Activity-Based Costing

Shital Jhunjhunwala
Associate Professor
DOC, DSE
ABC--1
ABC SJ
 COST FLOW
l
l
Direct l Direct Cost l
l
Materials l
or l
l
l
l Cost
+ Prime Cost l
of
= l
l
l
l
l
Production
Direct
}
l
l
+ = l
l

Labour
l
l
l +
l
l
Factory l
General
l
l Overhead l
Administration
l

l
l
l
Cost
l
l
l
l
+
l
l
l
l
Marketing
l l Cost
l l
l Full
l
l Cost
l
l
l
l
l
ABC--2
ABC l SJ
l
 COST ALLOCATION – GENERAL
APPROACH
INDIRECT COST COST POOL COST POOL COST POOL
POOLS 1 2 n

INDIRECT COST APPLICATION APPLICATION APPLICATION

APPLICATION
BASE 1 BASE 2 BASE n
BASES

INDIRECT COSTS
COST OBJECT
DIRCECT COSTS

DIRECT DIRECT DIRECT

DIRECT COSTS
COST 1 COST 2 COST n
SJS
ABC--3
ABC SJ
 ABC traces cost based on Cause & Effect
Product

COSTS
Demand

Consumed ACTIVITIES
by

Consume

Product
RESOURCES
that Cost
ABC--4
ABC SJ
 Ramesh , Harish & Sandeep order separate
items for lunch.

Ramesh order amounts to Rs. 14

Harish consumed Rs. 30
Sandeep order is Rs. 16

What is the average cost per person ?

ABC--5
ABC SJ
 Rs. 60 ÷ 3 = RS. 20

Ramesh and Sandeep Harish is

are overcosted. undercosted.

ABC--6
ABC SJ
 CROSS-SUBSIDISATION – AN EXAMPLE
COST OF SETUP ACTIVITIES - 1,20,000/-

PRODUCT VOLUME BATCH SIZE

L 5,000 ( 10% ) 500

H 45,000 ( 90% ) 9,000
50,000

ABC--7
ABC SJ
 CROSS-SUBSIDISATION – AN EXAMPLE
TRADITIONAL COSTING
PRODUCT ALLOC. OF SETUP COSTS
L 12,000 ( 10% OF 1,20,000 )
H 1,08,000 ( 90% OF 1,20,000 )

ABC
PRODUCT SETUPS ALLOC. SET
UP COSTS
L 10 ( 67% ) 80,000 ( 67% )
H 5 ( 33% ) 40,000 ( 33% )
15
ABC--8
ABC SJ
 ABC Terminology

Resources

Resource
Activities
Drivers

Cost Object Cost Drivers

ABC--9
ABC SJ
 Juice Seller
Sells Orange and Pineapple juice to customers who
come to the stall.

ABC--10
ABC SJ
 Traditional Product Cost
Orange Pineapple
Glasses 50 50
No. Of Fruit 100 25
Total cost Rs. Rs.

Total (Indirect) 200 100 100

Cost of Fruits 500 500
Total Product Cost 600 600
Cost per Unit 12 12
Selling Price 12 12
Profit - -

ABC--11
ABC SJ
 Activities
Purchase Fruits
Process 1 Cutting

Process 2 Blending
Pours & Serves the juice

ABC--12
ABC SJ
 Resources
Cart Juicer

Glasses

Electric Power
Manpower

ABC--13
ABC SJ
 Resource Driver
Purchasing Cutting Blending Serving
Manpower 30% 60% 6% 4%
Electric power - - 100% -
Juicer - - 100% -
Glasses - - - 100%
Cart - 45% 45% 10%

ABC--14
ABC SJ
 Activity Cost
Rs. Purchasing Cutting Blending Serving
Manpower 100 30 60 6 4
Electricity 20 20
Juicer 10 10
Glass 50 50
Cart 20 9 9 2

Total 200 30 69 45 56

ABC--15
ABC SJ
 Cost Driver
Orange Pineapple
Glasses 50 50
No. Of Fruit 100 25
Purchasing 30 Distance 10 20
Cutting 69 Time (min) 1 10
Blending 45 Time (min) 1 2
Serving 56 Number 50 50

ABC--16
ABC SJ
 Product Cost Under ABC
Orange Pineapple
Glasses 50 50
No. Of Fruit 100 25
Total cost Rs. Rs.
Purchasing 30 10 20
Cutting 69 6 63
Blending 45 15 30
Serving 56 28 28
Total (Indirect) 200 59 141
Cost of Fruits 500 500
Total Product Cost 559 641
Cost per Unit 11.18 12.82
Selling Price 12.00 12.00
Profit .82 - .82

ABC--17
ABC SJ
 Traditional Product Cost
Orange Pineapple
Glasses 50 50
No. Of Fruit 100 25
Total cost Rs. Rs.

