Activity Based Costing

Problems with Traditional costing

Traditional costing may lead to : Under costing of the products and Over costing of the products
Reasons for over costing and under costing Indirect costs are recovered on the basis of volume only

Activity Based Costing

ABC is an accounting technique that allows an organization to determine the actual cost associated with each product and the services produced by the organization. It is defined as a technique which involves identification of costs with each cost driving activity and make it as the basis for absorption of costs over different products or jobs.

Significant terms
Cost objects - Mean either products, services

or locations Activities _ Consists of aggregate of different tasks associated with cost objects. Cost drivers _ An activity which generates cost. Or it signify factors, forces or events that determine the costs of activities. Cost Pool:- another name of cost centre. a location, person or item of equipment in respect of which costs may be ascertained and related to cost units for control purpose)

Activity Based Costing

Cost of activities/ cost pools

activities

Cost drivers

Cost allocated to cost objects

In ABC, the overhead costs of an organization are identified with each activity which is acting as a cost driver. After identifying the overhead cost with each cost centre, the cost per unit of cost driver can be ascertained to jobs (cost objects) on the basis of number of activities required for their accomplishment.

Traditional costing Vs. ABC

COST OF A PRODUCT/SERVICE

DIRECT COSTS

INDIRECT COSTS

TRADITIONAL COSTING

ABC

VOLUME BASED ALLOCATION BASES

COST DRIVERS ARE used AS THE ALLOCATION BASES

STEPS INVOLVED IN ABC