHOD.

Genesis of the method.

The developments in production methods in many industrial companies tend to make the relevance of
full cost methods. The shortcomings of traditional practices are due to:
- Automation of production processes. With the development of automation of production processes, the
the share of production costs allocated to manufacturing, including direct expenses, is steadily decreasing. From now on, costs
increasingly consist of expenses (indirect costs) related to the operation of services
research, development, management, at the expense of manufacturing services and workshops. logistics activities,
transport, computer science, and quality research have developed significantly. Their costs have increased very sharply. This
It is no longer just the volume of production that explains the evolution of production costs;
- The evolution of indirect costs (their share tends to increase in the total costs when the processes are
automated) and the reduction of the share of direct labor in the cost of products. Choose direct labor as Unit
The distribution work had meaning in that it was representative of the processes established and widely
majority in the cost chain (70% to 80%). Nowadays, this no longer makes sense: on one hand, the MOD activity has
left room for indirect activities and on the other hand, the proportion of the remaining labor force is drastically reduced.
the relationship between direct costs and indirect costs is completely reversed. We speak of a 'reversed cost pyramid'.
- To the decrease in the weight of production activity itself while the support activities of production
become predominant, both upstream and downstream of production (planning, scheduling, research, control
of quality, etc.)

- To the lack of homogeneity of activities within the same analysis center that often groups very diverse activities:
for example, in a supply center, the search for suppliers, the management of purchases and orders,
receipt of goods. However, the allocation of indirect costs is done based on a single unit of work.
The consequence of the uniqueness of the choice of the unit of work has the following consequence: a product consuming one unit.
ignored works in cost calculation bear an underestimated cost allocation, to the detriment of products whose
l’unité d’œuvre principale a été prise en compte. C’est un des effets de subventionnement qui s’exprime ainsi : l’objet de
The cost consuming the most the unit of work retained as the allocation key subsidizes the cost object consuming it.
less
- To the allocation of indirect costs based mostly on volume: costs are attributed based on the time spent.
direct work. That is to say, the variable taken into account in the distribution of indirect costs is the volume of
production. The more a product is manufactured in large quantities, the more it bears the indirect costs. It is unknown that it exists.
other criteria for allocating indirect costs other than production volume. The 'non-volumetric' activities
are neglected in full cost methods. For example, the effect of 'batch size' is overlooked. By practicing a
allocation of indirect costs based on volume, we therefore reduce the cost of small series to overload
the cost of large series. It is another phenomenon of subsidization that expresses itself as follows: large
series subsidize the small ones.
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3) THE CHARACTERISTICS OF THE ABC METHOD

Levels of analysis
In order to understand the reasoning to be adopted for the implementation of the ABC method, it is necessary to know the meaning of the
words used.
The ABC method distinguishes three levels of analysis:
the elementary level of the task,
the intermediate level of the activity,
3) the upper level of the process.
 Task: The task is the first level in the description of work. It does not lead to a cost calculation. Example:
unloading a truck, sorting accounting documents, drafting a letter, etc.
Activity: An activity is defined as a set of basic tasks. The first principle is, first of all, to list all of them.
the value-generating activities and then to assess for each of them, the corresponding cost.
A set of elementary tasks performed by an individual or a group. Homogeneous tasks in terms of performance allowing
to provide a product or service to a customer (external or internal). These tasks are carried out from a set of resources
(materials, hours of work, days worked, ...).

Process: A process is a set of activities necessary to provide a product or service.

Combination of activities utilizing diverse resources and skills and crossing the vertical structures
formal steps aimed at producing an output (product/service) that is valuable for the client (internal or external) and allows for
the company to achieve a certain performance.
Activity-based accounting is based on a cross-sectional view of the company. It seems wise to then break down
The business by activity and not by cost center. Each activity linked with the others contributes to value creation.
generated by the company.

Indirect charges
Step 1

Centre 1 Center 2
Step 2

Activity 1 Activity 2 Activity 3 Activity 4

Step 3

Cost driver Cost driver Cost driver

Step 4

Product A Product B
. Step 1 is identical to that of a traditional cost accounting.
. In step 2, we distinguish, within each center, activities that are sets of tasks presenting a
certain homogeneity. The center's charges are then distributed among these different activities.
* In step 3, we aim to define a cost driver for each activity.
replacing the unit of work). It is an event whose occurrence best explains the consumption of costs.
(resources) by the corresponding activity. The inducer is the unit of measurement of the activity.
. In step 4, we allocate activity costs to cost objects.

