ACTIVITY BASED COSTING-

PRACTICAL APPLICATIONS

By

Parmit Choudhury (08BS0002164)

Rishabh Gutgutia (08BS0002691)
Rahul Chandalia (08BS0002495)
What is ABC?
 Activity based costing is an accounting
methodology that assigns costs to activities
rather than products or services
 This enables resource and overhead costs to be
more accurately assigned to the products and
the services that consume them

Activity-Based Costing
 Traditional allocation method


Cost Product
 Activity-based
s allocation method s

Cost Act ivit ies Product s

s

First st age Second st age

3
Why use Activity-Based-
Costing
 Underst and TRUE profit abilit y of our cust om ers,
product s, or services
 Quant ify t he cost of non-value added act ivit ies
such as errors and reworks
 Ident ify opport unit ies t o reduce cost s and/or
increase efficiency
 Obt ain act ionable inform at ion t o negot iat e price
increases for unprofit able client s
 Underst and why profit abilit y m ay be m ediocre
despit e good st rat egic fundam ent als
 St rat ify overhead cost s so t hey can be m anaged
m ore effect ively

Difference Between Traditional and
ABC
 ABC systems accumulate
costs into activity cost
pools. These are designed
to correspond to the major
activities or business
processes.
 ABC systems allocate costs
to products , services, and
other cost objects from the
activity cost pools using
allocation bases
corresponding to cost
drivers of activity costs.
 Relatively expensive to
implement and maintain.
 ABC
 Traditional costing systems
accumulate costs into
facility-wide or
departmental cost pools.

 Traditional systems allocate
costs to products using
volume-based allocation
bases: units, direct labor
input, machine hours.

 Inexpensive to implement
and maintain.
 Traditional
Contd…
 Focuses on estimating the costs
of many cost objects of
interest: units , batches,
product lines, business
processes, customers, and
suppliers.
 Because of the ability to align
allocation bases with cost
drivers, provides more
accurate information to
support managerial decisions.
 Allows for non-linearity of costs
within the organization by
explicitly recognizing that
some costs are not caused by
the number of units produced.
 ABC
 Focuses on estimating the
cost of a single cost object
—unit of product or
service.

 Because of the inability to
align allocation bases with
cost drivers, leads to
overcosting and
undercosting problems.

 Generally estimates all of the
costs of an organization as
being driven by the
volume of product or
service delivered.
 Traditional
ABC-Steps to
Implementation
Steps to implementation
 Ident ify t he Resources (expendit ures) of an
organizat ion
 Det erm ine Act ivit ies (work perform ed) t hat
are support ed by Resources
 Define Cost Object s (product s, services,
cust om ers)
 Develop Resource Drivers t o link Resources
t o Act ivit ies
 Develop Cost Drivers t o link Act ivit ies t o
Cost Object s

 XYZ Ltd plans to use activity based costing to determine it product costs . It
presently , uses a single factory overhead rate for allocating factory overhead
to products , based on direct labourhours . The total factory overhead cost is
as follows .

Department Factory Overhead(Rs)

Production Support 1225000
Production (Factory 175000
Overhead
Total Costonly) 1400000

Major activities in the production support department

Production Support Budgeted Cost(Rs)
Activities
Set up 428750
Production Control 245000
Quality control 183750
Material Management 367500
Total 1225000
 Other details

Product A Product B Product C Total

Number Of 10000 2000 50000 62000
Units labour 25000
Direct 10000 140000 175000
hours
Setups 80 40 5 125
Production 80 40 5 125
orders
Inspections 35 40 0 75
Material 320 400 30 750
requisitions
 TRADITIONAL ABSORPTION COSTING METHOD

Recovery rate = total overheads

total number of direct labour hours

1400000
175000 = Rs 8 / labour
hour

A B C
No of labour hours 25000 10000 140000
Recovery rate 8 8 8
Total production overhead by 200000 80000 1120000
each
No ofunit
units produced 10000 2000 50000
Factory overhead cost per 20 40 22.4
unit(Rs)
ACTIVITY BASED COSTING APPROACH

Set up Production Quality Material

Total 428750 control
245000 control
183750 management
367500
costs(a)
Cost Drivers No of set ups Production Inspections Material
No of 125 orders
125 75 requisitions
750
units(b)
Activity Rate 3430 1960 2450 490
(a/b)
 A B C
Set up cost 80 * 3430 40*3430 5* 3430
Production control = 274400
80* 1960 =137200
40* 1960 =17150
5* 1960
Quality control =156800
35*2450 =78400
40*2450 0=9800
*2450
Material management =85750
320* 490 =98000
400* 490 =0
30 * 490
Production =156800
25000*1 =19600
10000*1 =14700
140000*1
(Factory
Total overhead
Overhead only) 698750
Cost =25000 =10000
519600 = 140000
181650
(175000/175000
No of units =1 ) 10000 2000 50000
Overhead cost /unit(ABC) 69.87 259.8 3.633

A B C
Overhead cost/unit 20 40 22.4
(Traditional method)
ABC model for a
University
Efficiency information
Annual Accounting Department Costs
Comparison of Traditional and ABC Cost
Reporting
Traditional ABC
Faculty Salary Research
Other avenues Service
Research Teaching by program
Admin. Exp PPA
Infrastructure cost BBA
Travel MBA
Events Ph.D
Misc Unused Capacity
Total Total
 Traditional costing gives information about
the costs of resources being supplied.
 ABC perspective on the same data provides
information about what the college’s
constituents are getting for their money.
 The problem of measuring the contributions
of departments to programs is solved.
 Cost of unused capacity .

Disparity among various
departments
Annual total cost per studentas per ABC costing (Rs )
MBA Ph.D CPA
Accounts Dept Cost
Allocated 1727 1935 17529
Infrastructure cost 1311 2227 13300
Support Dept Cost
Support Staff 3729 6821 2355
Space 2579 4948 1060
Total Cost 9346 16931 34244
 Help estimating the amount of financial aid.
 In governments and not-for-profits
organizations, expenditures must be linked
to specific institutional objectives.
 Level of expenditures must be assessed in
relation to the priority assigned to those
objectives.
 Cost data necessary to assure consistency
between expenditures and objectives.
 No comparable mechanism to detect and
root out inefficiencies.
Support costs
Support Staff cost per student per program
Program No. of Students Cost per student
MBA ### ###
BBA ### ###
Ph.D ### ###
Space cost per student per program
Program No. of Students Cost per Student
MBA ### ###
BBA ### ###
Ph.D ### ###
Thank
you