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ACTIVITY ACTIVITY BASED BASED
COSTINGCOSTINGMUHAMMAD AZEEM
VUGUIDE.TK
ROADMAP OF THE PRESENTATION
WHAT IS COST?
IMPORTANCE OF TRUE PRODUCT COST
METHODS OF CALCULATING COST
IMPORTANTANCE OF ACTIVITY-BASED COSTING
STEPS FOR IMPLEMENTING ACTIVITY-BASED
COSTING
TRADITIONAL COSTING VS ACTIVITY-BASED
COSTING
COST COLOURS
LIMITATIONS OF ACTIVITY BASED COSTING
SUMMARY
WHAT IS COST? According To American Accounting
Association
WHY KNOWLEDGE OF TRUE PRODUCT COST IMPORTANT?
To discover opportunities for cost
improvements
To prepare and actualize a business plan
To improve strategic decision making
METHODS OF CALCULATING COST
1. Direct costing
2. Traditional costing
3. Activity based costing
(ABC)
ACTIVITY-BASED COSTING
Activity-based costing is a method that is
designed to provide management with
cost information
Activity-based costing is ordinarily used
as supplement
Most organization that use Activity-based
costing have 2 costing systems
IN ACTIVITY-BASED COSTING Non manufacturing as well as
manufacturing costs may be assigned to
product
Some manufacturing costs may be
excluded from product cost
A number of overhead cost pools are
used each of which is allocated to
product
The allocation basis often differ from those used in traditional costing system
Overhead rates may be based
on level of activity
WHY ACTIVITY-BASED COSTING IS IMPORTANT?
Major advantage of using Activity-
based costing is that it avoids or
minimizes distortion in product
costing
Activity-based costing generates
useful information
Activity-based costing also
provides a clear metric for
improvement
Activity-based costing
encourages management to
evaluate efficiency
STEPS FOR IMPLEMENTING ACTIVITY-BASED COSTING
STEP 1: IDENTIFY AND DEFINE ACTIVITIES AND ACTIVITY COST POOLS
STEP 2: DIRECTLY TRACE OVERHEAD COSTS TO ACTIVITY AND COST OBJECTS
STEP3: ASSIGN COSTS TO ACTIVITY COST POOLS
STEP 4: CALCULATE ACTIVITY RATES
STEP 5: ASSIGN COST TO COST OBJECTS
STEP 6: PREPARE MANAGEMENT REPORT
TRADITIONAL TRADITIONAL COSTINGCOSTING
VS VS
ACTIVITY-BASED ACTIVITY-BASED COSTINGCOSTING
TRADITIONAL TRADITIONAL COSTINGCOSTING
ACTIVITY-BASED ACTIVITY-BASED COSTINGCOSTING
1. NON MANUFACTURING COSTS
Only manufacturing costs are assigned to products
Products are assigned all overhead costs – manufacturing as well as non manufacturing
2. MANUFACTURING COSTS
All manufacturing costs are assigned to products
Products are assigned all overhead costs – manufacturing as well as non manufacturing
COST OF IDLE CAPACITY
TRADITIONAL COSTING SYSTEM
ACTIVITY-BASED COSTING SYSTEM
• Predetermined overhead rates are computed
Rate = ESTIMATED FOH BASE
This results in
• Products are
charged for the costs
of capacity they use
• The costs of idle
capacity are not
charged to products
This results in • more stable unit costs• consistency with the objective of assigning
• Applying idle capacity costs to products• Unstable unit product costs
FLOW OF ACTIVITIES
ACTIVITY-BASED COSTING MODEL
TRADITIONAL COSTING SYSTEM
CONSUMPTION OF RESOURCES VS CONSUMPTION OF ACTIVITIES
Activity-based costing assumes
Products consume activities
Activities consume resources
Traditional Costing assumes
cost objects consume resources
STRUCTURE-ORIENTATION VERSUS PROCESS-ORIENTATION
TRADITIONAL COSTING SYSTEM
ACTIVITY-BASED COSTING SYSTEM
• Traditional costing
systems are more
concerned about
the organizational
charts than the
actual process
• result
capacity management
unknown
• ABC gathers
information from the
processes
• result
both capacity management
and resource management
is known
COST COLOURS
There are three colours used for cost classification.
1. GREEN COLOUR COST:
automatically adjusts with changes in
activity
management action not required
EXAMPLE
direct material cost
shipping cost, etc.
2. YELLOW COLOUR COST:
need to be adjusted with changes in
activity
management action required
EXAMPLE
direct labor cost
indirect factory wages
factory utilities
3. RED COLOUR COST:
management action required to
adjust these costs
difficult to change with activity
EXAMPLE
Factory equipment depreciation
Factory/Administration building lease
LIMITATIONS OF ACTIVITY BASED COSTING
Activity-based costing is more costly to
maintain than a traditional labor costing
system
Activity-based costing does not have full
support of top management
Activity-based costing can easily be
misinterpreted
Organization using activity-based costing
have to maintain 2 cost systems
SUMMARY
Activity-based costing estimates the
cost of sources consumed by cost
objects such as product and customers
The approach taken in activity-based
costing assumes that cost objects
generate activities that in turn
consumes costly resources.
Activities form the link between costs
and cost objects
Activity-based costing is concerned
with overhead – both manufacturing
overhead and selling, general, and
administrative overhead
