Activity Based Costing

&

Transfer Pricing
ABSTRACT
Activity Based Costing (ABC) is a method
for developing cost estimates in which
the project is subdivided into discrete,
quantifiable activities or a work unit.
The concepts of ABC were developed in
the manufacturing sector of the United
States during the 1970s and 1980s.
Activity Based Costing

Activity based costing is that in which costs are first

traced to activities and then to products.
*Focuses on activities performed to produce products.

*System assumes that activities are responsible for

the incurrence of costs and products create demand
for these activities.

*ABC tries to ascertain the factors that cause each

major activities and the relationship between
activities and products produced.
 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?
Stages of Activity Based Costing
• Identify the chosen cost objects : The cost objects of any
organization are the products or services and the goal is to first
calculate the total cost of manufacturing and distributing these
products and their unit cost.
• Identify the different activities within the organization :After
the identification of cost objects, the main activities, which are
being performed in the organization, have to be identified. Usually
the number of over cost centers in ABC will be much more as
compared to traditional overhead system.
• Identifying the direct cost of products :The direct cost of products
or objects may comprise direct material cost, direct labor cost and
direct expenses
• Relating the overhead to the activities :After identifying the
organizations activities, the various items of overhead are related to
activities both support and primary, that caused them.
• Spreading the support activities across the primary activities:
The spreading of support activities (i.e., activities which support or
assist manufacturing) across the primary activities (correlated to the
number of units produced) is done on some suitable base which
reflects the use of support activity.
• Determining the activity cost drivers :The determination of the
activity cost drivers is done in order to relate the overhead collected
in cost pools to the cost objects of products. It is done on the basis
of the factor that drives the consumption of the activities.
• Calculating the activity cost driver rates :

Activity cost driver rate =     Total cost of activity

                                Activity driver
These activity cost driver rates are to be used for ascertaining the
amount of overhead chargeable to various cost objects or products

Classification of Activities
* Unit level activities:-
they are those activities which are performed each time a unit is
produced.
* Batch level activities:-
they are those which are performed each time a batch of goods is
produced.
* Product level activities:-
they are those activities which are performed to support the
production of each different type of product.
* Facility level activities:-
they are those activities which are needed to sustain a factory’s
general manufacturing process.
 Building an ABC Model
Identify Identify Identify
Resources Activities Cost Objects

Define Define
Activity Resource
Drivers Drivers

Enter Enter Enter

Calculate
Resource Resource Activity
Costs
Costs Driver Qty. Driver Qty.
 Transfer Pricing
In divisionalsied companies, where the profit or
investment centers are created, there is likely to
be inter-divisional transfer of goods and
services and this internal transfer create the
problem of transfer pricing.
A transfer price is that notional value at which
goods and services are transferred between
divisions in a decentralized organization.
Transfer prices are normally set for intermediate
products which are goods and services that are
supplied by the selling division to buying
division.
Methods of Transfer Pricing
*Cost-based prices

*Market – based prices

*Negotiated prices
THANK YOU