IE 314 -

Managerial
Accounting
March 1, 2022
 Objectives

What is Activity-Based Costing?

Benefits of ABC-System

Steps involved in designing an

Activity-Based Accounting System

Illustrative Problems
 Activity-Based Costing

Activity-based costing approaches costs from the perspective that products do

not cause costs; they require activities, and the activities themselves are the
causes of all costs incurred.

This method is better suited to the increasingly complex flow of today's

manufacturing processes. Shifting the focus from products to activities
highlights the existence of non-value-add, or NVA, activity.

If activity is occurring that does not contribute efficiently to the

production of the finished good or service, it can be targeted
for reduction or elimination, thereby reducing costs.
Steps involved in designing an Activity-Based Costing

Step 1 Step 2 Step 3 Step 4

Process Identifying Assign cost Select Cost
Value activity to Activity Drivers
Analysis centers Centers
 Step 1 : Process Value Analysis
1. Analyze activities necessary to make the product of perform the service.
- Done by preparing a detailed listing of all the processes needed to
finish product or perform a service.

2. Classify each activity as value added or non-value added

- Classified to two: value added by mandate and discretionary.

3. Identify ways to eliminate, if not, reduce a non-value added activity.

- The following are cited as 5 major activities that are wasteful and
unnecessary
1. Scheduling
2. Moving
3. Waiting
4. Inspecting
5. Storing
 Step 2 : Identifiying activity centers
An activity center is defined as a part of the production process for which
management wants a separate reporting of the cost of the activity involved.
Classified into 4

1. Unit-level activities
- performed every time a unit is produced.
e.g. machining and assembly

2. Batch-level activities
- performed every time batch of goods is handled.
e.g inspection, production scheduling and material handling.
 Step 2 : Identifiying activity centers
3. Product-level activities
- performed as needed to support the production of each different type
of products. These are also termed as sustaining activities. These
activities consume inputs that develop products or allow products to be
consumed or sold.

e.g. engineering activities, development of product-testing

procedures, marketing a product, process engineering and
expediting.

4. Facility-level activities.
- those that sustain a factory’s general manufacturing
process.
e.g. plant management, security, depreciation
etc.
Step 3: Assign Cost
to Activity
Centers
After activities are identified and described,
the next job is determining how much it cost
to perform each activity.
This needs identification of the resources
being consumed by each activity.
It is necessary to assign costs of resources to
activities using direct and driver tracing.
Step 4: Select Cost
Drivers
Assigning costs from activity center to the
product using appropriate cost drivers. The
following must be considered when selecting
a cost driver:
1. The ease of obtaining data relating to the
cost driver
2. The degree to which the cost driver
measures actual consumption by
products of the activity involved.
 Benefits of Activity-Based Costing
The primary benefit of activity-based costing is that it brings a much
higher level of focus and understanding to bear on fixed cost
categories.

However, there is a significant up-front time investment required

to develop a system of accounting that accurately addresses
each category of activity involved in a business.

This process will usually involve some form of

value-stream or process-flow analysis, which,
while time-consuming, will provide invaluable
insights into the true drivers of a company's
costs.