Activity Based Costing

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 Activity Based Costing
• Direct cost ,which mainly include materials and
labour ,are chargeable to end products without
difficulty and are thus convenient to handle.
• It is indirect cost ,also known as overhead which
creates problem to for cost accountant in
determining the accurate product cost.
• In order to determine the total cost of an end
product ,under the traditional approach ,indirect
costs are allocated and apportioned.
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• Activity Based Costing is an upcoming and
more refined approach for charging indirect
costs to products and computing more
accurate product costs.
• Traditional Approach:

prince dudhatra-9724949948
• Activity Based Costing Approach:
• ABC is a new and scientific approach
developed by Cooper and Kalpan(1988)for
assigning overhead to end products,jobs
,processses.
• It aims to rectify the problem of inaccurate
cost information due to selection of wrong
bases of indirect cost apportionment.

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• It is a modern tool of charging overhead costs in
which costs are first traced to activities and then to
products or jobs.
• Its main focus on activities performed in production
of goods and services.
• Thus,activities become the focal points for cost
computation.
• Costs are charged to products and services based on
individual products consumption of each activity.

prince dudhatra-9724949948
• In brief, in ABC overheads are first assigned to
activities and then absorbed by cost objects
on basis of activities consumed by these cost
objects.

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• Terms used in ABC
• Activity: An activity may be defined as a
particular task or unit of work with a specific
purpose. Examples of activities are placing of
purchase order, setting up of machine etc.
• Cost Object: It is an item for which cost
measurement is required.example,o product ,a
service,or job or customer etc are cost objects.

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• Cost driver: It is a factor that causes a change in the
cost of an activity.
• Business Function Cost driver
• Purchase of mat’s No.of ordersplaced
• No.of inspections
• No.of receipts of mat
• Production No.of machine setup
• No. of machine hours
• No. of units
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• Reasearch and devp.: No.of res.project
• personnel hourson

• project
• Customer Service: No.of pro.serviced
• No.of hrs.spentservicing

prince dudhatra-9724949948
• Following are the steps in Abc cost allocation:
• 1. Identification of main activities
• 2. Creation of cost pool
• 3. Determination of activity cost drivers
• 4. Calculation of activity cost driver rate
• 5. Charging the costs of activities to products.

prince dudhatra-9724949948
• 1. Identification of main activities:
• First major activities are identified.the no. of
activities in an organisation should neither be
too large or too small.Total cost involved in
activity should be significant enough to justify
to give a activity a separate treatment.
• 2. Creation of Cost pool: Cost pool is grouping
of individual cost items.A cost pool is created
for each activity.
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• Cost pool is like a cost centre around which costs
are accumulated.
• 3. Determination of activity cost drivers:
• The factors that influence the cost of particular
activity is known as cost driver.
• 4. Calculation of activity cost driver: Just as an oh
absorption rate is calculated in traditional costing
system,in ABC cost driver rate is calculated:
• =Total cost of activity/cost drivers.
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• 5. Charging the costs of activities to products.
• The cost of activities is traced to products on
basis of demand of products.
• The cost driver are used to measure product
demand of activities.eg.set up cost is also
included in the product cost.Cost of other
activities also will be charged to product.

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 Advantages of ABC-costing
• It is primarily developed on account of the
limitations of traditional system of charging
overhead.Adv:
• 1.Accurate and reliable:ABC is more reliable system .
• 2. Better pricing decision:
• 3. Realistic approach:
• Distribution of oh based on activities(ABC) is an
objective and reliastic .aginst traditional method of
OH costing uses arbitrary bases of App.of OH.

prince dudhatra-9724949948
• 4. Control on costs:This method gives more
control on cost over those activities which
cause it.
• 5.Greater cost efficiency:ABC helps to identify
those activities which are unnecessary and
thus achive greater efficiency.

prince dudhatra-9724949948
• Thank You.

prince dudhatra-9724949948