1. Activity-Based Costing

2. Learning Objectives
Explain under-costing and over-costing of products or services
Distinguish between the traditional and the activity-based costing approaches to designing a costing system
Present three guidelines for refining a costing system
Describe a four-part cost hierarchy
Cost products or services using activity-based costing
Compare activity-based costing systems and simple costing system
Activity-Based Management

4. Cost Smoothing (Peanut butter costing)
The term cost smoothing describes a particular costing approach that uses broad averages for assigning the cost of resources uniformly to cost objects when the products/services use those resources in a non-uniform way
Cost smoothing can lead to or of product and services

5. Over & Undercosting
Overcosting –
Undercosting –

6. Under costing and Over costing Example
Jose. Rob, and Naney order separate items for lunch
Jose’s order amounts to $14
Rob Consumed
Naney’s order is
Total $ 60
What is the average cost per lunch?

7. Cross – Subsidization
Means that if a company undercosts one of its products, then it will overcost at least one of its other products.
Similarly, if a company overcosts one of its products, it will undercost at least one of its other products.
It occurs when a cost is

9. Product costing with single indirect cost pool system
Use seven step process
Identify the product that are the chosen cost objects
Identify the direct costs of the products
Select the cost allocation bases to use for allocating indirect costs to the products
Identify the indirect costs associated with each allocation base
Compute the rate per unit of each allocation base used to allocate indirect costs to the products
Compute the indirect costs allocated to the products
Compute the total cost of the products by adding all direct and indirect costs assigned to the products

11. Refining a costing system
A refined costing system reduces the use of broad averages for assigning the cost of resources to cost objects and
Provides the better measurement of the costs of indirect resources used by different cost objects

12. Rationale for selecting a more refined costing system
The Past
The Present

16. Background to ABC………. The promoters of ABC;
Robert Kaplan and his colleagues from HBS

17. ABC as a powerful programme of cost management
In 1980s’; American Goods were Struggling in the Global Market But
Japanese were successful in
Cost reduction
Quality improvement
their products became very competitive in the global market

18. several waves of developing ABC
In the first wave,
In the second,
In the third wave,

19. Deficiencies and misconceptions of traditional costing
Cost centre managers’ mistaken belief on profitability improvement.
The traditional cost allocation system could prompt managers to make unwise decisions.
Not flexible
Problem of timeliness

20. The above deficiencies led to the new programme of cost management initiated by Harvard business School academics and allied professional journals.
The 1987 historical analysis of the ‘ relevance lost’ thesis became a turning point in the history of management accounting, and the birth of subsequent cost management techniques.

23. Cost Hierarchies
A cost hierarchy categorizes various activity cost pools on the basis of
Different types of cost drivers/cost-allocation bases or
Different degrees of difficulty in determining cause and effect relationship

24. Cost Hierarchies Unit-level (output-level) Batch-level
Product-sustaining-level
Facility-sustaining-level

25. Output Unit-Level Costs
These are resources sacrificed on activities performed on each individual unit of product or service.
Examples: Energy. Machine deprecation, Repairs
Batch - Level Costs
These are resources sacrificed on activities that are related to a group of units of product(s) or service(s) rather than to each individual unit of product or service.
Examples: Setup hours, Procurement costs

26. Product-Sustaining Costs
These are often called service-sustaining costs and are resources sacrificed on activities undertaken to support individual products or services. Example: Design costs Engineering costs, overtime
Facility – Sustaining Costs
There are resources sacrificed on activities that cannot be traced to individual products or services but support the organization as a whole. Example: General Administration. rent. building security

27. QUIZ unit-level costs. batch-level costs. product-sustaining costs.
Advertising of a specific product is an example of
unit-level costs.
batch-level costs.
product-sustaining costs.
facility-sustaining costs.

29. QUIZ
The allocation of indirect costs in an activity-based costing system
may require other costs to be allocated to activities before the costs of the activities can be allocated to the products.
is simplified because more costs are identified as direct costs.
requires the use of heterogeneous cost pools.
is simplified because a limited number of activities are identified as cost objects.

30. Comparison between Simple Costing System vs ABC System

31. Simple Costing System

32. Activity Based Costing System

33. QUESTION

34. Conclusions Each method is mathematically correct
Each method is acceptable
Each method yields a different cost figure, which will lead to different Gross Margin calculations
Only Overhead is involved. Total Costs for the entire firm remain the same – they are just allocated to different cost objects within the firm
Selection of the appropriate method and drivers should be based on experience, industry practices, as well as a cost-benefit analysis of each option under consideration

35. A Cautionary Tale
A number of critical decisions can be made using this information;
Should one product be “pushed” over another?
Should one product be dropped?
Accounting for overhead costs is an imprecise science. Accordingly, best efforts should be put forward to arrive at a cost that is fair and reasonable.

36. ABC vs. Simple Costing Schemes
ABC is generally perceived to produce superior costing figures due to the use of multiple drivers across multiple levels
ABC is only as good as the drivers selected, and their actual relationship to costs. Poorly chosen drivers will produce inaccurate costs, even with ABC

37. Limitations of ABC Systems
Numerous measurements are required to implement the system
Required to estimate the costs of activity pools and to identify and measure cost drivers for those pools
Activity-cost rates need to be updated regularly.
Costly to operate and difficult to understand

38. Activity Based Management (ABM)