ACTIVITY BASED COSTING(ABC)

SUBMITTED BY AKSHIT JAIN ALI MAVLI ANUJ SHANGARI ANKUR VYAS ANUJ KAKKAR DILIP GOWDA PRATIK MAHAJANSHETTI MAYANK MRINAL

WHAT IS ABC• Activity Based Costing is a management accounting approach

which allocate all direct and indirect (overhead) costs to cost objects (products and services) in order to help management understand critical business information. It allocates direct and indirect costs to products and services based on the level of activities used to create and deliver those products and services.

• CIMA (Chartered Institute of Management Accountants)  defines ABC as an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs.

OBJECTIVES OF ABC

Identifying available resources & resource-consuming activitiesAssigning costs of available resources to activitiesAssigning costs of activities to cost objects(i.e. products, batches

of products)

STAGES OF ALLOCATION IN ABC

There is Two Stages of Allocation in Activity-Based Costing

Stage 1: Allocation to Activities The first step in Activity-Based Costing is to divide the expenses of certain overhead activities to a per-event cost.

Stage 2: Allocation to Production The second step in activity-based costing is to allocate the activity cost to each product.

TRACING COST TO ACTIVITIESThis step is to identify major activities that cause/drive overhead costs to be incurred.

Some of the activities are related to production volume (such as production runs, salary of supervisors and so on) but others are not (such as inspection/handling of materials, setting up equipment and so on).

The cost of resources consumed in performing these activities are grouped into cost pools.

Common Activities Associated Costs Cost Driver

Processing purchase order for materials

Labour costs for workers determining order quantities, contacting vendors, and preparing purchase orders

Number of purchase orders processes

Handling material Labour costs for workers handling material, depreciation of equipment used to move material

Number of material requisitions

Inspecting incoming material

Labour costs for workers performing inspections, depreciation of equipment used to test strength of materials, tolerances, etc.

Number of receipts

Setting up equipment

Labour costs for workers involved in setups, depreciation of equipment used to adjust equipment

Number of setups

Producing goods using manufacturing equip.

Depreciation on manufacturing equipment Number of machinehours

Supervising assembly workers

Salary of assembly supervisors

Number of assembly labour-hours

Inspecting finished goods

Labour cost for finished goods inspections, depreciation of equipment used to test whether finished goods meet customer specifications, etc.

Number of inspections

Packing customer orders

Labour cost for packing workers, cost of packing materials, etc.

Number of boxes packed

TRACING COSTS FROM ACTIVITIES TO PRODUCTS The next step is to assign costs to products/jobs using cost

drivers as a measure of activity. Cost drivers represent the quantity of activities used to produce individual products.

They identify the linkage between activities and cost objects and serve as quantitative measures of the output of activities. In fact, they are the central innovation of ABC system. Three types of cost drivers are:

Transaction Duration Intensity (Direct charging)

Transaction Drivers Transaction drivers are used to count the frequency of an activity/the number of times an activity is performed.

Duration Drivers

Duration drivers represents the amount of time required to perform an activity. Intensity Drivers Intensity drivers are used to charge directly for the resources used each time an activity is performed.

ADVANTAGES1. Product cost determination under activity-based costing is more accurate and reliable because it focuses on the cause and effect linkage of costs and activities in the context of producing goods.

2. Fixation of selling price for multi-products under activity-based costing is fair and correct because overheads are allocated on the basis of relevant cost drivers.

3. Control of overheads consisting of fixed and variable becomes possible by controlling and monitoring activities. Linkage between cost and activities are clearly identified in activity-based costing and thus provides opportunities to control overhead costs.

4. Sufficient information can be obtained to make decisions about the profitability of different product lines.

5. Fair allocation of overheads occupy a considerable portion in the total cost components.

LIMITATIONS 1. Difficult to identify the overall activities that influence costs.

2. Not easy to select the most suitable cost drive.

3. Difficult to evaluate cost on the basis of activities.

4. Not suitable for small manufacturing concerns.

TRADITIONAL COSTING VS ABC traditional cost accounting it is assumed that cost objects consume resources whereas in ABC it is assumed that cost objects consume activities.

Traditional cost accounting mostly utilizes volume related allocation bases while ABC uses drivers at various levels.

Traditional cost accounting is structure-oriented whereas ABC is process-oriented.

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ABC – WHEN DO WE USE IT?

Product lines differ in volume and manufacturing complexity.

Product lines are numerous and diverse, and they require different degrees of support services.

Overhead costs constitute a significant portion of total costs.

The manufacturing process or number of products has changed significantly - for example, from labor intensive to capital intensive automation.

Production or marketing managers are ignoring data provided by the existing system and are instead using “bootleg” costing data or other alternative data when pricing or making other product decisions.