Activity-based costing (ABC) is a methodology that assigns costs to products based on the activities required to produce them and the resources consumed by those activities. ABC first traces costs to activities, then assigns costs to products based on their consumption of activities. It focuses on identifying the activities performed during production and determining the cost drivers that cause the costs of each activity. ABC provides more accurate product costs than traditional costing systems and highlights inefficient activities. However, it can be costly to implement and does not encourage changing work processes.

1. ACTIVITY BASED
COSTING

2. 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.

3. • 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

4. Identify activities
Determine cost for each activity
Determine cost drivers
Collect activity data
Calculate product cost

5. 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

6. 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

7. Difference between ABC and
Absorption Costing

8. 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