Module 11
ACTIVITY BASED COSTING
Dr. Varadraj Bapat
Activity Based Costing
(ABC)
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•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
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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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• facilitates opportunities for cost
control.
• permits comparison of different
options; and
• enables strategic decision
making.
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The Concept of ABC
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Activity-Based
Costing
Departmental
Overhead i ty
Rates ex
p l
o m
Plant-wide f C
Overhead lo e
v
Rate Le
Overhead Absorption
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The Concept of ABC
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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
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ABC is a costing system,
which focuses on activities
performed to produce
products.
ABC relates cost (resources
consumed) to work
accomplished (outputs
produced).
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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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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
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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
ABC’s 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.
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Treatment of
Costs under ABC
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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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ABC’s Basic Steps
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1 . Analyze activities.
2 . Gather cost data.
3 . Trace costs to activities.
4 . Establish output measures.
5 . Analyze costs.
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ABC’s Basic Benefits
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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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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
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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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Cases of overstated costs and
under-stated margins and
mistakes in pricing and other
critical decisions.
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Activity Based
Management
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Activity based management involves
any use of ABC information to support
the organization’s strategy, improve
operations, or manage activities and
their resulting costs.
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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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Relation ABC and ABM
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Cost Assignment View
Resource costs ABM
Process View
Activity Analysis Activity Evaluation
Root Activity Performance
Causes Triggers Measures
Activities
Cost Objects
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Eliminating non-
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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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ABM seeks to satisfy
following customers needs
•Lower costs
•Higher quality
•Faster response time
•Greater innovation
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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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Customer Profitability
Analysis
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A costly customer is one:
Demands
Orders faster
small service
quantities
Requires
special
packaging
Often
changes Orders
orders frequently
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