ACTIVITY BASED COSTING
Question 1:-
Question 1:-What is meaning of Activity Based Costing (ABC) and State list of features of ABC?What is meaning of Activity Based Costing (ABC) and State list of features of ABC?
Answer:-
Answer:- ABC is that costing in which costs are first traced to activities and then to products. This costing ABC is that costing in which costs are first traced to activities and then to products. This costing
system assumes that activities are responsible for the incurrence of costs and create the demands for
system assumes that activities are responsible for the incurrence of costs and create the demands for
activities.
activities.
Meaning of Activity based costing :-
Meaning of Activity based costing :-CIMACIMAdefines Activity Based Costing as,defines Activity Based Costing as,
‘cost attribution to cost units on the basis of benefit received from indirect activities e.g. ordering,
‘cost attribution to cost units on the basis of benefit received from indirect activities e.g. ordering,
setting up, assuring quality.’
setting up, assuring quality.’
Features of ABC are as follows:-
Features of ABC are as follows:-
ABC is a twABC is a two-stage approach costing o-stage approach costing method that first assigns method that first assigns costs to activities costs to activities & then& then
allocates them to products
allocates them to productsbased on the each product’s consumption of activities.based on the each product’s consumption of activities.
The The cost accumulated cost accumulated in the in the two-stage two-stage approach is approach is called called activity-related costs.activity-related costs.
An activity An activity is necessary task is necessary task that an that an organization undertakes to organization undertakes to deliver a deliver a product or product or service.service.
ABC is ABC is based on based on the concept the concept that products that products consume activities consume activities & activities & activities consume rconsume resources.esources.
ABC can be ABC can be used by any used by any organization that wants organization that wants a better understanding of a better understanding of the costs of ththe costs of thee
goods and services.
goods and services.
Question 2
Question 2:- What are Benefits of ABC?:- What are Benefits of ABC?
Answer:- The bene
Answer:- The benefits of ABC arefits of ABC are
1.
2.
2. It recognise the fact It recognise the fact that indirect cost depends that indirect cost depends on many activities other on many activities other than labour hour than labour hour andand
machine hours.
machine hours.
3.
3. Cost of a Cost of a product is product is the sum the sum of the coof the costs of sts of all activities all activities whether directly whether directly or indirectly.or indirectly.
4.
4. Products do not conProducts do not consume costs directly. Msume costs directly. Money is spent ooney is spent on activities which arn activities which are consumed bye consumed by
product/ services. Cost is apportioned over products on the basis of activities involved in that.
product/ services. Cost is apportioned over products on the basis of activities involved in that.
Question 3
Question 3:- What is difference between ABC & absorption based costing?:- What is difference between ABC & absorption based costing?
Answer
Answer :- Difference between Activity based costing and Absorption based costing:- Difference between Activity based costing and Absorption based costing
Traditional Absorption Costing
Traditional Absorption Costing Activity Based CostingActivity Based Costing
Overheads are first apportioned to departments
Overheads are first apportioned to departments
cost centres and then to product.
cost centres and then to product.
Overheads are apportioned to various activities and
Overheads are apportioned to various activities and
then to product.
then to product.
It is not realistic and correct way of distributing
It is not realistic and correct way of distributing
overheads cost.
overheads cost.
It is modern and best way to distribute overhead
It is modern and best way to distribute overhead
costs to various products and services.
costs to various products and services.
Overhead is apportioned on the following basis
Overhead is apportioned on the following basis
Direct Direct labour labour hour hour raterate
Machine Machine hour hour raterate
Prime Prime costcost
Direct Direct Material Material costcost
Direct Direct Labour Labour costcost
Overhead is apportioned on the basis of activities
Overhead is apportioned on the basis of activities
involved in a production process.
involved in a production process.
Formula of overhead recovery rate =
Formula of overhead recovery rate =
ℎ
ℎ
ℎ
ℎ
Formula of overhead recovery rate =
Formula of overhead recovery rate =
ℎ
ℎ
Question 4:-
Question 4:- What are the objectives of ABC? What are the objectives of ABC?
Answer
Answer :- The objectives of Activity Based Costing are as under::- The objectives of Activity Based Costing are as under:
1.
1. To To improve improve calculation of calculation of product product costing.costing.
2.
2. To identify To identify non-value adding non-value adding activities in activities in the production the production process & process & remove themremove them
3.
3. To provide required To provide required information for decision mainformation for decision making like excess oking like excess of activities if f activities if involvedinvolved
4.
