Meaning• Activity-Based Costing is a methodology that assigns resources to activities, and activities to cost objects based on a cause-and-effect relationship.• ABC is that costing in which costs are first traced to activities and then to the products.• It is a costing system which focuses on activities performed to produce products.• Activities are responsible for incurrence of Costs.
• Provide Quality of information to design a cost system.• Distinction between cost behavior patterns which are volume, diversity, events & time.• Cost driver need to be identified
Identify activitiesDetermine cost for each activity Determine cost drivers Collect activity data Calculate product cost
Benefits / Advantages of ABC• Focus attention on Activities• Most accurate product / service costs• Managers manage activities and not products• ABC focuses on cause and effect relationship• ABC highlights problem areas easily
Limitations / Weakness of ABC• ABC fails to encourage managers to think about changing work processes• ABC does not conform to GAAP• Costly for long run• ABC does not encourage the identification and removal of constraints creating delays and excesses
Examples of Activity and its Cost Drivers• Machine Set-up • No. of Production Runs• Purchase Materials • No. of orders Placed• Warehousing • Items in Stock• Material Handling • No. of Parts• Inspection • Inspection per Item• Quality Testing • Hours of Test Time• Receiving Material • No. of Receiving Orders• Packing • No. of Packing Orders• Store Delivery • No. of Store Delivers• Line Item Ordering • No. of Line Items