COMSATS INSTITUTE OF INFORMATION

TECHNOLOGY, SAHIWAL

ACTIVITY BASED COSTING AND TRADITIONAL

COSTING SYSTEM
Muhammad Mustafa ( Mbasp09-A-001)
Muhammad Arbab Jehangir (003)
Muhammad Nadeem (014)
Rizwan Haider (083)
Muhammad Kazim (087)

Department : Management Sciences

THE WMTS ARTS
 ROADMAP OF THE PRESENTATION

 WHAT IS COST?
 What is Activity Base Costing System?
 IMPORTANTANCE OF ACTIVITY-BASED COSTING
 STEPS FOR IMPLEMENTING ACTIVITY-BASED
 COSTING
 What is Traditional Costing System?
 ACTIVITY-BASED COSTING VS TRADITIONAL
COSTING
 LIMITATIONS OF ACTIVITY BASED COSTING
 SUMMARY
 WHAT IS COST?

According To American Accounting Association

 Cost is a forgoing, measured in monetary terms, incurred

or potentially to be incurred to achieve a specific objective.

 Each modification implies a certain attribute which is

important in computing and measuring the cost which is to
serve the management levels in achieving their basic
objectives of planning and control.

 It is a fundamental axiom that a cost must be understood

in its relationship to the aims or purposes which it is to
serve.
 METHODS OF CALCULATING COST

 Activity based costing

(ABC)

 Traditional costing
(TCM)
 HISTORYOF ACTIVITY-BASED COSTING

 ABC was first clearly defined in 1987 by Roberts Kaplan

and W.Bruns.

 They initially focused on manufacturing industry where

increasing technology and productivity improvements
have reduced the relative proportion of the direct costs of
labor and materials, but have increased relative
proportion of indirect cost.

 For Example, Increased automation has reduced labor,

which is a direct cost, but has increased depreciation,
which is an indirect cost.
WHAT IS ACTIVITY-BASED COSTING SYSTEM?

 “A method of measuring the cost and performance of

activities and cost objects.”

 Activity based costing (ABC) is a costing method that is

designed to provide managers with cost information for
strategic and other decisions that potentially affect capacity
and therefore fixed costs. Activity based costing is ordinarily
used as a supplement to rather than as a replacement for the
companies usual costing system.
WHY ACTIVITY-BASED COSTING IS IMPORTANT?

 ABC is a cost accounting methodology that can provide

definitions of processed, identify what the cost drivers of those
processes are, determine the unit costs of various products and
services, and create various reports on agency components that
can be utilized to generate activity or performance based
budgets.

 A major advantage of using ABC is that is avoids or minimizes

distortions in product costing that result from arbitrary
allocations of indirect costs.
 WHY TO USE ABC?

 Sales are increase but profits are declining.

 Overhead rates are very high and increasing
overtime.
 Product lines are diverse.
 Direct labor is small percent of total cost.
 Competitors’ high-volume product seems to
be priced unrealistically low.
STEPS FOR IMPLEMENTING ACTIVITY-BASED COSTING

 STEP 1:
IDENTIFY AND DEFINE ACTIVITIES
AND ACTIVITY COST POOLS

 STEP 2:
DIRECTLY TRACE OVERHEAD COSTS
TO ACTIVITY AND COST OBJECTS

 STEP3:
ASSIGN COSTS TO ACTIVITY COST POOLS
 STEPS

 STEP 4:
CALCULATE ACTIVITY RATES

 STEP 5:
ASSIGN COST TO COST OBJECTS

 STEP 6:
PREPARE MANAGEMENT REPORT
 Traditional Costing System
 It is a well-known fact that the traditional
costing systems utilize a single, volume-
based cost driver.
  This is the reason why the traditional product
costing system distorts the cost of products. 
 In most cases this type of costing system
assigns the overhead costs to products on the
basis of their relative usage of direct
labor. For this reason traditional cost systems
often report inaccurate product costs. 
 TRADITIONAL COSTING V/S ACTIVITY-
BASED
COSTING
 Manufacturing and Non manufacturing cost

 Cost Pool

 Allocation Basis

 Cost Objectives
 (Cont…)

 Decision support

 Cost control

 Cost
LIMITATIONS OF ACTIVITY BASED COSTING

 Activity-based costing is more costly to

maintain than a traditional labor costing
system.
 Activity-based costing does not have full
support of top management.
 Activity-based costing can easily be
misinterpreted.
 Organization using activity-based costing
have to maintain 2 cost systems
 SUMMARY

 Activity-based costing estimates the

cost of sources consumed by cost
objects such as product and customers

  The approach taken in activity-based

costing assumes that cost objects
generate activities that in turn
consumes costly resources.
 SUMMARY

 Activities form the link between costs

and cost objects.

 Activity-based costing is concerned

with overhead – both manufacturing
overhead and selling, general, and
administrative overhead.
THANKS