4. To To reduce non-essential reduce non-essential use use of common of common resourcesresources
5.
5. To Help To Help managers in managers in evaluating the evaluating the efficiency of efficiency of internally provided internally provided servicesservices
6.
6. To calculate the To calculate the full cost of pfull cost of products for financial roducts for financial reporting purposes and reporting purposes and for determining cost-for determining cost-
based prices
based prices
Question 5:-
Question 5:- What are different types of activities involved in ABC?What are different types of activities involved in ABC?
Answer:-
Answer:- Different types of activities for ABC are as follows:-Different types of activities for ABC are as follows:-
Meaning of Activities:
Meaning of Activities: Activities means tasks. Activities means tasks. For example, purchase of For example, purchase of materials ismaterials isan activity consistingan activity consisting
of many tasks like advertisement inviting quotations, Identification of best suppliers, placement of purchase
of many tasks like advertisement inviting quotations, Identification of best suppliers, placement of purchase
order etc.
Types of Activities:
Types of Activities: Activities basically fall into four different categories known as the Activities basically fall into four different categories known as themanufacturing costmanufacturing cost
hierarchy
hierarchy. These categories were first identified by. These categories were first identified byCooper Cooper in 1990. The categories are: in 1990. The categories are:
1.
1. Unit level activities:Unit level activities: Activities Activities which get affected which get affected by number of units by number of units produced.produced.ExamplesExamplesUseUse
of indirect materials
of indirect materials
2.
2. Batch level activities:-Batch level activities:- Activities Activities which which get get affected affected by by the the number number of of batches.batches. ExamplesExamples
Material ordering in batches, Activities related to setting up a production run
Material ordering in batches, Activities related to setting up a production run
3.
3. Product level activities:-Product level activities:- Activities Activities which which get get affected affected by by creation creation of of new new product.product. ExamplesExamples
Designing the new product.
Designing the new product.
4.
4. Facility Level Activities:-Facility Level Activities:- Activities Activities which which are are necessary necessary regardless regardless of of which which products products areare
produced and not directly connected to production of individual product.
produced and not directly connected to production of individual product. ExamplesExamples ProductionProduction
manager salary
manager salary
Question 6:-
Question 6:- What are the importance of ABC? What are the importance of ABC?
Answer:-
Answer:-Importance of ABC as under:Importance of ABC as under:
1.
1. To link To link the cost the cost to its to its causal factorcausal factor – – i.e. the Cost Driver i.e. the Cost Driver
2.
2. To To identify identify costs costs for for activities.activities.
3.
3. To ascertain To ascertain product costs product costs with greater with greater accuracy by accuracy by relating overheads relating overheads to activitiesto activities
4.
4. To overcome To overcome the inherent limitations of the inherent limitations of traditional absorption costing traditional absorption costing (use of blanket (use of blanket overheadoverhead
rates)
rates)
5.
5. To assist To assist managers in managers in budgeting and budgeting and performance measurementperformance measurement
6.
6. To provide To provide the links between the the links between the activities in an activities in an organisation and indirect organisation and indirect cost incurred.cost incurred.
7.
7. To help To help in cost in cost control and control and cost reduction cost reduction as well as as well as improved profitability.improved profitability.
8.
8. To provide valuable economic information to support a To provide valuable economic information to support a company’s operational improvement andcompany’s operational improvement and
customer satisfaction programs.
customer satisfaction programs.
9.
9. To furnish To furnish many significant many significant benefits over benefits over traditional costing traditional costing techniquestechniques
(a)
(a) most most accurate accurate data data about about product cost;product cost;
(b)
(b) more more comprehensive comprehensive cost information cost information for performance for performance measurement;measurement;
(c)
(c) relevant data for management’s decisionrelevant data for management’s decision-making;-making;
Question 7
Question 7:- What are the uses of ABC?:- What are the uses of ABC?
Answer
Answer :-:-USES OF ABCUSES OF ABC
The areas in which activity based information is used for decision making are as under: -
The areas in which activity based information is used for decision making are as under: -
1.
1. Activity Activity costs:costs: ABC ABC is is designed to designed to track track the costhe cost of t of activities, sactivities, so we o we can can use use it to it to see if see if activityactivity
costs are in line with industry standards. If not, ABC is an excellent feedback tool for measuring
costs are in line with industry standards. If not, ABC is an excellent feedback tool for measuring
the ongoing cost of specific services as management focuses on cost reduction.
the ongoing cost of specific services as management focuses on cost reduction.
2.
