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Activity Based Costing

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15 views9 pages

Activity Based Costing

Uploaded by

dariouskakooza
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Cost and Management Accounting

DFM 2024 Notes


CPA Willy Okot

ACTIVITY BASED COSTING

DEF: Activity-based costing (ABC) is a costing method that assigns overhead and indirect
costs to related products and services.

This cost accounting method recognizes the relationship between costs, overhead
activities, and manufactured products, assigning indirect costs to products less arbitrarily
than traditional costing methods. However, some indirect costs such as management and
office staff salaries are difficult to assign to a product.

ABC is an approach to costing and activity monitoring which assigns resources consumed
to activities and activities to cost object (based on estimated consumption). Cost drivers
are used to apportion activity costs to output.

Comparison to traditional cost allocation systems that rely on single fixed overhead
absorption rate proved insufficient in accurate allocating fixed cost to the appropriate
product and there is need to have accurate cost information hence the emergence of ABC
system.

Advantages of ABC system

 A better understanding of cost drivers.

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 Allotment of overheads is fairer and therefore product costs are more accurate.
 When cost plus methods of pricing are used, prices based on ABC are likely to reflect
more accurately the true cost of producing a product
 Budget setting is more meaningful as all financial plans are based on actual drivers
of these costs and not unsupported estimates.

Disadvantages of ABC system

 Selection of cost drivers may not be easy


 Additional time and cost of setting up and administering the system
 Many judgemental decisions still required in the design of an ABC system.

Stages in setting up an ABC system.

Step 1: Identify the major activities that take place in an organization.

Step 2: Identify the indirect costs associated with each activity. The activity Centre is
known as Cost Pool.

Step 3: Determine the factors that cause the cost of each activity. These factors are called
Cost Drivers.

Step 4: Compute the absorption rate per unit of the cost driver for each cost pool.

Step 5: Allocate indirect costs to cost objects (products or services) for each activity on
the basis of their usage of the activity. Indirect costs are allocated by absorbing them into
product or services at a rate per unit of the cost drivers.

Consideration when selecting cost driver

1. The cost of measuring the driver.


2. Correlation coefficient.
3. Behavioral effects.

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Examples

Question One

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Solution

(b) Activity Based Costing.

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Question Two

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Solution

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Question Three.

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Solution

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