1) ABC assigns overhead costs to products and services based on their actual consumption of activities, rather than simple allocation bases like direct labor hours. 2) The concept originated in US manufacturing in the 1970s-80s to better understand overhead costs. 3) ABC identifies unprofitable products/processes and helps set appropriate prices to maximize profits.

2. Subject
Managerial Accounting
Instructor
Mr.Taymor Ali

3. Topic
Activity-Based Costing
System
Presenter
Asma Yasmin

4. Activity-Based Costing
Activity-Based Costing System 4

5. In contrast to traditional/absorption costing system, ABC system first
accumulates overheads costs for each organizational activity, and then
assigns the costs of the activities to the products, services, or customers
(cost objects) causing that activity.
Activity-Based Costing System 5

6. The concept of ABC was
developed in the manufacturing
sector of United State during
the 1970s and 1980s.
Activity-Based Costing System 6

7. Activity-based costing (ABC) is a
costing methodology that identifies
activities in an organization and
assigns the cost of each activity with
resources to all products and services
according to the actual consumption
by each.
Activity-Based Costing System 7

8. • Identify and eliminate the unprofitable
products and services.
• Identify and eliminate production or service
processes that are ineffective
• Lower the prices of those that are
overpriced
• Allocate processing concepts that lead to the
very same product at a better yield
Activity-Based Costing System 8

9. • Step 1
Identify Cost Objects (Products)
Product A
Product B
• Step 2
Identify direct costs i.e. Direct Materials, Direct Labor, Direct expense
Material Cost
Product A = 25000
Product B = 20000
Direct Labor
Product A = 15000
Product B = 10000
• Step 3
• Select the cost allocation bases to be used for overheads cost
No of batches 40
Activity-Based Costing System 9

10. • Step 4
Identify the overheads cost associated with the bases selected i.e.
Rs.600,000.
• Step 5
Compute the allocation rate
Overhead Cost of the activity ÷ Quantity of allocation base
Rate = 600,000 ÷ 40 = 15,000 per batch
• Step 6
Compute overheads cost for allocation to products
Product A: 3 batches × 15,0000 per batch = Rs.45,000
Product B: 1 batch × 15,0000 per batch = Rs.15,000
Activity-Based Costing System 10

11. • Step 7:
Compute total costs of products
Activity-Based Costing System 11
Detail Product A Product B
Material Cost 25,000 20,000
Labor Cost 15,000 10,000
FOH Cost 45,000 15,000
Total Cost of Products 85,000 45,000

12. Activity-Based Costing System 12
1. ABC system provides accurate costing of products/services.
2. Management has better understanding overheads cost.
3. ABC system integrates well with Six Sigma and other
continuous improvement programs.
4. The in-depth study of overheads cost under ABC system
makes all wastages visible to management and all non-value
added activities known to them. Thus, better controls can be
exercised on them.

13. Activity-Based Costing System 13
1. Implementing ABC system requires a big budget initially.
2. After implementation, the maintenance of the system is
costly.
3. ABC system produces numbers such as product margins that
are different from the profits produced by traditional costing
system. Management may be double minded as they are used
to work with traditional costing system, as a requirement for
external reporting.

14. Activity-Based Costing System 14