Activity Based Costing

• Activity based costing (ABC) is an accounting

methodology that assigns costs to activities
rather than products or services.
• This enables resources and overhead costs to
be more accurately assigned to the products
and the services that consume them.
• ABC is based on the principle that ‘products
consume activities.’

Management Accounting - 2e
By Paresh Shah Oxford University Press
 Activity Based Costing
• Activities can be defined as a named
process, function, or task that occurs over
time and has recognized results. Activities use
up assigned resources to produce products
and services. Inputs are transformed into
outputs under the parameters set by
controls performed by the organization’s
employees and their tools.

Management Accounting - 2e
By Paresh Shah Oxford University Press
 Basis Of ABC
• Identifying major activities and their costs
• Determining the cost drivers
• Cost Object
– Factor for which cost measurement is required
• Cost Driver
– Factor that causes a change in the cost of an
activity
• Resources are people and machines.
Management Accounting - 2e
By Paresh Shah Oxford University Press
 Basis Of ABC
• Resource drivers are the measure of the
frequency and intensity of the demands placed
on resources by activity.
• Activities are the processes performed by the
people and machine.
• Activity drivers measure the frequency and
intensity of the demands placed on activities by
cost objects enabling costs to be assigned to cost
objects.
Management Accounting - 2e
By Paresh Shah Oxford University Press
 How To Use ABC?
• ABC is used to determine the cost and benefits
associated with reengineering processes and systems.
• ABC approach will account for
– Activities or processes
– Frequency and cost of the activity
– The do-nothing scenario
– Which process provides value
• Determination cost drivers for activities
• Estimate application rates for each activity driver
• Application of costs to products

Management Accounting - 2e
By Paresh Shah Oxford University Press
 Benefits Of ABC
Over Absorption Costing
• More realistic product costs
• Awareness of the link between activity and cost
behaviour
• Support Cost reduction activities
• Facilitates the preparation of an activity-based
budget
• It helps in decision-making.
• Identification of non-value adding activities helps
the management to control cost.

Management Accounting - 2e
By Paresh Shah Oxford University Press
 Other Concepts Related To ABC
• Activity Based Management
– It is a systematic method of planning, controlling,
and improving labour and overhead cost. ABM is
based on the principle activities consume costs.
• Activity Accounting
- It is a system that defines and reports the
activities, costs, activity, characteristics, and
outputs of each department, cost center, or
group of employees in an organization.
Management Accounting - 2e
By Paresh Shah Oxford University Press
 Other Concepts Related To ABC
• Activity Based Budgeting
– It is a systematic method of planning and
budgeting the resources of an organization. In
essence, ABB is activity accounting in reverse,
e.g. start ABB at the bottom of the activity
accounting spreadsheet. Define the cost per
output target and planned activity workloads to
determine headcount and expense budgets.

Management Accounting - 2e
By Paresh Shah Oxford University Press