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Activity Based Costing,[object Object]
What is ABC?,[object Object],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.,[object Object],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.,[object Object]
Direct & Indirect Costs?,[object Object],Direct costs A cost that can be directly traced to producing specific goods or services., e.g., salaries for project staff and materials required for a particular project.,[object Object],Indirect costs are costs that are not directly accountable to a cost object (such as a particular function or product). Indirect costs may be either fixed or variable. Indirect costs include taxes, administration, personnel and security costs, and are also known as overhead.,[object Object]
Activities such as purchasing, design, production, sales, marketing and customer service are utilized by different products and services (cost objects) based on their complexity and business requirements.,[object Object],Compared to traditional accounting, activity based costing is a decision making tool which provides more accurate cost and profit information and allows management to understand the cost and profit drivers and improve their business.,[object Object]
ABC Vs. Traditional Methods,[object Object],Resources,[object Object],Resources,[object Object],Everything in the organization,[object Object],Consume,[object Object],Traced by Resource Drivers,[object Object],Activities,[object Object],What is actually being done,[object Object],Allocation Basis,[object Object],Allocate,[object Object],Consume,[object Object],Traced by Activity Drivers,[object Object],Objects,[object Object],Objects,[object Object],-Products,[object Object],-Services,[object Object]
Difference between Traditional & ABC Method,[object Object],In traditional cost accounting it is assumed that cost objects consume resources whereas in ABC it is assumed that cost objects consume activities.,[object Object],Traditional cost accounting mostly utilizes volume related allocation bases while ABC uses drivers at various levels.,[object Object],Traditional cost accounting is structure-oriented whereas ABC is process-oriented.,[object Object]
Steps necessary to develop ABC System:,[object Object],Identifying available resources & resource-consuming activities,[object Object],Assigning costs of available resources to activities,[object Object],Assigning costs of activities to cost objects(i.e. products, batches of products),[object Object],How ABC Works,[object Object]
1. Identifying available resources & resource-consuming activities,[object Object],Identify resources,[object Object],Resource Consumption Cost Drivers,[object Object],Transaction Drivers,[object Object],Duration Drivers,[object Object],Activity Levels: There are different activity levels such as:,[object Object],unit level activities (activities performed on each unit such as packaging), ,[object Object],batch level activities (activities performed on batch level such as scheduling and set up), ,[object Object],product level activities (activities performed on each product such as design, engineering and marketing) and ,[object Object],facility level activities (activities performed at each facility such as safety and maintenance).,[object Object]
2. Assigning costs of available resources to activities,[object Object],Assign the cost of resources to the activities that consume those resources, for this company will choose resource consumption cost drivers. E.g. if a machine(m/c) set-ups activity requires 0.5m/c hrs, and each m/c hr costs $20 then m/c set-ups activity costs $10($20x0.5).,[object Object],Assigning cost of resources to the activities consuming those resources, a company can determine the cost of each activity and ultimately cost of factory’s output.,[object Object],3. Assigning costs of activities to cost objects(i.e. products, batches of products),[object Object],[object Object]
Activity consumption drivers measure amount of activity consumed by a cost object.,[object Object]
Example of ABC,[object Object],Friends company, a manufacturer of valves, produces and sells two types of valves: Gas Safety Valves(GSV) and MSC Valves(MSC). Friends company has following data for two products:,[object Object],In addition, Friends company has identified the following activities, costs, and activity consumption cost drivers:,[object Object]
Friends company also collected the activity data for each product:,[object Object],Using the total cost for each activity & the total amount of activity cost driver we can determine the activity cost rate:,[object Object]
Calculating per-unit cost of each product manufactured by Friends Company.,[object Object]
Using the obtained data we can perform the product profitability analysis; that is, we will determine the unit margin profit of each product,[object Object],Comparing the product profitability analysis under traditional and activity-based costing.,[object Object]

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