The document discusses Activity Based Costing (ABC), an approach for assigning overhead costs to products and services. It notes that traditional costing methods can misallocate overhead, affecting management decisions. ABC addresses this by tracing overhead costs to the activities that cause those costs, and then assigning the costs of each activity to products based on their use of that activity. This provides a more accurate picture of product costs. The document outlines the basic concepts and steps of implementing ABC, including identifying activities, assigning resource costs to activities, defining activity cost drivers, and calculating activity costs to allocate to cost objects like products.

1. Activity Based Costing
(ABC)

2. In the past, overhead costs were relatively small, and
the problems arising from inappropriate overhead
allocations were not so significant
 But nowadays, factories are highly automated, resulting
in increasing depreciation charges, maintenance cost
and machinery set-up cost
 Errors in overhead absorption may seriously affect the
management decisions

2

3. 
The Activity-based costing (ABC) system is developed
to provide better approach for assigning overheads to
products and computing product costs.
3

4. Today’s businesses are working in an increasingly
complex environment because of…..
Use of Advanced Technology
Product Life Cycle
Product Complexity
Channels of Distribution
Quality Requirements
Product Diversity

5. Direct materials and direct labor costs
are easy to trace
Overhead cannot be traced easily and
must be assigned with estimates

6. Spreads overhead cost over entire
customer base.
Each order “appears” to cost the same.
Orders with high profit margins
subsidize orders with low profit
margins

7. A single or plant wide rate called a
predetermined overhead rate is used:
Job Order = Direct Labor Costs
Process Cost = Machine Hours

8. Amount of direct labor used in
many industries has decreased
Total overhead from depreciation
on equipment, utilities, repairs,
maintenance has increased

10. Conventional Costing
Expenses
AB Costing
Economic
Element
Resources
Activities
Work
Performed
Cost Objects
Product or
service
Cost Objects

11. Basics of A B C
• Cost of a product is the sum of the costs of
all activities required to manufacture and
deliver the product.
• Products do not consume costs directly
• Money is spent on activities
• Activities are consumed by product/services

12. Basics of A B C (contd.)
• ABC assigns Costs to Products by tracing
expenses to “activities”. Each Product is charged
based on the extent to which it used an activity
• The primary objective of ABC is to assign costs
that reflect/mirror the physical dynamics of the
business

13. An overhead cost allocation system that
allocates overhead to multiple activity
cost pools and assigns the activity cost
pools to products or services by means
of cost drivers that represent the
activities used.

14. Any event, action, transaction, or
work sequence that causes a cost to be
incurred in producing a product or
providing a service.

15. The overhead cost allocated to a
distinct type of activity or related
activities.

17.  Any
factor or activity that has a direct
cause-effect relationship with the
resources consumed.
 In ABC cost drivers are used to assign
activity cost pools to products or services.

18. Illustration 4-3

19. Steps in ABC Costing
Cost pools are groups
or categories of
individual expense
items
Steps:
1. Form cost pools
2. Identify activities
3. Map resource costs to activities
4. Define activity cost drivers
5. Calculate cost

20. In developing an ABC system, the organization
identifies the activities being performed:
Activity Dictionary
•Move material
•Respond to customers
•Schedule production
•Purchase material
•Inspect items
•Improve products
•Introduce new products
•Explore new markets

21. 
Financial accounting categorises expenses by
spending code; salaries, fringe benefits, utilities,
travel, communication, computing, depreciation etc.
•ABC collects expenses from this financial
system and drive them to the activities
performed.

22. Mapping
Accounting Records
Salaries
313,000
Activities
Business Development
ABC Records
Salaries Depreciationlectricity Supplies Travel
E
20,000
25000
5000
Total
5000 55,000
Depreciation
155,000
Maintianing Present Business 80,000
60000
50000
5000
10000 205,000
Electricity
132,000
Purhcasing Material
125,000
50000
20000
20000
60000 275,000
Supplies
25,000
Set up Machines
25,000
10000
2000
37,000
Travel
100,000
Running Machines
50,000
10000
50000
110,000
Total
725,000
Resolve Quality Problems
13,000
5000
25000 43,000
Total
313,000 155000 132000
25000 100000 725,000

