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05/03/2023
ACTIVITY BASE COSTING
COST ACCOUNTING (ABC)
PRESENTED BY RASHID ALI
AND TANWEER
05/03/20233
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)
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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.
Cost accounting Sir Abdul Razaq
Origin of ABC
ACTIVITY BASE COST
ABC HIERARCHYUNIT-
LEVEL COSTS
BATCH-LEVEL
COSTS:
PRODUCT-LEVEL COSTS:
FACILITY-LEVEL
COSTS:
ABC HierarchyUnit-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
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TRADITIONAL V/S ACTIVITY BASE COSTING
*Traditional V/S activity base costing
ABC approach1. 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
05/03/2023Footer Text 9
Traditional V/S ABC 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
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
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
05/03/2023 Footer Text 12
Traditional V/S ABC 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
Stages of ABC Stage 1: Allocation to ActivitiesThe first step in Activity-Based Costing is to divide the expenses of certain overhead activities to a per-event cost.
Stage 2: Allocation to ProductionThe second step in activity-based costing is to allocate the activity cost to each product.
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ABC process
Cost pools
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
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
Disadvantages •Misinterpretation of Data•Expensive Implementation•Substantial resourcesrequired to implementand maintain.•Does not conform toGAAP. Two costingsystems may be needed
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
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