Activity Based Costing

What is ABCActivity-based costing (ABC) is a better, more accurate way of allocating overhead.

Requirement of Cost SystemsValuation of inventory and measurement of the cost of goods sold for financial reporting.

Estimation of the costs of activities, products, services, and customers.

Providing economic feedback to managers and operators about process efficiency.

Todays businesses are working in an increasingly complex environment.Use of Advanced TechnologyProduct Life Cycle

Product ComplexityChannels of DistributionQuality RequirementsProduct Diversity

Chart5

305020

304030

303040

302050

Direct Material

Labour

Overheads

Composition of Cost

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet1

Direct Material

Labour

Overheads

Composition of Cost

Sheet2

Sheet3

Conventional CostingTotal Cost = Material + Labour+ OverheadsOverheads are allocated to the products on volume based measures e.g. labour hours, machine hours, units produced

Will this not distort the costing in the new environment?ABC provides an Alternative.

Conventional CostingExpensesCost ObjectsAB CostingResourcesActivitiesCost ObjectsEconomic ElementWork PerformedProduct or service

Basics of A B CCost of a product is the sum of the costs of all activities required to manufacture and deliver the product.Products do not consume costs directlyMoney is spent on activitiesActivities are consumed by product/services

Basics of A B C (contd.)ABC assigns Costs to Products by tracing expenses to activities. Each Product is charged based on the extent to which it used an activity

The primary objective of ABC is to assign costs that reflect/mirror the physical dynamics of the business

Basics of A B C (contd.)Provides ways of assigning the costs of indirect support resources to activities, business processes, customers, products.It recognises that many organisational resources are required not for physical production of units of product but to provide a broad array of support activities.

ABC systems addresses the following Questions:What activities are being performed by the organisational resources?How much does it cost to perform activities?Why does the oranisation need to perform those activities?How much of each activity is required for the organisations products, services, and customers?

Basics of A B C : How?Steps:Form cost poolsIdentify activitiesMap resource costs to activitiesDefine activity cost driversCalculate cost

Cost pools are groups or categories of individual expense items

Identify ActivitiesIn developing an ABC system, the organisation identifies the activities being performed:Move material Schedule productionPurchase materialInspect items

Respond to customers Improve productsIntroduce new productsExplore new markets

Activity Dictionary

Map resource costs to activitiesFinancial accounting categorises expenses by spending code; salaries, fringe benefits, utilities, travel, communication, computing, depreciation etc.

ABC collects expenses from this financial system and drive them to the activities performed.

Mapping

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

ActivitiesActivity RateContainersBaby Product

Unit Level

Acquire and Use material for containers0.041,200,00048,000

Acquire and Use material for baby-care products107,00070000

Batch Level

Set up manually controlled machines300123,600

Set up computer controlled machines600169600

Product Level

Design and manufacture moulds1000

11,000

44000

Use manually controlled machines15000115,000

Use conputer controlled machines40000140000

Customer Level

Consult customers100

Containers2200

B.products404000

Provide warehousing for customers0.2

Containers8,0001,600

B.products2,000400

Faciltiy Level

Manage workers0.2

Containers4,000800

B.products10,0002000

Use main building3

Containers5,00015,000

B.products7,00021000

85,200151,000

Sheet3

Accounting RecordsABC Records

Salaries313,000ActivitiesSalariesDepreciationElectricitySuppliesTravelTotal

Depreciation155,000Business Development20,000250005000500055,000

Electricity132,000Maintianing Present Business80,0006000050000500010000205,000

Supplies25,000Purhcasing Material125,00050000200002000060000275,000

Travel100,000Set up Machines25,00010000200037,000

Total725,000Running Machines50,0001000050000110,000

Resolve Quality Problems13,00050002500043,000

Total313,00015500013200025000100000725,000

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

ActivitiesActivity RateContainersBaby Product

Unit Level

Acquire and Use material for containers0.041,200,00048,000

Acquire and Use material for baby-care products107,00070000

Batch Level

Set up manually controlled machines300123,600

Set up computer controlled machines600169600

Product Level

Design and manufacture moulds1000

11,000

44000

Use manually controlled machines15000115,000

Use conputer controlled machines40000140000

Customer Level

Consult customers100

Containers2200

B.products404000

Provide warehousing for customers0.2

Containers8,0001,600

B.products2,000400

Faciltiy Level

Manage workers0.2

Containers4,000800

B.products10,0002000

Use main building3

Containers5,00015,000

B.products7,00021000

85,200151,000

Sheet3

Accounting RecordsABC Records

Salaries313,000ActivitiesSalariesDepreciationElectricitySuppliesTravelTotal

Depreciation155,000Business Development20,000250005000500055,000

Electricity132,000Maintianing Present Business80,0006000050000500010000205,000

Supplies25,000Purhcasing Material125,00050000200002000060000275,000

Travel100,000Set up Machines25,00010000200037,000

Total725,000Running Machines50,0001000050000110,000

Resolve Quality Problems13,00050002500043,000

Total313,00015500013200025000100000725,000

Activities: TypesUnit level: Performed each time a unit is producedBatch level: Performed each time a batch is producedProduct level: Performed to support production of different type of productCustomer Level: Performed to support servicing customersFacility level:Residuary head

Define activity driversThe linkage between activities and cost objects, such as products, customers,, is accomplished by using activity drivers.An activity driver is a quantitative measure of the output of an activity.The selection of an activity driver reflects a subjective trade-off between accuracy and cost of measurement.