The approach used is characterized by:

a breakdown of the costs of existing centers into activities,
the identification of activity units known as 'cost drivers', which can be classified into:
o volume drivers: machine hours, labor hours, kilogram of raw material, etc...
o organization or management inductors: number of series produced, number of orders placed, number
deliveries, etc...
o product or service drivers: number of references, number of suppliers, number of customers, etc...
o characteristics of the company: area, turnover, etc...

Activities with the same inductive are grouped in a 'consolidation center'.

For each center, it is a matter of calculating the unit costs of these inductors by dividing the total cost by the number of inductors.

Indirect costs will then be allocated to the cost prices of products and services based on the costs of the cost drivers.

4) Cost price of products.

 The production costs of the products include:
Direct charges:

o the costs of raw materials, components,

o the costs of direct labor.
Indirect charges:
o the costs of inductors for the different activities carried out.

This activity-based cost approach allows for a better consideration of their economic reality in production processes.
complex and automated.

Remarks:

The activity-based costing method is similar to and differs from the full costing method.
The treatment of direct costs is identical. However, indirect costs go through two levels before being
attributed to the cost of goods:
- analysis center
- activity
2. The distinction between auxiliary centers and main centers becomes unnecessary, which eliminates the secondary distribution of
indirect charges.
3. ABC has the advantage of accurately assigning costs to products without reallocating costs.
indirect costs using a often arbitrary unit of work.
 EXAMPLE.
A company specializes in the manufacturing of two finished products (P1 and P2) from 3 raw materials A, B, and C.
purchased from a supplier.
About a third of the revenue comes from the sale of the finished product P1 to a major client.
Finished products P2 are manufactured and sold to order to a large number of customers.
WORK TO BE DONE:

1) calculation of costs and results according to the full cost method & the ABC method.
2) Compare and comment on the results obtained.

Additional Information:

Raw Materials P1 P2 Unit Purchase Price

A 1 1 25 DT
B 1 2 50 DT
C 1 45 DT

These raw materials go through an Assembly Workshop where they require the following labor times, in minutes:

Finished Products P1 P2
Labor Time 15 minutes 20 min

The hourly wage of direct labor, including social charges, is estimated at 100 DT.

For the first half of year N, the indirect costs are allocated among three analysis centers for the following amounts:

Centers Supply Assembly Workshop Distribution

Total Secondary Distribution 202,500 DT 1 200 000 DT 480,000 DT
Nature of the Unit of Work 1 Purchase Date Material 1 Minute of Labor 1 turnover
First

Sales for the period are as follows:

Finished Products P1 P2
Quantités Vendues 10,000 7,500
Unit Selling Price 180 DT 400 DT

Definition of Activities and Cost Drivers

Center Activity Total Activity Nature of the Cost Driver
1. Supply Market Management (Research of 81,000 DT 1 Purchase Dinar
suppliers, call for tenders, negotiation
Contract tracking.
Reception & Control 121,500 DT Raw material unit
purchased
 Total Indirect Charges Center 202 500 DT
Supply

2. Assembly Workshop Scheduling and Preparation 360 000 DT Number of series put into
fabrication (20 Series for P1)
100 series for P2
Assemblage 840 000 DT Labor Time
Direct
Total Indirect Charges Center 1 200 000 DT
Assembly Workshop

3. Distribution Shipping 180,000 DT Number of series manufactured and

sold (i.e. 120 units)
The Sales Administration 300,000 DT 1 Dinar of Turnover
Total Indirect Charges Center 480 000 DT
Distribution

Calculation of Inductor Costs

Activity Total Charge Nature of the Inductor Volume of Cost of the Inductor
Indirects of the the Inductor
Activity
Market Management 81,000 DT 1 Purchase Dinar 2,025,000 DT 0.04 DT
Reception & Control 121,500 DT The Raw Material Unit 50,000 2.43 DT
purchased
Scheduling and Preparation 360 000 DT Number of series put into 120 4 500DT
fabrication (20 Series for P1)
& 100 series for P2)
Assemblage 840,000 DT Labor Time 300 2.80 DT
Direct
Shipping 180,000 DT Number of series manufactured and 120 4,500 DT
sales (i.e. 120 units)
The Sales Administration 300,000 DT Revenue Dinar 4 800 000 DT 0.0625 DT