Total (Indirect) 200 100 100

Cost of Fruits 500 500
Total Product Cost 600 600
Cost per Unit 12 12
Selling Price 12 12
Profit - -

ABC--18
ABC SJ
 The purpose of ABC is to make this
link
We know: So we must find So we can
out... …and why determine:

What resources How much activities What drives activity The cost of outputs
cost cost costs

People Selling such as Products

Equipment Manufacturing
No. of customers Services
Travel Filing
Materials Training No. of products Channels
Buildings Paying suppliers No. of invoices
Customers
etc Planning etc
etc etc

Activities/ Activity
Resources processes Cost objects
drivers

... in order to be able to assign costs accurately to products and services

ABC--19
ABC SJ
 COMPARISON OF TRADITIONAL
COSTING & ABC – 1
(A) TRADITIONAL PRODUCT COSTING

PRODN DEPTL.OH
PRODUCTS
DEPTS RATES

A RATE 1

OVERHEAD
B RATE 2
COST

C RATE 3

STAGE 1: O/H ASSIGNED TO STAGE 2: O/H ALLOCATED TO

PRODN DEPTS PRODUCTS

ABC--20
ABC SJ
 COMARISON OF TRADITIONAL
COSTING & ABC – 2
(B) ACTIVITY BASED PRODUCT COSTING

ACTIVITY COST ACTIVITY

PRODUCTS
POOLS ALLOC.RATES

A A1

B B1

OVERHEAD C C1
COST
D D1

E E1
STAGE 1: O/H ASSIGNED TO STAGE 2: O/H ASSIGNED TO PRODUCTS
COST CENTRES/ COST POOLS USING COST DRIVER RATES

ABC--21
ABC SJ
 Refining a Costing System

Direct-cost tracing

Indirect-cost pools

Cost-allocation basis

ABC--22
ABC SJ
 Activity-Based Costing System

Fundamental Assignment to Other

Cost Objects Cost Objects
Activities Cost of:
• Product
• Service
Costs of Activities • Customer

ABC--23
ABC SJ
 Cost Hierarchies

ABC systems commonly use a

four-part cost hierarchy to
identify cost-allocation bases:
1. Output unit-level costs
2. Batch-level costs
3. Product-sustaining costs
4. Facility-sustaining costs
ABC--24
ABC SJ
 Output Unit-Level Costs

These are resources sacrificed

on activities performed on each
individual unit of product or service.
Energy
Machine depreciation
Repairs

ABC--25
ABC SJ
 Batch-Level Costs

These are resources sacrificed on

activities that are related to a group
of units of product(s) or service(s)
rather than to each individual unit
of product or service.
Setup-hours
Procurement costs

ABC--26
ABC SJ
 Product-Sustaining Costs

These are often called service-sustaining

costs and are resources sacrificed on
activities undertaken to support
individual products or services.
Design costs
Engineering costs

ABC--27
ABC SJ
 Facility-Sustaining Costs

These are resources sacrificed on

activities that cannot be traced to
individual products or services but
support the organization as a whole.
General administration
– rent – building security

ABC--28
ABC SJ
 Overhead Costs
Total budgeted cost = $3,894,000 Identification
of Activity
Activity Cost Pools
Cost
Pools

Product-
Unit Batch Sustaining Facility
Level Level Level Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,212,600 $3,000 $700,000 $507,400

ABC--29
ABC SJ
 Activity Cost Drivers
Least

Cost & Accuracy

Transaction

Duration

Intensity (Direct charging)

Most

The choice of a transaction, duration,, or intensity

cost driver can occur for almost any activity

ABC--30
ABC SJ
 Selecting Activity Cost Drivers
 Activity cost drivers are the central innovation of activity-based cost
systems
 They are also the most costly to measure
 The selection of an activity cost driver reflects a subjective trade-off
between accuracy and the cost of measurement
 An ABC system with 50 activity cost drivers and 2,000
products would require that 100,000 data elements be
estimated
 Because of the large number of potential activity-to-product linkages,
management accountants attempt to economize on the number of different
activity cost drivers
 Activities triggered by the same event may all use the same activity cost
driver
 For example, preparing production orders, scheduling production runs,
performing first part inspections, and moving materials may all use the
number of production runs

ABC--31
ABC SJ
 Factors in Selecting
Activity Cost Drivers

Degree of correlation

Cost of Measurement

Behavioral effects

ABC--32
ABC SJ
 ABC IDENTIFIES A SET OF ACTIVITIES
AND DRIVERS:
Activity Driver
 purchase ordering # of orders
 materials handling # of moves for mat’ls
 production scheduling # of production runs
 machine set up setup hrs
 first unit inspection DL hrs
 every unit inspection # of units
 machine supplies, maintenance # of machine hrs
 parts administration # of parts
 product design # of products
 Engineering (modify product characteristics) ECO’s
 housekeeping, lighting, rent sq. ft.
 plant mgmt, acctg # of workers
 Introduce new products # of new products produced

ABC--33
ABC SJ
 Questions

ABC--34
ABC SJ
 Thank You

ABC--35
ABC SJ