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

ActivitiesActivity RateContainersBaby Product

Unit Level

Acquire and Use material for containers0.041,200,00048,000

Acquire and Use material for baby-care products107,00070000

Batch Level

Set up manually controlled machines300123,600

Set up computer controlled machines600169600

Product Level

Design and manufacture moulds1000

11,000

44000

Use manually controlled machines15000115,000

Use conputer controlled machines40000140000

Customer Level

Consult customers100

Containers2200

B.products404000

Provide warehousing for customers0.2

Containers8,0001,600

B.products2,000400

Faciltiy Level

Manage workers0.2

Containers4,000800

B.products10,0002000

Use main building3

Containers5,00015,000

B.products7,00021000

85,200151,000

Sheet4

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Sheet3

Accounting RecordsABC Records

Salaries313,000ActivitiesSalariesDepreciationElectricitySuppliesTravelTotal

Depreciation155,000Business Development20,000250005000500055,000

Electricity132,000Maintianing Present Business80,0006000050000500010000205,000

Supplies25,000Purhcasing Material125,00050000200002000060000275,000

Travel100,000Set up Machines25,00010000200037,000

Total725,000Running Machines50,0001000050000110,000

Resolve Quality Problems13,00050002500043,000

Total313,00015500013200025000100000725,000

MBD00041CFA.xls

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

Sheet3

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

Sheet3

Ascertaining Cost

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

ActivitiesA. RateA.VolumeContainersBaby Product

Unit Level

Acquire and Use material for containers0.041,200,00048,000

Acquire and Use material for baby-care products107,00070000

Batch Level

Set up manually controlled machines300123,600

Set up computer controlled machines600169600

Product Level

Design and manufacture moulds1000

11,000

44000

Use manually controlled machines15000115,000

Use conputer controlled machines40000140000

Customer Level

Consult customers100

Containers2200

B.products404000

Provide warehousing for customers0.2

Containers8,0001,600

B.products2,000400

Faciltiy Level

Manage workers0.2

Containers4,000800

B.products10,0002000

Use main building3

Containers5,00015,000

B.products7,00021000

Total Cost85,200151,000

Sheet4

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Sheet3

Accounting RecordsABC Records

Salaries313,000ActivitiesSalariesDepreciationElectricitySuppliesTravelTotal

Depreciation155,000Business Development20,000250005000500055,000

Electricity132,000Maintianing Present Business80,0006000050000500010000205,000

Supplies25,000Purhcasing Material125,00050000200002000060000275,000

Travel100,000Set up Machines25,00010000200037,000

Total725,000Running Machines50,0001000050000110,000

Resolve Quality Problems13,00050002500043,000

Total313,00015500013200025000100000725,000

MBD00041CFA.xls

Sheet1

T1T2E3T4

Direct Material30303030

Labour50403020

Overheads20304050

Sheet2

ActivitiesDriversActivity CostActivity VolumeActivity Rate

Unit Level

Acquire and Use material for containersNo. of Containers40,0001,000,0000.04

Acquire and Use material for baby-care productsNo. of products80,0008,00010

Batch Level

Set up manually controlled machinesNo. of batches of containers3,00010300

Set up computer controlled machinesNo. of batches of B. Produst12,00020600

Product Level

Design and manufacture mouldsNo.of moulds required5,00051000

Use manually controlled machinesProduct type (containers)15,000115000

Use conputer controlled machinesProduct type (B.Products)40,000140000

Customer Level

Consult customersNo. of consultations4,00040100

Provide warehousing for customersNo. of cubit feet2,00010,0000.2

Faciltiy Level

Manage workersSalaries3,00015,0000.2

Use main buildingSquare feet48,00016,0003

Sheet3

Building an ABC Model

IdentifyResourcesIdentifyActivitiesIdentifyCost ObjectsDefineResourceDriversDefineActivityDriversEnterResourceCostsEnterResourceDriver Qty.EnterActivityDriver Qty.CalculateCosts

ABC: Where to Use?High OverheadsProduct Diversity or Multiple ProductsCustomer DiversityService DiversityStiff Competition