activity based costing dr. varadraj bapat module 11
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ACTIVITY BASED COSTING
Dr. Varadraj Bapat
Module 11
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Activity Based Costing (ABC)
•Concept of ABC•Traditional Costing V/s ABC•Treatment of cost under ABC•Steps of ABC•Benefits•Limitations•Activity Based Management: ABM•Relation between ABC & ABM
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Reasons to choose the right way of costing
In business, arriving at the correct cost is very important, because it:
• identifies money-makers and money losers;
• finds an economic break-even point;
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• facilitates opportunities for cost control.
• permits comparison of different options; and
• enables strategic decision making.
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Level of C
omplexity
Level of C
omplexity
Overhead Absorption
Plant-wide Overhead
Rate
DepartmentalOverhead
Rates
Activity-BasedCosting
The Concept of ABC
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Overhead Absorption
Plant-wide Overhead
Rate
DepartmentalOverhead
Rates
The Concept of ABC
Department D1 OH Rate = Overheads
Apportioned / Machine Hours
Plant OH Rate = Overhead Cost / Machine Hours
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Introduction
ABC is a costing system, which focuses on activities performed to produce products.
ABC relates cost (resources consumed) to work accomplished (outputs produced).
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ABC is a management tool that provides better allocation of resources.
The ABC or unit cost goal is a benchmark that represents an expectation of the cost incurred for the production of an output.
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ABC aligns costs to outputs thereby increasing cost visibility, and is useful in forecasting financial baselines.
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Traditional Costing V/s ABC
Resources
Activities
Objects
Resources
Objects
ABC Traditional
Consume
Consume Allocate
-Products/Services- Customers- Etc
Everything in Organization
What is actually being done
Traced by Activity Drivers
Traced by Resource Drivers
- Products- Services
Cost Centre
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ABC’s Basic Premise
Cost objects consume activities. Activities consume resources. This consumption of resources is
what drives costs. Understanding this relationship
is critical to successful budget management.
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Treatment of Costs under ABC
In ABC, products are assigned the overhead costs that are supposed to be related to the allocation base.
Non-manufacturing costs Manufacturing costs Plant wide Overhead Rate Departmental Overhead Rates Costs of idle capacity
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ABC’s Basic Steps
1 . Analyze activities.2 . Gather cost data.3 . Trace costs to activities.4 . Establish output measures.5 . Analyze costs.
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ABC’s Basic Benefits
Makes it possible to determine production cost traced to outputs.
Targets areas needing management attention.
Encourages the consideration of alternative methods of production.
Highlights operational efficiency.
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Identifies financial benchmarks for activity performance.
Generates more information to measure and reward performance, and prioritizes activities for cost reductions.
Provides a common managerial framework among support activities.
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Limitations of ABC
Trade-off between expense and accuracy.
Need for more precise data Need of full support of top level
management, and support of ABC based performance review.
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Cases of overstated costs and under-stated margins and mistakes in pricing and other critical decisions.
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Activity Based Management
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Activity based management involves any use of ABC information to support the organization’s strategy, improve operations, or manage activities and their resulting costs.
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Activity Based Costingestablishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based managementfocuses on managing activities toreduce costs.
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Relation ABC and ABM20
ActivityTriggersActivityTriggers
Cost ObjectsCost Objects
Activities
RootCausesRoot
Causes
Process ViewActivity Analysis
Resource costsResource costs
Cost Assignment View
PerformanceMeasures
PerformanceMeasures
Activity Evaluation
ABM
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Eliminating non-value added costs using ABM
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•Identifying Activities•Identifying non-value added activities•Understanding activity linkage, root causes and triggers•Establishing performance measures•Reporting non value added costs
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ABM seeks to satisfy following customers needs
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•Lower costs•Higher quality•Faster response time•Greater innovation
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Customer Profitability Analysis
Customer profitability analysis uses activity-based costing to determine the activities, costs and, profit associated with serving particular customers.
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Customer Profitability Analysis
A costly customer is one:
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Orders small
quantities
Often changes orders
Requires special
packaging
Orders frequently
Demands faster service