Activity-based

Costing
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 Hello!
I’m Mercy Nuñez from
BS Accountancy 2-D
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 What I will talk about

Activity-Based Management; Costs Computation in

1 Value-Added and Non-Value- 4 Activity-Based Costing
Added Activities

Manufacturing Cycle Efficiency Conditions for Effective Use

2 (MCE)
5 of Activity-Based Costing

3 Importance of Cost Drivers 6 Criticisms of Activity-Based

Costing
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 Activity-Based Management;
1 Value-Added and
Non-Value-Added Activities
Activity-based management (ABM)

► analyzes activities and identifies their
cost drivers.
► classifies activities relative to
customer value and strives to
eliminate or minimize those activities
for which customers would choose
not to pay.
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► helps assure that customers perceive
an equitable relationship between
product selling price and value.
► improves processes and operational
controls.
► analyzes performance problems.
► translates company goals into

organizational activities.
 Activity-Based Management;
1 Value-Added and
Non-Value-Added Activities
Value-Added (VA) Activity

► increases the worth of a product or

service.
► is one for which the customer is
willing to pay.
► is an actual production or service task.
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 Activity-Based Management;
1 Value-Added and
Non-Value-Added Activities
Non-Value-Added (NVA) Activity
► lengthens the production or > moving
performance time. > waiting, packaging (unless essential to
► increases the cost of product or services the convenient or proper delivery of a
without adding product or service value. product), or
► is one for which the customer would > engaging in a task that is (or appears to
not be willing to pay. be) essential to business operations but
► is created by: for which customers would not willingly
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> inspecting (except in certain industries choose to pay.

such as food and pharmaceutical),
 Manufacturing Cycle
2 Efficiency (MCE)

► MCE is calculated as total value-added time

divided by total cycle time.
► MCE measures how well a company uses its
time resources.
► VA activities increase MCE, while NVA activities
decrease MCE.
► In a service company, cycle efficiency is
computed as total actual service time divided by
total cycle time (from original service order to
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service completion).
 3 Importance of Cost Drivers

► Cost drivers identify what causes a cost to be incurred so that it can

be controlled.

► Cost drivers should indicate at what level a cost occurs.

Unit costs are caused by Batch costs are Product/process Organizational

the production or
acquisition of a single
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caused by a group costs are caused costs are caused by
by the facility operations
of things being
development, and the

unit of product or the made, handled, or management of

production, or
delivery of a single unit of processed at a acquisition of the organizational
service. single time. different items. infrastructure.
 3 Importance of Cost Drivers

► Cost drivers allow costs to be pooled together such that they have a
common activity base that can be used to allocate those costs to
products or services.

► Cost drivers promote the effective and efficient management of costs.

► Cost drivers help identify costs related to product variety and

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product/process complexity.
 Activity-based costing (ABC) is a cost accounting system that focuses on an
organization's activities and collects costs on the basis of the underlying nature
and extent of those activities. It is a process of overhead allocation. ABC differs
from a traditional cost accounting system in that ABC.

4 Identifies several
levels of costs
rather than the
Costs traditional concepts
Computation of variable (at the
unit level) or fixed.
in Activity-
Based
Considers some
Costing costs that are
considered period
costs for external
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Collects costs in
cost pools based
Assigns costs within
the multiple cost pools
on the underlying to products or services
using multiple drivers
nature and extent
of activities.
(both volume and non-
volume-related) that
best reflect the factor
May, under certain
causing the costs to be
incurred. considers
conditions, provide a some costs that are
more realistic picture considered product
of actual production costs for external

cost than has reporting as period

reporting as product traditionally been costs.
costs. available. .
 5 Conditions for Effective Use of
Activity-Based Costing
► ABC is appropriate in an organization that:
- produces and sells a wide variety of products or
services.
- customizes products to customer specifications.
- uses a wide range of techniques to manufacture
products or to provide services.
- has a lack of commonality in overhead costs of
products or services.
- has experienced problems with its current
overhead allocation system.
- has experienced significant changes in its
business environment, including widespread
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adoption of new technologies.
► Installation of an ABM or ABC system allows
management to:
- see the cost impact of an organization's cross-
functional activities.
- understand that fixed costs are, in fact, long-run
variable costs that change based on an identifiable
driver.
- realize the value of preparing process maps and
value charts. determine that the traditional bases
(direct labor and machine hours) might not produce
the most logical costs for products or services.
- recognize that standard products/services often
financially support premium products/services.
- set prices that reflect the activities needed to
produce special or premium products.
 6 Criticisms of Activity-Based Costing

► ABC requires substantial time and cost to implement.

► ABC does not specifically conform to generally accepted accounting
principles.
► ABC cannot “cure” product failures, sales volume declines, or financial
losses.
► ABC does not reduce overhead costs.
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Thank
you!
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