2. Customer Customer profitability:profitability: Though most of the costs incurred for individual customers are simplyThough most of the costs incurred for individual customers are simply
product costs, there is also an overhead component, such as unusually high customer service
product costs, there is also an overhead component, such as unusually high customer service
levels, product return handling, and cooperative marketing agreements. An ABC system can sort
levels, product return handling, and cooperative marketing agreements. An ABC system can sort
through these additional overhead costs and determine which customers are actually providing a
through these additional overhead costs and determine which customers are actually providing a
reasonable profit. This analysis may result in some unprofitable customers being turned away, or
reasonable profit. This analysis may result in some unprofitable customers being turned away, or
more emphasis being placed on those customers who are contributing more in profits.
more emphasis being placed on those customers who are contributing more in profits.
3.
3. Distribution cost:Distribution cost: Organisation uses a variety of distribution channels to sell its products, suchOrganisation uses a variety of distribution channels to sell its products, such
as
asretail, Internet, distributors, and mail order catalogs. Most of the structural cost of maintaining aretail, Internet, distributors, and mail order catalogs. Most of the structural cost of maintaining a
distribution channel is overhead, so if we can make a reasonable determination of which
distribution channels are using overhead, we can make decisions to alter how distribution
distribution channels are using overhead, we can make decisions to alter how distribution
channels are used, or even to drop unprofitable channels.
channels are used, or even to drop unprofitable channels.
4.
4. Make Make or or buy:buy: ABC enables the manager ABC enables the manager to decide whether to decide whether he should get he should get the activity done the activity done withinwithin
the firm or outsource the same. Outsourcing may be done if the firm is incurring higher overhead
the firm or outsource the same. Outsourcing may be done if the firm is incurring higher overhead
costs as compared to the outsourcer or vice-versa.
costs as compared to the outsourcer or vice-versa.
5. Margins:
5. Margins:With proper overhead allocation from an ABC system, we can determine the margins of With proper overhead allocation from an ABC system, we can determine the margins of
various products, product lines, and entire subsidiaries. This can be quite useful for determining
various products, product lines, and entire subsidiaries. This can be quite useful for determining
where to position company resources to earn the largest margins.
where to position company resources to earn the largest margins.
6.
6. Minimum Minimum price:price: Product pricing is really based on the price that the market will bear, but theProduct pricing is really based on the price that the market will bear, but the
marketing manager should know what the cost of the product is, in order to avoid selling a product
marketing manager should know what the cost of the product is, in order to avoid selling a product
that will lose a company money on every sale. ABC is very good for determining which overhead
that will lose a company money on every sale. ABC is very good for determining which overhead
costs should be included in this minimum cost, depending upon the circumstances under which
costs should be included in this minimum cost, depending upon the circumstances under which
products are being sold.
products are being sold.
7.
7. Production facility cost:Production facility cost:It is usually quite easy to segregate overhead costs at the plant-wideIt is usually quite easy to segregate overhead costs at the plant-wide
level, so we can compare the costs of production between different facilities.
level, so we can compare the costs of production between different facilities.
Question 8:-
Question 8:- What are the limitations of What are the limitations of ABC?ABC? Answer:-
Answer:- LIMITATIONS OF ABCLIMITATIONS OF ABC
Activity based costing help managers in decision making. However activity based costing has certain
Activity based costing help managers in decision making. However activity based costing has certain
limitations or disadvantages which as are under:
limitations or disadvantages which as are under:
1.
1. Implementing an Implementing an ABC system ABC system requires substantial resources, requires substantial resources, which is which is costly to costly to maintain.maintain.
2.
2. Activity Based Costing Activity Based Costing is a comis a complex system which plex system which need lot of record need lot of record for calculations.for calculations.
3.
3. In small organisation mangers are accustomed to use In small organisation mangers are accustomed to use traditional costing systems to run theirtraditional costing systems to run their
operations and traditional costing systems are often used in performance evaluations.
operations and traditional costing systems are often used in performance evaluations.
4.
4. Activity based costing data Activity based costing data can be easily misinterpreted can be easily misinterpreted and must be used with and must be used with care when used incare when used in
decision making. Managers must identify which costs are really relevant for the decisions at hand.
decision making. Managers must identify which costs are really relevant for the decisions at hand.
5.
5. Reports generated by Reports generated by this systems do this systems do not conform to not conform to generally accepted accounting generally accepted accounting principlesprinciples
(GAAP). Consequently, an organization involved in activity based costing should have two cost
(GAAP). Consequently, an organization involved in activity based costing should have two cost
systems - one for internal use and one for preparing external reports.