Activity–Based Costing (ABC)
Activity-based costing (ABC) is a costing ABC is a
method that assigns overhead and indirect good supplement
costs to related products and services. to our traditional
ABC is designed to provide managers with cost system
cost information for strategic and other
decisions that potentially affect capacity, and I agree!
therefore, affect “fixed” as well as variable
costs.
This accounting method of costing recognizes
the relationship between costs, overhead
activities, and manufactured products.
Activity-Based Costing (ABC)
An event that causes the
Activity consumption of overhead
resources
A “cost bucket” in which
Activity costs related to a particular
Cost Pool activity are accumulated
Activity An allocation base in an
activity-based costing
measure system
Activity-Based Costing (ABC)
Model
Cost Objects
(e.g., products Activities
and customers)
Consumption
of Resources
Cost
Traditional Costing System
Product Costs
Direct labor Direct labor and direct materials
Direct materials are easy to trace to products.
The problem comes with factory
Factory Overhead overhead.
Period Costs
Administrative expense
Sales expense
Typically used one rate to allocate overhead to products.
This rate was often based on direct labor dollars, direct
labor hours or machine hours used.
This made sense, as direct labor was a major cost driver in
early manufacturing plants
Traditional Costing System
Advantages:
All manufacturing costs are classified as material, labor, or
overhead and assigned to products regardless of whether they
drive or are driven by production.
Offers accurate cost figures with large production volumes
Cheap to implement
Still able to tract all direct costs
There is only one overhead cost pool and a single measure of
activity
Disadvantages:
Weak in comparison to allocation through multiple cost drivers.
Use of single cost driver may under-allocate or over-allocate.
Does not account for non-manufacturing costs.
Differences Between ABC and
Traditional Product Costs :
Cost Pools
Applied
Focus
Rate
Differences
Cost
Suited for
Assignment
Benefits
Problems with Traditional
Costing Systems
Manufacturing processes and the products they produce
are now more complex.
This results in over-costing or under-costing.
Complex products are not allocated an adequate amount
of overhead costs.
Simple products get too much.
When do we use ABC costing?
When one or more of the following
conditions are present:
Product lines differ in volume and manufacturing
complexity. For e.g. The manufacturing process
has changed significantly from labor intensive to
capital intensive automation.
Product lines are numerous and diverse, and they
require different degrees of support services.
Overhead costs constitute a significant portion of
total costs.
When do we use ABC costing?
The manufacturing process or number of products has
changed significantly—for example, from labor intensive
to capital intensive automation.
Production or marketing managers are ignoring data
provided by the existing system and are instead using
“bootleg” costing data or other alternative data when
pricing or making other product decisions.
Level of Activities in ABC
i. Unit-level activities: Activities performed for each unit of
production.
ii. Batch-level activities: Activities performed for each of batch of
products.
iii. Product-level activities: Activities performed in support of an entire
product line.
iv. Customer-level activities: Activities related to specific customer
v. Organization-sustaining activities: Activities carried out irrespective
of which products, which customers, etc.
Steps for implementing ABC
Define activities, activity cost pools, and activity
measures: Identify the activities that will form the
foundation for the system.
Assign overhead costs to activity cost pools.
Calculate activity rates.
Assign overhead costs to cost objects using the activity
rates and activity measures.
Prepare management reports.
ABC Limitations
Substantial resources Resistance to
required to implement unfamiliar numbers
and maintain. and reports.
Desire to fully Potential
allocate all costs misinterpretation of
to products. unfamiliar numbers.
Does not conform to
GAAP. Two costing
systems may be needed.
THANK YOU!
