ACTIVITY BASED COSTING

This chapter has a lot to do with implementing the spirit of Benjamin Franklin’s observation—in cost management terms—that it really does matter how accurately you calculate a cost. Having accurate costs is important for a variety of reasons: a company might find that it has a difficult time determining which of its products is most profitable. Alternatively, it finds its sales increasing but profits declining and cannot understand why. Perhaps the company keeps losing competitive bids for products and services and does not understand why. In many cases, accurate cost information is the answer to these questions. Accurate cost information provides a competitive advantage

Activity based costing(ABC) …. A method of costing Activity-based costing (ABC) is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each Activity-based costing (ABC) is a method for determining accurate costs. While ABC is a relatively recent innovation in cost accounting, it is rapidly being adopted by companies across many industries.

Basic Definitions An activity is a specific task or action of work done. An activity can be a single action or an aggregation of several actions. E.g. moving inventory from workstation A to workstation B is an activity that may require only one action Production set-up is an activity that may include several actions. A resource is an economic element needed or consumed in performing activities. E.g. Salaries and supplies are resources needed or used in performing manufacturing activities. A cost driver is a factor that causes or relates to a change in the cost of an activity. Because cost drivers cause or relate to cost changes, measured or quantified amounts of cost drivers are excellent bases for assigning resource costs to activities and for assigning the cost of activities to cost objects.

Activity based costing(ABC) ABC is a costing approach that assigns resource costs to cost objects such as products, services, or customers based on activities performed for the cost objects. The premise of this costing approach is that a firm’s products or services are the results of activities and activities use resources which incur costs. Costs of resources are assigned to activities based on the activities that use resources ,and costs of activities are assigned to cost objects based on activities performed for the cost objects. ABC recognizes the causal or direct relationships between resource costs, cost drivers, activities, and cost objects in assigning costs to activities and then to cost objects.

Activity based costing(ABC) ABC assigns factory overhead costs to cost objects such as products or services by identifying the resources and activities as well as their costs and amounts needed to produce output. Using resource consumption cost drivers, a firm determines the resource costs consumed by activities or activity centers (activity cost pools) and calculates the cost of a unit of activity. The firm then assigns the cost of an activity to products or services by multiplying the cost of each activity by the amount of the activity consumed by each of the cost objects.

ABC – procedure

Steps in developing ABC Step -1: Identify Resource Costs and Activities Step -2 : Assign Resource Costs to Activities Step – 3 : Assign Activity Costs to Cost Objects

Limitations of ABC Benefits of ABC Allocations. Omission of costs. Better profitability measures. Better decision making. Process improvement. Cost estimation. Cost of unused capacity. Limitations of ABC Allocations. Omission of costs. Expense and time.

THANK YOU -PHARMA STREET