1. ACTIVITY BASED COSTING
Module 11
ACTIVITY BASED COSTING
Dr. Varadraj Bapat

2. Activity Based Costing (ABC)
Concept of ABC
Traditional Costing V/s ABC
Treatment of cost under ABC
Steps of ABC
Benefits
Limitations
Activity Based Management: ABM
Relation between ABC & ABM
Dr. Varadraj Bapat

3. Reasons to choose the right way of costing
In business, arriving at the correct cost is very important, because it:
• identifies money-makers and money losers;
• finds an economic break-even point;
Dr. Varadraj Bapat

4. • facilitates opportunities for cost control
• facilitates opportunities for cost control. • permits comparison of different options; and • enables strategic decision making.
Dr. Varadraj Bapat

5. The Concept of ABC Activity-Based Costing Departmental Overhead Rates
Level of Complexity
Plant-wide
Overhead
Rate
Overhead Absorption
Dr. Varadraj Bapat

6. The Concept of ABC Overhead Absorption Departmental Overhead Rates
Department D1 OH Rate = Overheads Apportioned / Machine Hours
Plant-wide
Overhead
Rate
Plant OH Rate = Overhead Cost / Machine Hours
Dr. Varadraj Bapat

7. Introduction
ABC is a costing system, which focuses on activities performed to produce products.
ABC relates cost (resources consumed) to work accomplished (outputs produced).
Dr. Varadraj Bapat

8. ABC is a management tool that provides better allocation of resources.
The ABC or unit cost goal is a benchmark that represents an expectation of the cost incurred for the production of an output.
Dr. Varadraj Bapat

9. ABC aligns costs to outputs thereby increasing cost visibility, and is useful in forecasting financial baselines.
Dr. Varadraj Bapat

10. Traditional Costing V/s ABC
Resources
Everything in Organization
Resources
Traced by Resource Drivers
Allocate
Consume
What is actually being done
Activities
Cost Centre
Consume
Traced by Activity Drivers
-Products/Services
- Customers
- Etc
- Products
- Services
Objects
Objects

11. Cost objects consume activities. Activities consume resources.
ABC’s Basic Premise
Cost objects consume activities.
Activities consume resources.
This consumption of resources is what drives costs.
Understanding this relationship is critical to successful budget management.
Dr. Varadraj Bapat

12. Treatment of Costs under ABC
In ABC, products are assigned the overhead costs that are supposed to be related to the allocation base.
Non-manufacturing costs
Manufacturing costs
Plant wide Overhead Rate
Departmental Overhead Rates
Costs of idle capacity
Dr. Varadraj Bapat

13. ABC’s Basic Steps
1 . Analyze activities. 2 . Gather cost data. 3 . Trace costs to activities. 4 . Establish output measures. 5 . Analyze costs.
Dr. Varadraj Bapat

14. Makes it possible to determine production cost traced to outputs.
ABC’s Basic Benefits
Makes it possible to determine production cost traced to outputs.
Targets areas needing management attention.
Encourages the consideration of alternative methods of production.
Highlights operational efficiency.
Dr. Varadraj Bapat

15. Identifies financial benchmarks for activity performance.
Generates more information to measure and reward performance, and prioritizes activities for cost reductions.
Provides a common managerial framework among support activities.
Dr. Varadraj Bapat

16. Trade-off between expense and accuracy. Need for more precise data
Limitations of ABC
Trade-off between expense and accuracy.
Need for more precise data
Need of full support of top level management, and support of ABC based performance review.
Dr. Varadraj Bapat

17. Cases of overstated costs and under-stated margins and mistakes in pricing and other critical decisions.
Dr. Varadraj Bapat

18. Activity Based Management18
Activity Based Management
Activity based management involves any use of ABC information to support the organization’s strategy, improve operations, or manage activities and their resulting costs.
Dr. Varadraj Bapat

19. Activity Based Costing 19
Activity Based Costing
establishes relationships between overhead costs and activities so that we can better allocate overhead costs.
Activity-based management
focuses on managing activities to
reduce costs.
Dr. Varadraj Bapat

20. Relation ABC and ABM Process View Resource costs Cost Objects ABM Root20
Relation ABC and ABM
Resource costs
Cost Assignment View
ABM
Root
Causes
Process View
Activity Analysis
Performance
Measures
Activity Evaluation
Activities
Activity
Triggers
Cost Objects
Dr. Varadraj Bapat

21. Eliminating non-value added costs using ABM21
Eliminating non-value added costs using ABM
Identifying Activities
Identifying non-value added activities
Understanding activity linkage, root causes and triggers
Establishing performance measures
Reporting non value added costs
Dr. Varadraj Bapat

22. ABM seeks to satisfy following customers needs22
ABM seeks to satisfy following customers needs
Lower costs
Higher quality
Faster response time
Greater innovation
Dr. Varadraj Bapat

23. Customer Profitability Analysis23
Customer Profitability Analysis
Customer profitability analysis uses activity-based costing to determine the activities, costs and, profit associated with serving particular customers.
Dr. Varadraj Bapat

24. Customer Profitability Analysis24
Customer Profitability Analysis
A costly customer is one:
Orders small quantities
Demands faster service
Requires special packaging
Often changes orders
Orders frequently
Dr. Varadraj Bapat