Transcript Slide 1

Module 11
ACTIVITY BASED COSTING
Dr. Varadraj Bapat
Activity Based Costing
(ABC)
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•Concept of ABC
•Traditional Costing V/s ABC
•Treatment of cost under ABC
•Steps of ABC
•Benefits
•Limitations
•Activity Based Management: ABM
•Relation between ABC & ABM
Dr. Varadraj Bapat
Reasons to choose the
right way of costing
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In business, arriving at the
correct cost is very important,
because it:
• identifies money-makers and
money losers;
• finds an economic break-even
point;
Dr. Varadraj Bapat
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• facilitates opportunities for cost
control.
• permits comparison of different
options; and
• enables strategic decision
making.
Dr. Varadraj Bapat
The Concept of ABC
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Activity-Based
Costing
Departmental
Overhead
Rates
Plant-wide
Overhead
Rate
Overhead
Absorption
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The Concept of ABC
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Overhead Absorption
Departmental
Overhead
Rates
Department D1 OH
Rate = Overheads
Apportioned /
Machine Hours
Plant-wide
Overhead
Rate
Plant OH Rate =
Overhead Cost /
Machine Hours
Dr. Varadraj Bapat
Introduction
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ABC is a costing system,
which focuses on activities
performed
to
produce
products.
 ABC relates cost (resources
consumed)
to
work
accomplished
(outputs
produced).

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ABC is a management tool that
provides better allocation of
resources.
 The ABC or unit cost goal is a
benchmark that represents an
expectation
of
the
cost
incurred for the production of
an output.

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
ABC aligns costs to outputs
thereby
increasing
cost
visibility, and is useful in
forecasting
financial
baselines.
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Traditional
Costing V/s ABC
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ABC
Resources
Traditional
Everything in
Organization
Traced by Resource
Drivers
What is actually
Activities
being done
Consume
Resources
Allocate
Cost Centre
Consume
Traced by Activity
Drivers
-Products/Services
Objects
- Customers
- Etc
Objects
- Products
- Services
ABC’s Basic Premise
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Cost objects consume activities.
 Activities consume resources.
 This consumption of resources is
what drives costs.
 Understanding this relationship
is critical to successful budget
management.

Dr. Varadraj Bapat
Treatment of
Costs under ABC
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In ABC, products are assigned the
overhead costs that are supposed to
be related to the allocation base.
 Non-manufacturing costs
 Manufacturing costs
 Plant wide Overhead Rate
 Departmental Overhead Rates
 Costs of idle capacity
Dr. Varadraj Bapat
ABC’s Basic Steps
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1
2
3
4
5
.
.
.
.
.
Analyze activities.
Gather cost data.
Trace costs to activities.
Establish output measures.
Analyze costs.
Dr. Varadraj Bapat
ABC’s Basic Benefits
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Makes it possible to determine
production cost traced to
outputs.
 Targets areas needing
management attention.
 Encourages the consideration of
alternative methods of
production.
 Highlights operational efficiency.

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Identifies financial benchmarks
for activity performance.
 Generates more information to
measure
and
reward
performance,
and
prioritizes
activities for cost reductions.
 Provides a common managerial
framework
among
support
activities.

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Limitations of ABC
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Trade-off between expense and
accuracy.
 Need for more precise data
 Need of full support of top level
management, and support of
ABC based performance review.

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
Cases of overstated costs and
under-stated
margins
and
mistakes in pricing and other
critical decisions.
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Activity Based
Management
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Activity based management involves
any use of ABC information to support
the organization’s strategy, improve
operations, or manage activities and
their resulting costs.
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Activity Based Costing
establishes
relationships
between
overhead costs and activities so that
we can better allocate overhead
costs.
Activity-based management
focuses on managing activities to
reduce costs.
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Relation ABC and ABM
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Cost Assignment View
Resource costs
ABM
Process View
Activity Analysis
Root
Causes
Activity
Triggers
Activity Evaluation
Activities
Cost Objects
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Performance
Measures
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Eliminating nonvalue added costs
using ABM
•Identifying Activities
•Identifying non-value added activities
•Understanding activity linkage, root
causes and triggers
•Establishing performance measures
•Reporting non value added costs
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ABM
seeks
to
satisfy
following customers needs
•Lower costs
•Higher quality
•Faster response time
•Greater innovation
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Customer
Profitability Analysis
Customer
profitability
analysis
uses activity-based costing to
determine the activities, costs and,
profit associated with serving
particular customers.
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Customer Profitability
Analysis
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A costly customer is one:
Orders
small
quantities
Demands
faster
service
Requires
special
packaging
Often
changes
orders
Orders
frequently
Dr. Varadraj Bapat