ABC - 1

Activity-
Based
Costing
Systems
 ABC - 2

Activity-Based Costing

Activity-based costing (ABC) involves determining

the cost of activities and tracing their costs to cost
objectives on the basis of the cost objectives
utilization of units of activity.

Part of Activity-Based Analysis

 ABC - 3

FAULTY COST SYSTEM

Symptoms
Competitive analysis is confusing

Conflicting signals from functional

areas and the accounting system

Accounting system problems

 ABC - 4

WHY ABC NOW?

Competitive demands for diverse

products/services
Increased significance of overhead costs
Growth of nonunit-based overhead
Consumption ratios of unit-based and nonunit-
based overhead items differ
Improved information technology
Significance of strategic decisions
 ABC - 5

Activity-Based Costing

Activities performed to fill customer needs

consume resources that cost money.

Served Activities
Customer by Activities consume
activities resources

Resources
Costs cost Resources
money
 ABC - 6

Activity-Based Costing

The cost of resources consumed by activities

should be assigned to cost objectives.

Assigned Assigned to
Costs to Resources activity cost
resources pools

Cost Reassigned
to cost Activities
objectives objectives
 ABC - 7

Activity-Based Costing

Operationalizing the two-stage model requires:

Identifying activities.
Assigning costs to activities.
Determining the basis for assigning the
cost of activities to cost objectives.
Determining the cost per unit of activity.
Reassigning costs from the activity to the
cost objective on the basis of the cost
objectives consumption of activities.
 ABC - 8

Two-Stage Activity Based Costing

Method

First stage: Costs assigned to resources are

reassigned to activities.

Cost of Cost of Cost of

Resource 1 Resource 2 Resource n

Activity Activity Activity Activity Activity

1 2 3 4 n
Continued on next slide
 ABC - 9

Two-Stage Activity Based Costing

Method

Second stage: Costs assigned to activities are reassigned to

cost objectives using an activity cost driver.

Activity Activity Activity Activity Activity

1 2 3 4 n

Objective Objective Objective Objective

1 2 3 n
 ABC - 10

Manufacturing Cost Hierarchy

Unit level activities

Batch level activities
Product level activities
Facility level activities
 ABC - 11

Manufacturing Cost Hierarchy

This activity is Unit Level

performed for each Examples
unit of product Cost of raw materials
produced and sold.
Cost of inserting a
component
Utilities cost of
operating equipment
Some costs of
packaging
Sales commissions
 ABC - 12

Manufacturing Cost Hierarchy

Batch Level
Examples
Cost of processing This activity is
sales order performed for each
Cost of issuing and batch of product
tracking work order produced or sold.
Cost of equipment
setup
Cost of moving batch
between workstations
Cost of inspection
 ABC - 13

Manufacturing Cost Hierarchy

Product Level
Examples This activity is
Cost of product performed to support
development each different product
Cost of product
that can be produced.
marketing, such as
advertising
Cost of specialized
equipment
Cost of maintaining
specialized
equipment
 ABC - 14

Manufacturing Cost Hierarchy

Facility Level
Examples
This activity is Cost of maintaining general
performed to maintain facilities
general manufacturing Cost of nonspecialized
capabilities. equipment
Cost of maintaining
nonspecialized equipment
Cost of real property taxes
Cost of general advertising
Cost of general
administration
 ABC - 15

Changing Composition of Total

Manufacturing Costs

Activity-Based
Volume-Based Unit Multiple-Level
Level Analysis Analysis
Variable: Only one type Variable: Many types of
of variable cost is variable cost drivers are
considered: considered, including:
Unit level Unit level
Batch level
Product level
 ABC - 16

Changing Composition of Total

Manufacturing Costs

Activity-Based
Volume-Based Unit Multiple-Level
Level Analysis Analysis
Fixed: Costs that do not Fixed: Costs that do not
vary with the number of respond to change in
units variable cost drivers are
considered:
Facility level
 ABC - 17

Customer Cost Hierarchy

A merchandising organization or the sales

division of a manufacturing organization
might use the following hierarchy:

Unit level activities

Order level activities
Customer level activities
Facilities level activities
 ABC - 18

Customer Cost Hierarchy

An organization that sells to distinct

market segments might have the
following cost hierarchy:
Unit level activities
Order level activities
Customer level activities
Market segment level activities
Facility level activities
 ABC - 19

Benefits Of Activity Based

Costing
Greater understanding of the nature of
operations

More accurate product costing

Improvement in cost control

Integration with strategic management

accounting
 ABC - 20

Limitations Of Activity Based

Costing
Costly implementation process

ABC is NOT a guarantee of becoming a

world-class company
 ABC - 21

Practical Advice for Implementing ABC

1. Capture the attention of top management.

2. Dont shoot the customer.

3. Decide the form ABC will take.
4. Supplement the ABC measures creativity where appropriate.
5. Be careful in costing bottlenecks that create excess capacity.

6. Challenge managers who believe their costs are fixed.

7. Calculate costs top-down and bottom-up.
8. Account for cost of capital.

9. Use multi-functional teams.

10. Dont underestimate the need for managing change.