Activity
based
costing (ABC)
, - A type of system that can be used to ALLOCATE indirect costs to cost objects
- Costs assigned to cost objects divided into 2 categories
DIRECT COSTS INDIRECT COSTS (overheads)
➔ Can be accurately traced to cost object ➔ Cannot be specifically and exclusively raced back
to a cost object
➔ Not economically viable to trace back to cost
object
➔ Indirect costs are assigned to cost objects using
COST ALLOCATION
➔ Allocated based on :
o Allocation basis
o Cost driver
Example : cost object =cup of coffee Example: cost object = cup of coffee
Cost of coffee beans used Salary of coffee shop supervisor
ALLOCATION OF OVERHEADS (indirect costs)
OVERHEAD COST ALLOCATION SYSTEM
Traditional costing system ABC SYSTEM
Plant wide Departmental
rate overhead
rates
, WHY ARE COSTING SYSTEMS NECESSARY:
1) Various indirect costs are relevant with regard to decision making
a. Thus management needs applicable amounts for costs that relate to a specific product
2) A costing system needs to exist to focus attention on non-profitable products so that further research can be
done regarding these products
3) Production decisions are NOT independent, thus management needs information on how a decision regarding
one product will effect production and production cost as a whole
ABC addresses the needs above better :
- ABC apportion indirect costs to products based on the activity that production of the specific product
actually causes
- The amounts of cost amounts generated and apportioned are much more accurate , leading to the
following benefits (as compared to a traditional costing system )
BENEFITS of ABC over traditional costing system
➔ Indirect costs relation to the product is demonstrated by the activity, thus leading to relevant costing
information being more accurate
➔ Because there is more accurate allocation of indirect costs, products that are in fact NON-profitable can
be identified much easier and more accurately (especially to low volume items
➔ As activities within the organization and the activity caused by a specific product are KNOWN (done by
ABC) it is much easier more management to assess what the impact of a decision to cease to make a
product or change its design would have on total production and cost
based
costing (ABC)
, - A type of system that can be used to ALLOCATE indirect costs to cost objects
- Costs assigned to cost objects divided into 2 categories
DIRECT COSTS INDIRECT COSTS (overheads)
➔ Can be accurately traced to cost object ➔ Cannot be specifically and exclusively raced back
to a cost object
➔ Not economically viable to trace back to cost
object
➔ Indirect costs are assigned to cost objects using
COST ALLOCATION
➔ Allocated based on :
o Allocation basis
o Cost driver
Example : cost object =cup of coffee Example: cost object = cup of coffee
Cost of coffee beans used Salary of coffee shop supervisor
ALLOCATION OF OVERHEADS (indirect costs)
OVERHEAD COST ALLOCATION SYSTEM
Traditional costing system ABC SYSTEM
Plant wide Departmental
rate overhead
rates
, WHY ARE COSTING SYSTEMS NECESSARY:
1) Various indirect costs are relevant with regard to decision making
a. Thus management needs applicable amounts for costs that relate to a specific product
2) A costing system needs to exist to focus attention on non-profitable products so that further research can be
done regarding these products
3) Production decisions are NOT independent, thus management needs information on how a decision regarding
one product will effect production and production cost as a whole
ABC addresses the needs above better :
- ABC apportion indirect costs to products based on the activity that production of the specific product
actually causes
- The amounts of cost amounts generated and apportioned are much more accurate , leading to the
following benefits (as compared to a traditional costing system )
BENEFITS of ABC over traditional costing system
➔ Indirect costs relation to the product is demonstrated by the activity, thus leading to relevant costing
information being more accurate
➔ Because there is more accurate allocation of indirect costs, products that are in fact NON-profitable can
be identified much easier and more accurately (especially to low volume items
➔ As activities within the organization and the activity caused by a specific product are KNOWN (done by
ABC) it is much easier more management to assess what the impact of a decision to cease to make a
product or change its design would have on total production and cost
