Activity Based Costing

Activities can be defined as a named

process, function, or task that occurs over
time and has recognized results. Activities
use up assigned resources to produce
products and services. Inputs are
transformed into outputs under the
parameters set by controls performed
by the organizations employees and their
tools.

Basis Of ABC
Identifying major activities and their costs
Determining the cost drivers

Basis Of ABC
Resources are people and machines.
Resource drivers are the measure of the frequency and
intensity of the demands placed on resources by activity.
Activities are the processes performed by the people and
machine.
Activity drivers measure the frequency and intensity of
the demands placed on activities by cost objects
enabling costs to be assigned to cost objects.
Cost objects are the products and/or services produced.
Cost drivers are the factors that affect the cost of an
activity, e.g. poor quality.

How To Use ABC?

ABC is used to determine the cost and benefits
associated with reengineering processes and systems.
This cost and benefit analysis will then become part of
the overall business case for the project.
ABC approach will account for

Activities or processes
Frequency and cost of the activity
The do-nothing scenario
Which process provides value

Determine cost drivers for activities

Estimate application rates for each activity driver
Applying costs to products

Benefits Of ABC
Over Absorption Costing
More realistic product costs may be produced,
Management will be more aware of the link between
activity and cost behaviour
Cost reduction activities are more likely to be
successful
It may become apparent that costs are not driven
solely by output volumes
It facilitates the preparation of an activity-based budget
It helps in decision-making.
Identification of non-value adding activities helps the
management to control cost.

Target Costing
Target costing is defined as a marketbased cost that is calculated using a sales
price necessary to capture a
predetermined market share.
Business entities need to stand on their
feet, to eliminate inefficiencies, cut down
costs and improve productivity.
Fittest will survive.

Traditional Cost System VS

Proactive Cost Management
System

Traditional cost systems were designed in an era of benign

environment, when product life cycles were long.
In those days, when competition was not as keen, most price
decisions were based on cost-plus pricing
Proactive cost management system puts emphasis on resources
consumed in performing the organizations significant activities.
This emphasis, sometimes called activity accounting
Traditional cost system utilizes a single basis
Rather than relying on a single basis to distribute costs, ABC
assigns costs to activities and product based on how the costs
(resources) are actually consumed by the process or product

Basics Of Target Costing

Most firms define competitors as firms that make
things similar to what we make which are the
producers view of competition.
In target costing, competitors are defined from the
customers perspective: I am about to make a
purchase, so what are my options?
Target costing is a cost-management technique that
lets a firm manage its costs by determining how much
customers are willing to pay for a product
Product strategy defines the customers that a firm
wants to target, the features that these customers
want in the product, and the prices they are willing to
pay for each feature and for the product as a whole.

What Is Target Cost?

A target cost is the maximum amount of
cost that can be incurred on a product and
still earn the required profit margin from
that product.
Target Cost = Sales Price Desired Profit

Setting Target Costs

Cost Reductions
Cost reductions are associated with a cost
leadership strategy

Cost Adjustments
Cost adjustments are associated with
differentiation and time-to-market strategies.

Phases In Target Costing

Planning Phase
Development Phase
Production Phase

Streamlining The Process

Target costing is the true form of design
for cost.
Value engineering consists of generating
ideas for cost reduction without
compromising the features or extending
the development period of the product.
Computing overall target costs
Making it work
Calls for business process reengineering

Computing overall target costs

Once a target cost has been calculated for a new product,
the design team has to divide it up among the products
various functions. How much can the team spend on one
function as against all the others?
For target costing to succeed, targets must not only be
valid, managers must also see them as valid. The market
analysis that yields the target prices, the financial analysis
that generates the target costs, and the segregation
procedures that allocate costs among components and
sub- assemblies all must be trusted. The targetcosting process must, therefore, be highly transparent.

Benefits Of Target Costing

The process of target costing provides
detailed information on the costs
Target costing reduces the development cycle
of a product.
The internal costing model, using ABC, can
provide an excellent understanding of the
dynamics of production costs
The profitability of new products is increased
by target costing
Target costing is also used to forecast future
costs

Life Cycle Costing

The accumulation of costs for activities that occur
over the entire life cycle of a product, from inception
to abandonment, by the manufacturer and the
customer are known as life cycle costing.
The firm cannot regard a particular design
successful unless they meet the functionality needs
of the customer, the price demands of the
distribution channel, the manufacturability
requirements of the plant, and the financial
projections of the firm.

Life Cycle Cost Analysis

Life cycle cost analysis (LCCA) is a method for assessing the
total cost of facility ownership.
It takes into account all costs of acquiring, owning, and disposing
of an asset or asset system.
Lowest life cycle cost (LCC) is the most straightforward and
easy-to interpret measure of economic evaluation.
Some other commonly used measures are net savings (or net
benefits), savings-to-investment ratio (or savings benefit-to-cost
ratio), internal rate of return, and payback period.
There are numerous costs associated with acquiring,
operating, maintaining, and disposing of any asset.

Project Life Cycle Costing

Project life cycle costing is a new concept
which places new demands upon the
management accountant.
A key question for many accountants will be
whether the costs of developing realistic life
cycle costs will outweigh the benefits to be
derived from their availability.
Technology is concerned with pursuit of
economic life cycle costs.
It ensures that the assets produce the highest
possible benefit for least cost.