This document provides information about Activity-Based Costing (ABC), including: - ABC traces resource consumption and costs final outputs based on activity consumption estimates and cost drivers. - ABC arose in the 1980s as traditional cost accounting methods became less relevant due to changes in industry. - ABC assigns costs to specific activities first, then assigns activity costs to products based on cost drivers and consumption, providing more accurate product costs than traditional methods. - ABC identifies wasteful activities and improves processes, leading to more accurate pricing, profitability analysis, and cost reduction. However, ABC is more expensive to implement and maintain than traditional methods.

1. 5/14/2014

2. COST ACCOUNTING (ABC)

3. Definition
ABC is an approach to the costing and monitoring of
activities which involves tracing resource consumption
and costing final outputs. Resources are assigned to
activities, and activities to cost objects based on
consumption estimates. The latter utilize cost drivers to
attach activity costs to outputs.
CIMA (Chartered Institute of Management
Accountants)
5/14/20143

4.  Activity-Based Costing (ABC) arose in the 1980s from the
increasing lack of relevance of traditional cost accounting
methods.
 The traditional cost accounting methods were designed
around 1870 - 1920 and in those days industry was labor
intensive, there was no automation, the product variety was
small and the overhead costs in companies were generally
very low compared to today
 However, from the 1960s - particularly 1980s - this changed
rapidly and ABC emerge.
4Cost accounting Sir Abdul Razaq

5. ABC HIERARCHY
ACTIVITY BASE COST
UNIT-
LEVEL
COSTS
BATCH-
LEVEL
COSTS:
PRODUCT-
LEVEL
COSTS:
FACILITY-
LEVEL
COSTS:

6. ABC Hierarchy
Unit-level costs:
Unit level cost is the basic material cost if we need more production we have
to use more material and vise versa.
Batch-level costs:
Machine setup costs are often batch-level costs. The time required to prepare
a machine to run one batch of product is usually independent of the number
of units in the batch: the same time is required to prepare the machine to run a
batch of 100 units as a batch of 50 units
Product-level costs:
These costs are usually fixed and direct with respect to a given product
Facility-level costs:
These costs are usually fixed and direct with respect to the facility
6

7. TRADITIONAL V/S ACTIVITY BASE COSTING
7

8. *
ABC approach
1. Presence of case and effect
relationship between cost
allocation basis and indirect
pools
2. Rational basis of assigning
indirect costs to various
activities
3. Improved decision making such
as fixing selling price and
pinpointing the area where cost
reduction is possible
Traditional approach
1) Lack of cause and effect
relationship between cost
allocation basis and indirect
costs pool
2) Uses a few pools of indirect
costs resulting in over
costing or under costing of
products
3) Wrong pricing decisions
result in loss of market
share

9. Traditional V/S ABC
5/14/2014Footer Text 9
Particular With ABC Without ABC
Mfg. O/H cost assign to setups $200,000 $0
No of setups 400 N/A
Mfg. O/H cost per setup $500 $0
Total manufacturing O/H cost $2,000,000 $2,000,000
Less : cost trace to machine setups 200,000 0
Mfg. O/H cost allocated on M/H $1,800,000 $2,000,000
Machine hours 100,000 100,000
Mfg. O/h cost per M/H $18 $20
Mfg. o/H cost allocations $500 setup cost/batch
+$18 per M/H
$20 per M/H

10. Traditional V/S ABC
Particulars WITH ABC WITHOUT ABC
Mfg. o/h for setting up machine $500 $0
No of units batch 5000 N/A
Mfg. O/H caused by setup per unit $0.10 N/A
Mfg. O/H cost per machine hour $18 $20
No of units produced per machine hour 50 50
Mfg. O/H caused by production. Per unit $0.36 $0.40
Total Mfg. O/H Allocated. Per unit $0.46 $0.40

11. Particular ABC Without ABC
Mfg. O/H cost assigned to setup $200,000 $0
No of setup 400 N/A
Mfg. O/H cost per setup $500 $0
Mfg. O/H cost caused by procurement/handling $300,000 $0
Pound of material in products $3,000,000 N/A
Mfg. O/H per pound of product material $0.10 $0
Mfg. O/H cost by producing items:
Total mfg. O/H cost $2,000,000 $2,000,000
Less: cost trace to machine setup -200,000 0
Less: cost traced to procurement/handling -300,000 0
Mfg. O/H cost allocated per M/H $1500,000 $2,000,000
Machine hours (M/H) 100,000 100,000
Mfg. O/h cost allocated per M/H $15 $20
Mfg. O/H cost allocation $500 setup cost .batch
+$0.10lb.+ $15 per MH
$20 per M/H

12. Traditional V/S ABC
5/14/2014 Footer Text 12
Particular ABC(1) ABC(2) NOABC (3)
Mfg. O/H for setting up machine $500 $500 $0
No of units in batch 50,000 50,000 N/A
Mfg. O/H cost by setup units $0.01 $0.01 N/A
Mfg. O/H cost per lb. of product $0.10 $0.10 N/A
Lbs. of material in product 0.5 1.5 N/A
Mfg. O/H caused by weight per units $0.05 $0.15 N/A
Mfg. O/H cost per M/H $15 $15 $20
No of units produced per M/H 50 50 50
Mfg. O/H caused by production per units $0.30 $0.30 $0.40
Total O/H allocated per unit $0.36 $0.46 $0.40

13. Stages of ABC
Stage 1: Allocation to Activities
The first step in Activity-Based Costing is to divide the expenses of certain
overhead activities to a per-event cost.
Stage 2: Allocation to Production
The second step in activity-based costing is to allocate the activity cost to
each product.

14. ABC process

15. Cost pools

16. CHARACTERISTICS
 Activity based: The ABC system is based on activities. Activities
consist of different functions that are associated with cost objects.
 Activity cost center: This is also called cost pool—the overhead cost is
identified to an activity and assigned to each activity cost center.
 Use of cost drivers: The causes of occurrence of overheads are called
cost drivers. These are used to assign costs to products.
 Accumulation of overhead costs: Accumulation of overheads is done
on the basis of various activities. A single unit—the entire
organization—is not taken into account. No blanket rate is applied.
 Traceability: Overhead costs can be traced easily. Hence, cost data are
more reliable and accurate.
ABC

17. 
 Identifies Wasteful Products
 Improves Business Processes
 Activity-based costing provides a more accurate method of
product/service costing, leading to more accurate pricing
decisions
 Enables improved product and customer profitability
analysis
 It increases understanding of overheads and cost drivers;
and makes costly and non-value adding activities more
visible, allowing managers to reduce or eliminate them.
Advantages

18. Disadvantages
•Misinterpretation of Data
•Expensive Implementation
•Substantial resources
required to implement
and maintain.
•Does not conform to
GAAP. Two costing
systems may be needed

19.  http://classes.bus.oregonstate.edu/spring-
07/ba422/Management%20Accounting%20Chapter%2011.htm
 http://www.emblemsvag.com/abc.htm
Cost accounting
Presented to sir Abdul Razaq