Activity Based Costing • What is ABC?• Activity based costing is not a distinct method of costing

like job costing & process costing.It is only a new practice

Or intermediate change in the process of attribution of costs to jobs and processes.Earlier the costs were first collected for productions & service departments and finally the costs of production departments were absorbed by jobs and processes.Now in the context of activity based costing the costs are collected according to activities such as material ordering,material handling,quality testing etc. & jobs & processes for which cost collection is being attempted are loaded with costs of these activities rationally.

Conceptual Framework of ABC

• ABC is a system that focuses on activities the fundamental cost objects & uses the costs of these activities as building blocks for compiling the costs of other objects. CIMA London has defined ABC as “cost attribution to cost units on the basis of benefits received from indirect activities i.e.ordering ,setting up,asssuring quality etc.ABC emphasises links between performance of particular activities and the demand those activities make on the organisation resources.

• ABC can give manager a clear picture on the products,bands,customers,facilities,

regions and distribution channels generate revenues and consume resources.Under ABC costs are accumulated for each activity as a separate cost object.The cost are then applied to products based on the benefits received from various activities.The final product cost are built up from the costs of the specific actvities undergone.For introductions of ABC,it is necessary for managers to have conceptual break from traditional cost accounting system.They should separate the resources and match them to the level of activity that consumes the resources.

Advantages of Activity Based Costing

• It helps understanding the behaviour of overhead costs and their relationship to products,services,customers and market segments.

• It helps to allocate the resources to those activities,that will increase shareholders value.

• It links profitability analysis to operational decisions.• It ensures that the cost of non-value added activities is

visible to management.• It provides the right information for performance

measurement because it focuses on activities rather than resources.

• The understanding of cost driver for each activity gives better control over the factors,that cause cost.

• It provides accurate information on profit margin and performance measurement.

• It gives business an opportunity to improve their competitive position through better informations.

• Disadvantages of ABC• It is essentially not the panacea for all ills.• It absorbs a lot of resources.

• Too much emphasis on customer viability can lead to problems such as cheaper products and therefore,potentially lower sales.

• It may lead to weaker customer segmentation.

• It takes no account of opportunity costs.

• The basic objectives of ABC are two folds: