SubjectManagerial AccountingInstructor

Mr.Taymor Ali

TopicActivity-Based Costing

System Presenter

Asma Yasmin

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Activity-Based Costing

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Activity-Based CostingIn contrast to traditional/absorption costing system, ABC

system first accumulates overheads costs for each organizational activity, and then assigns the costs of the activities to the products, services, or customers (cost

objects) causing that activity.

The Concept

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Origin The concept of ABC was

developed in the manufacturing sector of United State during

the 1970s and 1980s.

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Definition Activity-based costing (ABC) is a costing methodology that identifies

activities in an organization and assigns the cost of each activity with resources to all products and services according

to the actual consumption by each.

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Aims of Model• Identify and eliminate the unprofitable products

and services.• Identify and eliminate production or service

processes that are ineffective• Lower the prices of those that are overpriced

• Allocate processing concepts that lead to the very

same product at a better yield

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Developing an Activity-Based Costing Syetem

• Step 1 Identify Cost Objects (Products) Product A Product B

• Step 2 Identify direct costs i.e. Direct Materials, Direct Labor, Direct expense Material Cost Product A = 25000 Product B = 20000 Direct Labor Product A = 15000 Product B = 10000

• Step 3• Select the cost allocation bases to be used for overheads cost No of batches 40

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Developing an Activity-Based Costing Syetem

• Step 4 Identify the overheads cost associated with the bases selected i.e.

Rs.600,000.

• Step 5 Compute the allocation rate Overhead Cost of the activity ÷ Quantity of allocation base Rate = 600,000 ÷ 40 = 15,000 per batch

• Step 6 Compute overheads cost for allocation to products Product A: 3 batches × 15,0000 per batch = Rs.45,000 Product B: 1 batch × 15,0000 per batch = Rs.15,000

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Developing an Activity-Based Costing Syetem

• Step 7: Compute total costs of products

Detail Product A Product B

Material Cost 25,000 20,000

Labor Cost 15,000 10,000

FOH Cost 45,000 15,000

Total Cost of Products 85,000 45,000

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Advantages1. ABC system provides accurate costing of

products/services.

2. Management has better understanding overheads cost.

3. ABC system integrates well with Six Sigma and other continuous improvement programs.

4. The in-depth study of overheads cost under ABC system makes all wastages visible to management and all non-value added activities known to them. Thus, better controls can be exercised on them.

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Disadvantages1. Implementing ABC system requires a big

budget initially.

2. After implementation, the maintenance of the system is costly.

3.ABC system produces numbers such as product margins that are different from the profits produced by traditional costing system. Management may be double minded as they are used to work with traditional costing system, as a requirement for external reporting.

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Appendix A: ABC Softwares

Thank You!