Activity Based Costing

Presented By A.L.C.S. Sudheer L. Naresh S.S. Rao R. Avinash K. Namrata

Contents
1 2 3 4 5

Introduction What is ABC? Characteristics of ABC Categories of ABC

Implementation of ABC
Benefits & Conclusion

What is ABC?

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.

ACTIVITY

BASED

COSTING

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

Historical development

Traditionally cost accountants added a broad percentage of analysis into indirect costs The percentages of indirect and overhead costs rose as indirect costs were not caused equally by all products Moreover, when multiple products share common costs, there is a danger of one product subsidizing another

Traditional Costing Methods.....

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

Activity-Based Costing
Traditional
Costs

allocation method
Products

Activity-based

allocation method

Costs First stage

Activities

Products Second stage

Need for a New System

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

Todays Complex Business Environment Use of Advanced Technology

Product Life Cycle

Product Complexity

Channels of Distribution
Quality Requirements

Product Diversity

Composition of Cost
100

0 1 2 3 4 Direct Material Labour Overheads

Activities and Related Cost Drivers

Activity-Based Costing (ABC)

Calculate unit cost Identify activities Identify cost driver Compute overhead rate Assign overhead costs

ABC systems addresses the following Questions:

What activities are being performed by the organizational resources? How much does it cost to perform activities? Why does the organization need to perform those activities? How much of each activity is required for the organization's products, services, and customers?

Characteristics of ABC

Simple traditional difference between fixed cost and variable cost Appropriate distinction between cost behavior patterns and volume related, diversity related, events related and time related Cost drivers need to be identified

COST DRIVER: Structural determinant of cost related activity

How to develop an ABC system?

Three key areas of ABC:

Product cost differentiation Activities and their cost drivers Identification of non-value added cost SHORT-TERM
Product Value Pricing

LONG-TERM
Value addition Corporate growth

Categories of ABC
Unit level activities Batch level activities Product level activities Facility level activities

Allocation of Overheads
Service Dept. & Factory overheads Activity Cost Pools Product lines

Assigning costs of Individual activities

Application of cost driver rates

Steps to develop ABC

Identify resources Trace cost of activities

Identify activities

Establish demands made Define activity drivers

Identify cost objects

Implementing ABC

Identifying the functional area Identifying key activities involved in each functional area Allocating the common indirect costs to various activities in each functional area

Continued..

Identifying the most suitable cost driver in each activity under functional area for better allocation of Indirect costs to get accurate cost information Prepare the statement of expenditure activity-wise and comparing it with the value addition activity-wise to know the activities which are to be eliminated or need improvement for better performance of organization.

Functional areas

Material management Stores Management Production Management Quality Control Management Personnel Management Sales Management Repairs and Maintenance Administration Public Relations

Ways of achieving cost reduction

Ways of achieving Cost Reduction Reducing set-up time Conventional Cost System Ignore or reduce direct labor Activity Based Cost System Reduce set up time to achieve low cost

Eliminating material handling activities Choosing an insertion process

Ignore or reduce direct labor Pick alternative with lowest unit level activities

Eliminate activities to reduce the cost of handling Pick lowest cost alternative

Using common components

Using common components to achieve cost savings; Using noncomponents creates no costly penalty

Use common components wherever possible

Benefits of implementing ABC

Cost management and Downsizing Determination of Product Service Costs Improvements in Performance

Product/Service Pricing
Make or Buy Decision Transfer Pricing

Gaining Competitive Advantage

Which product to promote? Analyze profit contribution & impact

What prices should we set?

Gaining Competitive Advantage

Which customers are profitable & why?

How should we measure performance?

Which distribution channels should we follow?

How ABC system supports Corporate Strategy?

Effective and accurate Redesigning the product Changing the system of evaluation of new process technologies Report on resource spending Improving activities Cost drivers rate Accurate feedback Provides accurate information of product cost