Scribd
Upload
53 views

ABC Methodology

This document discusses activity-based costing (ABC), a system that aims to assign costs to activities based on their use of resources. It defines key ABC terms and outlines the four-step process: 1) identify activities, 2) assign costs to cost pools for each activity, 3) determine cost drivers for each activity, and 4) assign activity costs to products based on their demand for activities. The document compares ABC to traditional cost allocation systems and notes ABC provides more accurate product costs. It also discusses benefits and limitations of ABC, such as improved decision making but difficulty selecting cost drivers.

Uploaded by

akeera
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
53 views

ABC Methodology

This document discusses activity-based costing (ABC), a system that aims to assign costs to activities based on their use of resources. It defines key ABC terms and outlines the four-step process: 1) identify activities, 2) assign costs to cost pools for each activity, 3) determine cost drivers for each activity, and 4) assign activity costs to products based on their demand for activities. The document compares ABC to traditional cost allocation systems and notes ABC provides more accurate product costs. It also discusses benefits and limitations of ABC, such as improved decision making but difficulty selecting cost drivers.

Uploaded by

akeera
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 17

Management, decision-making and control

It all starts here | Gothle Go Simolola Fano | Dit begin alles hier
Management, decision-making
and control

Topic:
Activity-based costing

Concept:
ABC Methodology
• Define all the relevant ABC terms, for
example, cost drivers, activities
• Compareand contrast an ABC system with
traditional cost allocation system;
• Explain the concept of an activity based
costing (ABC) system
Learning • Identify and explain each of the four stages
involved in designing ABC systems;
Outcomes • Calculate product cost by means of an
ABC system; and
• Analyse an ABC system and apply it to
manufacturing and service organisation.
• Discuss the appropriateness of cost
allocation for decision-making
Activity-based costing

DEFINITION: A system of cost allocation that


aims to use mainly cause-and-
effect cost allocations by assigning
costs to activities.
DESIGN:
1. Identify the major activities that takes
place in an organisation
2. Assign costs to cost pools for each
activity
3. Determine the cost driver for each
major activity
4. Assign the cost of activities to products
according to products demand for
activities
Step 1: Identify activities

• An activity is a task, action or unit of work being done within a company.


• Small tasks must be grouped into meaningful activities.
• Activities can be classified into four main categories:
• Unit level activities: relate to individual unit produced, e.g. DLH.
• Batch-level activities: performed each time a batch of goods is produced, and not individual
products, e.g. machine set-ups.
• Product-sustaining activities: performed to support the different products manufactured, e.g.
product testing procedures.
• Facility-sustaining activities: performed to sustain a factory’s general manufacturing process,
e.g. security.
Step 2: Assign costs to cost pools

• A cost pool involves related costs, such as departmental manufacturing


overheads that are allocated to one or most cost objectives, such as
products, services and activities.
• The following factors should be considered in determining the umber of
cost pools:
• The activity cost must be material in size in order to justify separate treatment
• The cost driver should be identified as the most suitable for the cost pool,
otherwise further division should be considered.
Step 3: Identify cost drivers

• Are factors that cause the different activity costs, more specifically,
overhead costs.
• Cost drivers must be identified for every activity.
• Examples of cost drivers are as follows:
Activities Cost drivers Activity classification
Direct labour hours Direct labour hours Unit-level
Set-ups Number of batches Batch-level
Maintenance Maintenance hours Product-sustaining
Accounting services Headcount Facility-sustaining
Methodology: ABC recognises that there are many activities or “cost drivers” causing
costs to be incurred. ABC involves two stages:

Stage one Stage two

Overhead costs are pooled Each cost activity is then linked


according to the activities Activity by a cost driver to the product
which cause the costs Rate output

E.g. purchasing material can be Even though all the activities


broken into relate to purchasing material,
the cost drivers are different

Purchase requests Number request

Ordering Number of orders


Number of
Material handling movements
Number of
Quality control inspections
Methodology
Overheads are allocated to products by dividing the activity cost
by the period cost driver volume and then by multiplying the
determined rate by the units of activity used by a product

Activity cost(R) Cost driver Volume (Units produced)

Remember to use
Activity Rate actual units when
allocating
overheads
Methodology
• Step 1: Determine the activities that relate to the
overheads
• Step 2: Quantify the activity cost
• Step 3: Determine the cost drivers associated with the
A typical ABC activity
system will involve • Step 4: Apply the rates determined in step 3 to a
the following step: product
Remember the
goal is not cram
this list, but to
Examples understand
what drives the
activity cost
Activities Cost drivers
Purchase request Number of requests
Material procurement Number of supplier orders
Number of items
Material handling Number of movements
Set-up Number of set-ups
Maintenance Number of maintenance hours
Machinery Number of machine hours
Fitting Number of labour hours
Quality control Number of inspections
Pricing Number of orders
Number of customers
Customer vetting Number of customers
Size of orders
Expediting delivery Number of deliveries
Administration Number of staff
A comparison of traditional and ABC
systems

ABC systems tend to


ABC systems seek to use only establish separate cost
cause-and-effect cost drivers driver rates for support
whereas traditional systems departments whereas
often rely on arbitrary traditional systems merge
allocation bases. support and production
centre costs.
Benefits of ABC
• When a high proportion of overhead costs are non-volume-
related, and a company produces a variety of products, the
resultant product cost is more accurate than that obtained
using traditional methods
• The flexibility of ABC allows the extension of cost analysis
to areas such as customer costing and internal
management costs
• Product costs reflect the long-run variable product cost,
which is important for strategic decision making
• ABC improves cost estimation, as cost behaviour
understanding is improved
• ABC improves strategic decision making in
• The pricing of products
• Improving the product range by discontinuing old
products and promoting new ones, and
• Assists in the cost of new products
• There is no real evidence that ABC improves company
profits
• ABC is based on absorption costing techniques, which
are only valid at a single historical level of production
• ABC is historic and lacks relevance for future strategic
decisions
• The selection of cost drivers is difficult and in some
instances has little relevance to activity
Limitations of • Costs such as rent, rates, depreciation, electricity,
insurance still have to be apportioned
ABC • ABC assumes that a single cost driver within a cost
pool fully explains the cost behaviour of the pool. It is
doubtful that detailed segregation of costs achieves
perfect cost homogeneity within a cost pool
• ABC requires an activity whose cost is measurable and
can be related to a product. Some costs such as
general advertising, audit fees, finance costs, and
goodwill have no meaningful cost driver and cannot
be linked to a specific product.
In conclusion
• ABC is an absorption costing
system
• It differs from a traditional costing
system as ABC uses a cause and
effect relationship between costs
and activity while the traditional
system is more arbitrary.
• 4 Step method of allocating
costs.
Questions???
• Class question
• Homework on eFundi
Hope this was useful.
We recommend that you watch the concept videos a
few times until you are comfortable with the
concept.

Do the practice questions on eFundi on your own


before you look the memo.

Remember to consult with your lecturers or the


academic trainees!

All the best with your studies 


Disclaimer: No part of this video may be reproduced or distributed in any form or in any way
without the written permission of the NWU

You might also like