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Stages in Abc

Activity-Based Costing (ABC) involves several stages, including identifying activities, relating overheads to these activities, and determining cost drivers for accurate cost allocation. ABC enhances cost control and decision-making by focusing on specific activities rather than traditional cost centers, allowing for a more precise allocation of costs. It is applicable in both service and manufacturing industries, particularly where overhead costs are significant.

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23 views3 pages

Stages in Abc

Activity-Based Costing (ABC) involves several stages, including identifying activities, relating overheads to these activities, and determining cost drivers for accurate cost allocation. ABC enhances cost control and decision-making by focusing on specific activities rather than traditional cost centers, allowing for a more precise allocation of costs. It is applicable in both service and manufacturing industries, particularly where overhead costs are significant.

Uploaded by

Janvi Jain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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STAGES IN ACTIVITY-BASED COSTING (ABC)

The various stages involved in ABC calculations are outlined below:

1. Identifying Different Activities Within the Organization:


In a traditional overhead system, the number of cost centers is relatively small, typically up
to fifteen. However, in Activity-Based Costing (ABC), the number of activities considered is
significantly higher, potentially reaching 200. The exact number depends on how the
organization classifies and subdivides its activities.

It is possible to break down the organization into numerous small activities. However, for ABC to be
practical, broader groupings are often necessary. In practice, around 40 activities may be used to
maintain feasibility. The increased number of activities compared to cost centers ensures greater
accuracy in cost allocation than the traditional costing method.

Examples of activities include:

o Production schedule changes

o Customer liaison

o Purchasing

o Production process setup

o Quality control

o Material handling

o Maintenance

2. Relating Overheads to Activities:


Overheads, both support and primary, are assigned to the activities that caused them.
This process creates cost pools or cost buckets using resource cost drivers that
accurately reflect causality.
3. Distributing Support Activities Across Primary Activities:
Support activities are allocated to primary activities based on an appropriate basis that
reflects their usage. The chosen base is the cost driver, which measures how support
activities contribute to the process.
4. Determining Activity Cost Drivers:
Activity cost drivers are identified to connect the overheads in cost pools to specific
cost objects or products. These drivers are based on factors influencing the
consumption of an activity. A key question to consider is: What causes an activity to
incur costs?
o For example, in production scheduling, the driver might be the number of
batches ordered.
5. Calculating Activity Cost Driver Rates for Each Activity:
Similar to the overhead absorption rate in traditional costing, activity-based costing
requires the calculation of cost driver rates.
Formula:

The activity driver rate is useful not only for determining product costs, as seen in
traditional absorption costing, but also for assigning costs to other cost objects, such
as customer segments and distribution channels. A key advantage of ABC is its ability
to allocate costs beyond just products.

The activity cost driver rates are then multiplied by the consumption levels of each
activity across various products or other cost objects.

Different Stages in Activity Based Costing

1. Identification of major activities of the organisation.

2. Creation of ‘cost pool’ (cost centre) for each major activity.

3. Allocation and apportionment of overhead cost to cost pools.

4. Determination of ‘Cost Driver’ for each activity.

5. Computation of Cost Driver absorption rate.

6. Computation of overhead cost per unit of output by using cost driver absorption rate.

Features of Activity-Based Costing (ABC)

ABC identifies and assigns costs based on specific activities rather than
Focus on
traditional cost centers. It recognizes that activities drive costs, not just
Activities
products or services.
Use of Cost Costs are traced to cost objects (products, services, customers) using activity
Drivers cost drivers, ensuring a more logical allocation.
Better Overhead Instead of using a broad allocation method (e.g., labor hours), ABC
Allocation assigns overhead costs based on actual consumption of activities.
Identification of Non-Value- Helps identify unnecessary or wasteful activities that do not
Adding Activities add value to the final product, improving cost efficiency.
Enhances Provides more accurate cost information, aiding in pricing, budgeting,
Decision-Making profitability analysis, and process improvement.
Unlike traditional costing, which uses a single overhead pool, ABC creates
Multiple Cost
multiple cost pools for different activities, leading to a more precise cost
Pools
allocation.
Improved Cost By understanding which activities consume resources, managers can
Control reduce costs and optimize operations.
ABC is beneficial for both service and manufacturing
Applicability in Service and
industries, especially where overhead costs are high and
Manufacturing
diverse.
Helps in Strategic Supports decisions related to product mix, customer profitability
Decision-Making analysis, outsourcing, and process improvements.
Eliminates Cost Reduces errors in cost allocation that occur in traditional costing
Distortion systems, ensuring that products are neither overcosted nor undercosted.

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