Activity-Based Costing (ABC)

Definition: Activity-Based Costing (ABC) is a method of assigning overhead and indirect costs
—such as salaries, utilities, and rent—to products and services. ABC identifies the various
activities in an organization and assigns the cost of each activity to all products and services
according to the actual consumption by each. This method aims to provide more accurate cost
information compared to traditional costing methods by focusing on the causes of costs and the
extent to which activities consume resources.

Key Components:

1. Activities: Actions or tasks that incur costs.

2. Cost Pools: Groups of individual costs related to a specific activity.
3. Cost Drivers: Factors that cause changes in the cost of an activity.
4. Cost Objects: Items for which costs are measured and assigned (e.g., products, services,
customers).

Example:

Imagine a company, "TechGadgets Inc.," which manufactures two products: Smartphones and
Laptops. To understand the costs associated with each product more accurately, TechGadgets
Inc. decides to implement Activity-Based Costing.

Standard costing

“a predetermined cost which is calculated from managements standards of efficient operations

and the relevant necessary expenditure.” They are the predetermined costs on technical estimate
of material labor and overhead for a selected period of time and for a prescribed set of working
conditions. In other words, a standard cost is a planned cost for a unit of product or service
rendered.

Key Components:

1. Standard Costs:

 Material Costs: The expected cost of materials required to produce a product.

 Labor Costs: The predetermined cost of labor needed to manufacture a product.
 Overhead Costs: The expected costs of indirect manufacturing expenses.

Imagine a company, "WidgetWorks Inc.," that produces gadgets. The company uses standard
costing to manage and control its costs.
 1. Set Standard Costs:

 Materials: $5 per unit

 Labor: $3 per unit
 Overhead: $2 per unit

Total standard cost per unit = $5 (Materials) + $3 (Labor) + $2 (Overhead) = $10

Cost-Volume-Profit (CVP) Analysis

Definition: Cost-Volume-Profit (CVP) analysis is a managerial accounting method used to

understand the relationships between cost, volume, and profit. It helps managers make decisions
about pricing, production levels, product mix, and the economic impact of various business
strategies. CVP analysis focuses on how changes in costs and volume affect a company's
operating profit.

Key Components:

1. Sales Price per Unit: The amount of money charged to the customer for each unit sold.
2. Variable Costs per Unit: Costs that vary directly with the level of production or sales
volume, such as raw materials and direct labor.
3. Fixed Costs: Costs that remain constant regardless of the level of production or sales
volume, such as rent, salaries, and insurance.
4. Contribution Margin: The difference between the sales price per unit and the variable
cost per unit. It represents the portion of sales revenue that contributes to covering fixed
costs and generating profit.
5. Break-Even Point: The sales volume at which total revenue equals total costs, resulting
in zero profit. At the break-even point, a company covers all its fixed and variable costs
but does not make any profit.
6. Marginal Costing vs. Absorption Costing
7. Marginal Costing:
8. Definition: Marginal costing, also known as variable costing or direct costing, is a
costing method in which only variable costs are considered when calculating the cost of a
product. Fixed costs are treated as period costs and are expensed in the period they are
incurred.
9. Example: If a company produces 1,000 units with variable costs of $5 per unit and fixed
costs of $10,000, the total cost under marginal costing for 1,000 units would be $5,000
(variable costs only).
10. Absorption Costing:
11. Definition: Absorption costing, also known as full costing, is a costing method where all
manufacturing costs, both variable and fixed, are included in the cost of a product. This
method allocates a portion of fixed manufacturing overheads to each unit of production.
Example: If the same company produces 1,000 units with variable costs of $5 per unit and fixed
costs of $10,000, the total cost under absorption costing would be $15,000. Each unit would
include a share of the fixed costs: $5 (variable cost) + $10 (fixed cost allocation) = $15 per unit.

Comparison:

Feature Marginal Costing Absorption Costing

Costs Included
Fixed Costs Treatment
Profit Calculation
Inventory Valuation
Decision Making
GAAP Compliance
Cost Control Focus
Variable costs only Variable and fixed costs
Period costs Product costs
Based on contribution margin After all costs are allocated
Variable costs only Full production cost
Easier for short-term decisions Provides a fuller cost picture
Not compliant Compliant
Focus on variable costs Includes control over fixed costs