Activity Based Costing (ABC)

Overview
ABC is an accounting system focusing on assigning indirect costs to products or
services.
Also known as transaction-based costing.
Utilized internally only as a supplementary costing system.
Eliminates cross-subsidy between high and low volume products.

Traditional Costing vs. ABC

Differences
Traditional Costing:
Cost object consumes resources.
Mostly uses volume-related allocation base.
Structure-oriented.
ABC:
Cost object consumes activities.
Uses drivers at various levels.
Process-oriented.

Example
Information of ABC Co
Units produced: 49,000 (product A), 1,000 (product B).
Direct materials: P10 (product A), P150 (product B).
Direct labor: P10 per hour (both products).

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 Overhead costs:
Production Dept: P700,000.
Engineering Dept: P450,000.
General Factory: P350,000.

Traditional Computation of Total Cost

1. Direct materials and labor costs.
2. Overhead computation.

3. Total cost and cost per unit.

ABC Computation
1. Direct materials and labor costs.
2. Overhead computation.
3. Total cost and cost per unit.

Measurement of Actual Profitability

Customer Unit-Level Activities
Tied to resources consumed for each unit sold to a customer.
Customer Batch-Level Activities
Resources required to support a sales transaction to a customer.

Customer-Sustaining Activities
Resources consumed to service a customer relationship.

Impact of Fixed Costs

Fixed overhead costs represent the largest group of costs.
Poor allocations lead to cross-subsidization errors and death spiral effects.

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 Hierarchy of ABC Activities
Unit level activities.
Batch level activities.
Product level activities.
Facility-level activities.

Problems/Concerns with Traditional Costing Methods

1. Application.
2. Cross-subsidization.

3. Poor cost accounting in charging common fixed costs.

Volume-Based Overhead Costing System

May overcost high volume products and undercost low volume products.

Key Concept and Objectives Underlying ABC

Concept: Resources are consumed by activities.
Objectives: Product or service costing, process analysis, management performance,
profitability assessment.

Construction of an ABC Model

1. Identify major activities and allocate overhead to activity cost pools.
2. Identify cost drivers and compute activity-based overhead rate (ABOR).

3. Assign overhead costs to each product.

4. Prepare management reports.

Product Planning and Design

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 Strategic phases: product concept development, competitive analysis, market
research, minimum viable product development, product launch, product lifecycle
maintenance, product sunsetting.

Process Improvement Methodologies

Six Sigma, TQM, Lean Manufacturing, Kaizen, PDCA, 5 Why Analysis, Business Process
Management (BPM).

Quality Management and Control

Quality, quality control, quality planning, test plans.

Action Analysis Report

Cost distinctions: green, yellow, red.

Factors Influencing Success

1. Strong support from top management.

2. Responsibility of a cross-functional team.

3. Limited use of ABC data for evaluation and rewards.

Implementation
Focuses on reclassifying indirect costs as direct costs.

Evaluation
Benefits and limitations of ABC methods.

Value Added vs. Non Value Added Activities

Distinguishing between value added and non value added costs.

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 This detailed summary provides a comprehensive understanding of Activity Based Costing
(ABC), including its principles, application, and impact on cost management.

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