ACTIVITY BASED COSTING

Meaning
Activity-Based Costing is a methodology that assigns resources to activities, and activities to cost objects based on a cause-and-effect relationship. ABC is that costing in which costs are first traced to activities and then to the products. It is a costing system which focuses on activities performed to produce products. Activities are responsible for incurrence of Costs.

 Provide Quality of information to design a cost system. Distinction between cost behavior patterns which are volume, diversity, events & time. Cost driver need to be identified

Identify activities Determine cost for each activity Determine cost drivers Collect activity data Calculate product cost

Benefits / Advantages of ABC

Focus attention on Activities Most accurate product / service costs Managers manage activities and not products ABC focuses on cause and effect relationship ABC highlights problem areas easily

Limitations / Weakness of ABC

ABC fails to encourage managers to think about changing work processes ABC does not conform to GAAP Costly for long run ABC does not encourage the identification and removal of constraints creating delays and excesses

Difference between ABC and Absorption Costing

abc

absorption

costing

1. Overheads are first related to the 1. Overheads are first related to the activities or grouped into cost pools. various production and service departments. 2. Activity cost drivers can be used to 2. Overhead rates are used determine the cost of the cost objects. ascertain cost of products only. to

3. It portrays more realistic cost 3. Since the overheads are related to the behavior since the overheads are cost centre, a realistic picture of the related to the cost drivers. cost behavior is not portrayed 4. All levels of activities in the 4. Only two levels of activity, i.e. facility manufacturing cost hierarchy i.e. unit level and level are identified. level, batch level, product level and facility level are identified.

Examples of Activity and its Cost Drivers

Machine Set-up Purchase Materials Warehousing Material Handling Inspection Quality Testing Receiving Material Packing Store Delivery Line Item Ordering No. of Production Runs No. of orders Placed Items in Stock No. of Parts Inspection per Item Hours of Test Time No. of Receiving Orders No. of Packing Orders No. of Store Delivers No. of Line Items