1. Activity Based Costing
Management Accounting

2. Review of Costing so far
In the last lectures we have assumed that Overheads are ‘Plantwide’ – Meaning that all indirect (Fixed Costs) apply to all of the factory
Overheads are costs which are not DIRECT
This is a fairly simple way to view cost behaviour and as we have seen cost do not really behave in such a linear manner

3. Problems with Standard Costs
Too Simple
Changes to the methods of Production
Reduction of Labour as a major cost of manufacturing
More diverse products from a single company
Overheads increasing/Labour Decreasing
Therefore it is important that our methodology of cost accounting changes to reflect this

4. Activity Based Costing (ABC)
Developed in the 1980’s by Kaplan and Johnson
Rather than the Direct and Indirect cost distinction, ABC focuses on the Activities of the organisation
In Standard Costing we use the unit of Production (Cost Object) as the basis of measuring cost
In ABC we use the Activity as the basis of measuring cost

5. What are Activities
Activities are anything that happens in the factory
Setting up Machinery
Scheduling Production
Maintaining Equipment
Ordering Materials
Inspecting Materials

6. Cost Objects, Activities and Resources
The Cost Object is the Product or Service that is Produced
The Activity is anything that happens in producing the Cost Object
Resources are consumed in producing the Cost Object

7. ABC in Operation A customer places and order
Cost Object
A customer places and order
The order will require both activity and resources
Activities
All of the activities, both direct and indirect (Fixed and Variable) that go to produce the cost object
Resources
Resources are consumed to provide the product or service

8. The Overhead Cost Pool
All of the Overheads that go into making a product are placed in an Overhead Cost Pool
These replace the Indirect or Fixed Costs of standard costing
This is then used as the allocation base of the Total Factory Overheads

9. Worked Example
Page 125

10. What happens to the overhead costs?
Costs change or shift when we move from Standard to Activity costing
Worked Example page 127

11. Process Improvements
Activity Based Costing provides much richer information to managers for the purposes of control
Therefore as opposed to standard costing the managers can effect change to make the processes more effective
This has developed into Activity Based Management (ABM) and Activity Based Budgeting (ABB)

12. The benefits of ABC ABC can provide much more information to managers
ABC can be used to make efficiency changes to the production process and the overheads
ABC is more accurate for costing products because it mirrors more accurately cost behaviour

13. The Limitations of ABC
ABC requires the production process to be redesigned
ABC is very expensive to implement
ABC like Standard Costing does not necessarily cost the products in the right way
Many firms which have implemented ABC have since abandoned it as it is too complex

14. The assumptions of ABC ABC makes a number of assumptions
Cost is strictly proportional to its activity measure
There is no real evidence for this
Cost is not subject to economies of scale or diseconomies of scale
This is definitely not true