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Chapter 07 Activity-based costing: A

tool to aid decision making
Submitted to: Sir Ameet Kumar
Submitted by: Aamir ali chandio

Activity-based costing is used by top companies such as coca cola and

citiGroup. It provides them with the cost information for making decisions.
Previously, we used absorption costing, which divided specifically the
manufacturing overhead. While ABC also includes nonmanufacturing costs
with are traceable to individual products such as shipping cost and salesman
commission. It this system nonmanufacturing as well as indirect manufacturing
costs are termed as Overhead costs.

Traditional absorption costing spread capacity irrespective of the use while activity-
based costing spread costs based on used capacity such as if producing a soap does
not only used labors but machines and admin. If they are used in producing the
soap it would be treated in ABC. While traditional absorption method simply
assumes at all.
ABC has five levels of activities including unit-level, batch level, customer-level,
product-level and organizational level. Taking the example of producing a bulb.
Providing power supply for the production ( unit-level), number of order and
placing to the customers of bulb (batch-level), designing a bulb (product-
level), giving special services by sales calls and catalogs (customer-level) and
conclusively all the resources from producing to shipping (organizational
It crucial to implement the ABC system properly to get benefit. Therefore, it is
divided into 5 main steps
First, it should define the activities and pools and measures such as from receiving
raw material to shipping orders to customers. It should assign different pools such
as for customers, products, relationship with customers and order sizes. Second, it
should assign overhead costs to each cost pools such as eliminating the
manufacturing costs it uses First stage allocation. This includes taking
interviews from workers and other human labor for how much they put efforts and
then allocate the amount. Third, it should calculate activity rates such as how many
customers are per activity rate or cost. Fourth, it uses second stage allocation
to applying overhead to customers and products (objects). Finally, prepare the
management report for decision making.
This system is helpful in external reports on products and are less detailed.
However, it has some limitations as well such as it is costly, less support from top
management, difficulty in identifying the relevant costs and costly maintaining two
reports for external and internal.