Activity Based Costing

System
&
Activity based Management

Presented by:-
Ankit Dekate
DEFINITION
• According to R. Cooper and R.S Kaplan “ABC
system calculate the cost of individual activities
and assign costs to cost objects such as products
and services on the basis of the activities
undertaken to produce each product or service.

• Activity Based Costing has been developed as a

more modern absorption costing method to
overcome the problem of undercosting and
overcosting and to produce more accurate
product costs.
ACTIVITY-BASED
ACTIVITY-BASED COSTING
COSTING MODEL
MODEL

Cost of Resources
Costs assigned using driver tracing
and direct tracing

Activities
Costs assigned using activity
drivers

Products
FEATURES OF ACTIVITY BASED
COSTING SYSTEM
• ABC system is a tool for refining a costing system
• It involves the creation of smaller cost pool linked
to the different activities.
• Cost collection is a made on the measurement of
activity performed by each activity –cost pool.
• Cost in each cost pool have a cause and effect
relationship with the cost allocation base over a
period of time.
• Some of the costs in cost pool can also traced
directly to products which leads to improvement
in cost accuracy since no assumption is made
about the cause and effect relationship between
the cost pool and the cost allocation base.
IMPORTANT OF ABC
SYSTEM
• Cost object - it refers to an item for which
cost measurement is required:

E.g.: A product ,a service or a customer

. Cost driver – a cost driver is any factor or force
that cause a change in the cost of an activity is
divided in to two part.

1) Resource cost driver

2) Activity cost driver
 Resource cost driver
It is a measure of the quantity of
resources consumed by an activity. It is used to assign the
cost of a resource to an activity or cost pool.

o Activity cost driver

It is a measure of the frequency and
intensity of demand, placed on activities by cost objects.
It is used to assign activity costs to cost objects.
STEP IN ACTIVITY BASED
COSTING
• Identifying the chosen cost objects:-
The cost objects of any organization are the
products or services and the goal is to first calculate the total
cost of manufacturing and distributing these products and
the unit cost.

• Identifying the different activities within the

organization:-
After the identification of the cost objects,
the main activities which are being performed in the
organization have to identified.
• Identify the direct costs of products:-
The direct cost of products/ objects may
comprise direct materials cost, direct labour cost and direct
expenses.

• Relating the overhead to the activities:-

After identifying the organization’s
activities, the various items of overhead are related to
activities, both support and primary, that caused them.

• Spreading the support activities across the

primary activities:-
The spreading of supporting activities across
the primary activities is done on some suitable base, which
reflects the use of the support activity.
• Determining the activities cost drivers:-
The determination of the activity cost drivers is
done in order to relate the overheads collected in cost pools
to the cost objects or products.

• Calculating the activity cost drivers:-

= Total Cost of Activity
Activity Driver

• Computing the total costs of products or cost

objects :-
The total costs of the products shall be computed
by adding all direct and indirect costs assigned to them.
ACTIVITY-BASED MANAGEMENT

ABM describes management decisions that use

activity-based costing information to satisfy
customers and improve profits.

Product pricing and mix decisions

Cost reduction and process improvement decisions

Design decisions
THE RELATIONSHIP OF ABC
AND ABM

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PROCESS VALUE ANALYSIS
 Process value analysis

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 Fundamental to activity-based responsibility
accounting
 Focuses on accountability for activities
rather than costs
 Emphasizes the maximization of systemwide
performance instead of individual
performance
 Process value analysis is concerned
with:
 Driver analysis
 Activity analysis
 Performance measurement
PROCESS VALUE ANALYSIS
 Driver analysis is the effort expended to identify
the factors that are the root causes of activity costs.

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 Activity analysis is the process of identifying,
describing, and evaluating the activities an
organization performs.
 Activity analysis should produce four outcomes:
 What activities are performed.
 How many people perform the activities.
 The time and resources are required to perform the activities.
 An assessment of the value of the activities to the
organization.
PROCESS VALUE ANALYSIS
 Value-added activities

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 Necessary to remain in business
 By mandate (e.g., comply with SEC reporting
requirements)
 May contain nonessential actions that create
unnecessary cost.
 Nonvalue-added activities
 All activities other than those essential to remain
in business
PROCESS VALUE ANALYSIS
 Nonvalue-added activities

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 Scheduling
 Uses resources to determine access to processes
 Moving
 Uses resources to move inventory among
departments
 Waiting
 Uses resources while waiting for next process
 Inspecting
 Uses resources to ensure conformance to
standards
 Storing
 Uses resources while goods are held in inventory
PROCESS VALUE ANALYSIS
 Kaizen costing: constant incremental
improvement, including cost reduction

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through activity management
 Activity elimination
 Focus on eliminating nonvalue-added activities
 Activity selection
 Choose among sets of competing strategies
 Activity reduction
 Decrease time and resources required by an
activity
 Activity sharing
 Use economies of scale to increase efficiency
PROCESS VALUE ANALYSIS
 Assessing activity performance

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 Financial
measures
 Nonfinancial measures
 Dimensions of performance assessment
 Efficiency
 Quality
 Time
BENCHMARKING
 Benchmarking is an improvement process
that is used to identify best practice within a
peer group and facilitate it’s incorporation
into your organization
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