ACTIVITY BASED COSTING
STEPS OF ACTIVITY BASED COSTING
1. Identify organisations major activities creating overheads.
2. Collect cost related to each activity in a separate cost pool.
3. Identify factor causing change in the cost of these activities. (cost drivers)
4. Calculate absorption rate per cost driver for each activity.
5. Charge cost to products on the basis of usage of these activities.
SUITABILITY OF ACTIVITY BASED COSTING (ABC)
❖ Number of products
❖ Cost structure
❖ When consumption of resources is not volume driven.
❖ Cost benefit analysis
❖ Resistance by employees
❖ Change in information system
Advantages of activity based costing ABC
Disadvantages of activity based costing ABC
1. Accurate cost calculation
1. ABC is time consuming and expensive.
2. Accurate selling price
3. Better cost control
2. Many judgmental decisions still required in
4. Better decision making
the construction of an ABC system.
5. Better planning/ activity based
budgeting
3. Selection of cost driver may not be easy.
6. Better profitability analysis.
Cost driver:
❖ Any factor, reason or base which
generate overheads cost.
❖ Reason which increase or decrease
overheads.
Cost pool:
❖ The costs that accumulate for each
activity cost centre is called a cost
pool.
❖ Cost of each activity
OAR =
Cost pool
Cost driver
Cost pool
Ordering costs: handling customer orders
Materials handling costs
Machine set-up costs
Production scheduling costs
Despatching costs
4. The cost of implementing and maintaining an
ABC system can exceed the benefits of
‘improved accuracy’ in product costs.
5.
ABC will be of limited benefit if overhead
costs are primarily volume related
6. Reduced benefit if the company is producing
only one product or a range of products with
similar costs
7. There must be a reason for using a system of
ABC. ABC must provide meaningful product
costs or extra information that management
will use. If management is not going to use
ABC information for any practical purpose, a
traditional absorption costing system would
be simpler to operate and just as good.
Cost drivers
Number of orders
Number of production runs
Number of machine set-ups
Number of production runs
Number of orders despatched