23. Activities: Types
• Unit level: Performed each time a unit is
produced
• Batch level: Performed each time a batch is
produced
• Product level: Performed to support production
of different type of product
• Facility level :Residuary head

24. I.
Unit-level activities
The costs of direct materials, direct labor, and machine maintenance are
examples of unit-level activities.
I.
Batch-level activities
are costs incurred every time a group (batch) of units is produced . Purchase
orders, machine setup, and quality tests are examples of batch-level activities.
I.
Product-line activities
Examples of product-line activities are engineering changes made in the
assembly line, product design changes, and warehousing and storage costs for
each product line.
I.
Facility support activities
The costs relating to the activities are administrative in nature and include
building depreciation, property taxes, plant security, insurance, accounting,
outside landscape and maintenance, and plant management's and support staff's
salaries.

25. The linkage between activities and cost objects, such
as products, customers,, is accomplished by using
activity drivers.
 An activity driver is a quantitative measure of the
output of an activity.
 The selection of an activity driver reflects a
subjective trade-off between accuracy and cost of
measurement.


26. Activitie s
Drive rs
Unit Le ve l
Acquire and Use material f or containers
Acquire and Use material f or baby-care products
No. of Containers
No. of products
Batch Le ve l
Set up manually controlled machines
Set up computer controlled machines
No. of batches of containers
No. of batches of B. Produst
Product Le ve l
Design and manuf acture moulds
Use manually controlled machines
Use conputer controlled machines
No.of moulds required
Product type (containers)
Product type (B.Products)
Cus tom e r Le ve l
Consult customers
Provide w arehousing f or customers
No. of consultations
No. of cubit f eet
Faciltiy Le ve l
Manage w orkers
Salaries

27. Activities
Drivers
Unit Level
Acquire and Use material for containers No. of Containers
Acquire and Use material for baby-care products No. of products
Batch Level
Set up manually controlled machines No. of batches of containers
Set up computer controlled machines No. of batches of B. Produst
Activity Cost Activity Volume
Activity Rate
40,000
80,000
1,000,000
8,000
0.04
10
3,000
12,000
10
20
300
600
5,000
15,000
40,000
5
1
1
1000
15000
40000
4,000
2,000
40
10,000
100
0.2
3,000
48,000
15,000
16,000
0.2
3
Product Level
Design and manufacture moulds No.of moulds required
Use manually controlled machines Product type (containers)
Use conputer controlled machines Product type (B.Products)
Customer Level
Consult customers No. of consultations
Provide warehousing for customers No. of cubit feet
Faciltiy Level
Manage workers Salaries
Use main building Square feet

28. Ascertaining Cost
Activities
A. Rate A.Volume
Containers
Baby Product
Unit Level
Acquire and Use material for containers
0.04
1,200,000
48,000
Acquire and Use material for baby-care products
10
7,000
70000
Batch Level
Set up manually controlled machines
Set up computer controlled machines
300
600
12
16
3,600
1
4
1
1
1,000
9600
Product Level
Design and manufacture moulds
Use manually controlled machines
Use conputer controlled machines
1000
15000
40000
4000
15,000
40000
Customer Level
Consult customers
Containers
B.products
Provide warehousing for customers
Containers
B.products
Faciltiy Level
Manage workers
Containers
B.products
Use main building
Containers
B.products
Total Cost
100
2
40
200
8,000
2,000
1,600
4,000
10,000
800
5,000
7,000
15,000
4000
0.2
400
0.2
2000
3
85,200
21000
151,000

29. More accurate product costing which
necessitates:
More cost pools used to assign
overhead
Enhanced control over overhead
Better management decisions

30. Products differ greatly in volume and manufacturing
complexity
Products lines are
numerous
diverse
require differing degrees of support services
Overhead costs constitute a significant portion of
total costs
The manufacturing process or number of products
has changed significantly
Production or marketing managers are ignoring data
provided existing system

31. An extension of ABC from a
product costing system to a
management function that focuses
on reducing costs and improving
processes and decision making.

32. An activity that increases the worth of a product or
service such as...
engineering design
machine set-ups
machining
assembling
painting
packaging

33. An activity that adds cost to, or increases the time spent on, a
product/service without increasing its market value such as:
Repair of machines
Storage of inventory
Moving of materials
Building maintenance
Inspections
Inventory Control