Activity Based Costing
Uploaded by
Sudeep D'SouzaActivity Based Costing
Uploaded by
Sudeep D'SouzaActivity Based Costing
Activity Based Costing (ABC) is a
managerial accounting system which
determines the cost of activities
without distortion and provides
management with relevant and timely
information. It does not represent just
a new set of overhead allocation rules
or techniques to value inventory. ABC
represents a way to look at operating
costs and provides methods to dissect
the underlying activities, which cause
costs to exist.
~ Allan G. Dunn, President of GDI
By Sudeep D’Souza
An Introduction to ABC
• ABC focuses on the Activities performed to produce products.
• Products create the demand for activities
• Costs are charged based on the individual products use of
each activity unlike the traditional system where the costs are
charged based on departments or plants.
• The cost unit for ABC is Cost / Activity
Resources or
Activities Products
factors
ABC can be used in both the Manufacturing
and Services organizations.
Steps in allocating overheads in ABC
Identify Main Material handling, purchasing, receipt,
Activities dispatch, assembly etc.
Identify Cost Number of Purchase orders, No. of Orders
Factors, Drivers Delivered, No. of setups
Collect costs of Cost pools which are directly equivalent to
each activity conventional cost centers.
Charge On basis of usage of activity expressed in
Overheads terms of cost driver.
from Cost Management by Jawahar Lal et al.
Allocating overheads in ABC an example
A company manufactures 2 products furnishes the following data for a year
Product Annual Output Total Machine Total Number of Total number of
(units) hours Purchase orders Setups
A 5,000 20,000 160 20
B 60,000 1,20,000 384 44
The annual overheads are as follows:
Volume related activity costs Rs. 5,50,000
Set-up related costs Rs. 8,20,000
Purchase related costs Rs. 6,18,000
from Cost Management by Jawahar Lal et al.
Traditional Method
Volume related activity costs Rs. 5,50,000
Set-up related costs Rs. 8,20,000
Purchase related costs Rs. 6,18,000
Total Cost Rs. 19,88,000
Total M/c hours (20,000+1,20,000) 1,40,000
Total Cost /hr (19,88,000/1,40,000) Rs. 14.20
Cost per unit of A (20,000x14.20/5,000) Rs. 56.80
Cost per unit of B (1,20,000x14.20/60,000) Rs. 28.40
Activity Based Costing Method
Volume related activity cost / machine hr (5,50,000/1,40,000) Rs. 3.9286
Set-up cost /setup (8,20,000/64) Rs. 12,812,50
Purchase related costs per purchase order (6,18,000/544) Rs. 1136.02
Particulars Cost Driver A B
Volume related costs Machine hours Rs. 78,572 Rs. 4,71,432
Set-up costs Number of Setups 2,56,240 5,63,728
Purchase related costs Number of Purchase orders 1,81,765 4,36,235
Total Costs 5,16,577 14,71,395
Cost / unit Rs. 103.32 Rs. 24.52
Cost in traditional method Rs. 56.80 Rs 28.40
Differences Between Traditional and ABC
Traditional Activity-Based Costing
Uses from one to three volume Uses activity based multiple cost
based cost drivers drivers(including both volume
and non volume based)
Assigns overhead costs first to Assigns overhead costs first to
departments and then to activities and then to products
products and services and services
Focuses on management Focuses on processes and
responsibility for costs within activities for cross-functional
department problem solving
from Cost Management 2e by Edward J. Blocher et al.
Benefits of ABC
• ABC provides more accurate and informative product costs, which lead to
more accurate product profitability measurements and to better-informed
strategic decisions about pricing, product line and capital expenditure.
• ABC provides more accurate measurements of activity driven costs, which
helps managers improve product and process value by making better
product design decisions and controlling costs better.
• ABC provides managers easier access to relevant costs for making
business decisions, enabling them to take a more competitive position.
from Cost Management 2e by Edward J. Blocher et al.
Limitations of ABC
Allocations: Even if activity data are available, some costs probably
require allocations to departments and products because finding a
specific activity that causes the incurrence of the cost may not be
practical. E.g. cleaning the factory and managing the production process.
Omission of Costs: ABC omits some costs identified with specific
products. Activities that cause such costs include marketing, advertising,
R&D, etc. The individual costs would simply be traced to individual
products and added to the manufacturing cost to determine the total
product cost.
Expense and Time: An ABC system is very expensive to develop and
implement and also time consuming.
from Cost Management 2e by Edward J. Blocher et al.
from Cost Management by Jawahar Lal et al.
Case Study on ABC Analysis
Fasteners Ltd. produces 4 products A,B,C & D, details of which are given below.
Product A B C D
Output (units) 120 100 80 120
Cost / unit (Rs)
Direct Material 40 50 30 60
Direct Labour 28 21 14 21
Machine hours 4 3 2 3
The 4 products are similar and are usually produced in production runs of 20 units
and sold in batches of 10 units.
Production Overheads
Cost Pool Overhead (Rs.) Cost Driver
Factory Work Expenses 20,860 Machine Hours
Set up Costs 10,500 No. of production runs
Stores receiving 7,200 Requisitions raised
Inspection / Quality control 4,200 No. of production runs
material handling and dispatch 9,240 No of orders executed.
The number of requisitions on stores was for 20 of each product and the number of
orders executed was for 42, each order being for a batch of 10 of a product.
Cost / unit of Drivers
Total Overheads Rs. Driver No. Cost / Unit
Factory Work Expenses 20,860 Machine hrs 1300 16.05
Set up Costs 10,500 Production Runs 21 500.00
Stores receiving 7,200 Requistions 80 90.00
Inspection / Quality control 4,200 Production Runs 21 200.00
material handling and dispatch 9,240 Orders 42 220.00
Cost Sheet
Product
Particulars
A B C D
Output 120 100 80 120
Direct Material 40 50 30 60
Direct Labour 28 21 14 21
Prime Cost 68 71 44 81
Overheads
Machine Hrs 4 3 2 3
Factory Work Expenses 64.18 48.14 32.09 48.14
Production Runs 6 5 4 6
Set up Costs 25 25 25 25
No of Requisitions 20 20 20 20
Store receiving 15 18 22.5 15
Inspection / QC 10 10 10 10
No of Orders 12 10 8 12
Handling & dispatch 22 22 22 22
Unit Cost 204.18 194.14 155.59 201.14
Total Cost 24502.15 19413.85 12447.38 24136.62
References
Activity Based Costing, A Step-by-Step, Proven Path for Rapid
Implementation
By Alan G. Dunn, President of GDI
Cost Accounting, by Jawarhar Lal & Seema Srivastava
Tata McGraw Hill Publications
Cost Management 2e, by Edward J Blocher et al
Mc GrawHill Irwin Publications