Table of Allocation of Indirect Costs

Analysis Center Supply Assembly Workshop Distribution

Total Secondary Distribution 202,500 DT 1 200 000 DT 480,000 DT
Nature of the Work Unit 1 purchase invoice 1 Minute of Labor 1 million in revenue
Direct
Number of Work Units 2,025,000 (a) 300,000 (b) 4,800,000
Cost of the Unit of Work 0,1 4 0.1

(a) Calculation of Total Purchase of Raw Materials in Quantity & Value

Subjects P1 P2 Total
First
Quantity Cost Amount Quantity Cost Amount Quantity Cost Amount
Unitary Unitary Unitary
A 10,000 25 250,000 7,500 25 187,500 17,500 25 437 5000
 B 10,000 50 500,000 15,000 50 750,000 25,000 50 1,250,000
C 7,500 45 337 500 7,500 45 337,500
Total 20,000 75 0000 30,000 1,275,000 50,000 2,025,000

(b) Calculation of Direct Labor Time and Cost

P1 P2 Total
Time by Quantity Rate Amount Time by Quantity Rate Amount Time Amount
Unit Schedule Unit Schedule
15 min 10,000 100 250,000 20 min 7,500 100 250,000 300,000 men 500,000
Hours 2,500 100 250,000 Hours 2,500 100 250,000 5,000 hours 500,000

Calculation of the cost price and the Analytical Result according to the Full Cost Method

Elements P1 P2 Total
Quantity Prix Amount Quantity Price Amount
Unitary Unitary
Direct Charges:

Purchase price 20,000 37.5 750,000 30,000 42.5 1 275 000 2,025,000
Direct Labor 150,000 100/60 250,000 150,000 100/60 250,000 500,000

Indirect Charges:

Supply Center 750,000 0.10 75 000 1,275,000 0.10 127 500 202,500
Assembly Workshop Center 150,000 4 600,000 150,000 4 600 000 1,200,000

Production Cost 10,000 167,500 1,675,000 7 500 300,333 2 252 500 3 927 500
Indirect charges:

Distribution Center 1,800,000 0.10 180,000 3,000,000 0.10 300,000 480,000

 Cost Price 10,000 185.5 1 855 000 7 500 340,333 2,552,500 4 407 500
Turnover 10,000 180 1,800,000 7,500 400 3 000 000 4,800,000
Analytical Result 10,000 -5.5 -55,000 7,500 59,666 447 500 392,000

Calculation of the cost price and Analytical Result according to ABC Method (Activity Based Costing)

Elements P1 P2 Total
Quantity Price Amount Quantity Price Amount
Unitary Unitary
Direct Charges:

Purchase price 20,000 37.5 750,000 30,000 42.5 1,275,000 2,025,000

Direct Labor 150,000 100 over 60 250,000 150,000 100/60 250,000 500,000

Indirect Charges:

Market Management 750,000 0.04 30,000 1,275,000 0.04 51,000 81,000

Reception & Control 20,000 2.43 48 600 30,000 2.43 72,900 121 500
Scheduling and Preparation 20 4,500 90,000 100 4,500 450,000 540,000
Assemblage 150,000 2,80 420,000 150,000 2.80 420,000 840,000
Shipping 1 800 000 0.0625 112,500 3,000,000 0.0625 187 500 300,000

Cost Price 10,000 170,110 1,701,100 7,500 360 , 850 2,706,400 4,407,500
Chiffre d’Affaires 10,000 180 1,800,000 7 500 400 3,000,000 4,800,000
Analytical Result 10,000 9,890 98,900 7,500 39,146 293,600 392,000

COMPARISON AND COMMENTARY ON THE OBTAINED RESULTS

With the activity-based costing method, the result appears more balanced between the two products. Activity-based accounting
allows for a better representation of the economic reality of costs in production companies.
CONCLUSION.

Activity-based costs are more relevant for various reasons:

The allocation of indirect costs is more credible as it better reflects the consumption of the various resources.
It better takes into account the complexity of production processes and the multiplicity of activities.
It better represents the complexity of certain products (many components, production batches),
It avoids the drawback of the classic method that sometimes involves the "subsidizing of a product in favor of a
other.