Focus Notes in - Collects costs in cost pools

based on the underlying nature

Activity-Based Costing -
and extent of activities.
Assign costs within the
multiple cost pools to products
or services using multiple
What is Activity-Based Costing (ABC)? drivers (both volume- and non-
 Activity-Based Costing (ABC) is volume related) that best reflect
a cost accounting system that the factor causing the costs to
focuses on an organization’s be incurred.
activities and collects costs on the - Considers some costs that are
basis of the underlying nature and considered product costs for
extent of those activities. external reporting as period
 Activity based costing (ABC) costs.
assigns manufacturing overhead - Considers some costs that are
costs to products in a more logical considered period costs for
manner than the traditional external reporting as product
approach of simply allocating costs costs.
on the basis of machine hours. - may, under certain conditions,
Activity based costing first assigns provide a more realistic picture
costs to the activities that are the of actual production cost than
real cause of the overhead. It then has traditionally been available.
assigns the cost of those activities What are the Conditions for Effective
only to the products that are Use of ABC?
actually demanding the activities.
 ABC is a process of overhead  ABC is appropriate in an
allocation organization that
- Produces and sells a wide
What is Activity-Based Management? variety of products or services.
Activity-based management (ABM) is a - Customizes products to
business process model that focuses on customer specifications.
controlling production or performance - Uses a wide range of
activities to improve customer value and techniques to manufacture
enhance profitability. products or to provide services.
- Has a lack of commonality in
Activity-Based costing (ABC) is one of the overhead costs of products or
concepts underlying activity-based services.
management. - Has experienced problems with
How does ABC differ from its current overhead allocation
traditional costing? system.
- Has experienced significant
ABC differs from a traditional cost changes in its business
accounting system in that ABC environment, including
- identifies several levels of costs widespread adoption of new
rather than the traditional technologies.
concepts of variable (at the unit
level) or fixed. How does ABC help management?
  Installation of an ABM or ABC 1. Margin accuracy for individual
system allows management to products and services, as well as customer
- See the cost impact of an classifications, is becoming increasingly
organization’s cross-functional difficult to achieve given that direct labor
activities. is rapidly being replaced with automated
- Understand that fixed costs are, equipment. Accordingly, a company's
in fact, long-run variable costs shared costs (i.e., indirect costs) are
that changed based on an becoming the most significant portion of
identifiable driver. total cost.
- Realize the value of preparing
2. Since the rapid pace of technological
process maps and value charts.
change continues to reduce product life
- Determine that the traditional
cycles, companies do not have time to
bases (direct labor and machine
make price or cost adjustments once
hours) might not produce the
costing errors are detected.
most logical costs for products
or services. 3. Companies with inaccurate cost
- Recognize that products or measurements tend to lose bids due to
services often financially over-costed products, incur hidden losses
support premium due to under-costed products, and fail to
products/services. detect activities that are not cost-effective.
- Set prices that reflect the
activities needed to produce 4. Since computer technology costs are
special or premium products. decreasing, the price of developing and
- Decide whether premium or operating ABC systems also has
low-volume products are decreased.
actually profitable for the
company.
- Calculate MCE and measure What are the advantages of ABC?
organizational performance.  ABC can be used to improve
- Be aware that the most business processes.
effective way to control costs is  ABC can identify wasteful
to minimize or eliminate NVA products.
activities.
- Accept that customers who are
not profitable should not What are some criticisms of ABC?
necessarily be retained.
 ABC requires substantial time and
What are some reasons why companies cost to implement.
are adopting Activity-Based Costing?  ABC does not specifically conform
While ABC systems are rather complex to generally accepted accounting
and costly to implement, Charles T. principles.
Horngren et al., (1999) suggest that many  ABC cannot “cure product failures,
companies, in both manufacturing and sales volume declines, or financial
nonmanufacturing industries, are adopting losses.
ABC systems for a variety of reasons:  ABC does not reduce overhead
costs.
 A study conducted on March 2014 by
Rosebud Rundora and Jacob Selesho is
What are the steps in Activity-Based
about the barriers to the Adoption of
Costing?
Activity-Based Costing for manufacturing
According to Ray H. Garrison and Eric W. SMEs on a municipality in South Africa.
Noreen, (1999) there are six basic steps They found out that barriers to ABC
required to implement an ABC system: adoption include:

1. Identify and define activities and 1. ABC is expensive to implement

activity pools
2. ABC requires adequate skills for its
2. Directly trace costs to activities (to the adoption.
extent feasible)
3. Many lack adequate knowledge about
3. Assign costs to activity cost pools ABC therefore training and education is
needed.
4. Calculate activity rates
4. There is no adequate awareness of ABC.
5. Assign costs to cost objects using the
activity rates and activity measures
previously determined
Prepared by:
6. Prepare and distribute management
J.C. Linnor M. Oraiz
reports
References:
Some terms defined:
Raiborn, C. & Kinney, M., 2012. Cost
In a business context, an activity is any
Accountng Principles- International
repetitive action that is performed in th
Edition, 9 Edition: Cengage Learning,
fulfillment of a business function.
USA.
Activity Pools- Refers to activities
Khozein and Dankoob, M., 2011. Activity
grouped into one because it has the same
Based osting System and its Succeed
cost driver.
Implementing in Organizations. Australian
Cost driver- is the factor that have direct Journal of Basic and Applied Sciences,
cause-and effect relationships to a cost. 5(10): 613-619, 2011 ISSN 1991-8178.

Activity Cost Pools- is any part of the Garrison, Ray, H. and Eric W. Noreen,
production or service process for which 1999. Managerial Accounting. 9th ed.
management wants a separate reporting of Boston: Irwin McGraw-Hill. Horngren,
costs. C.T., G. Foster, S. Datar, M. Rajan and C.
Ittner, 2005. Cost Accounting – A
Activity Rates- refers to the cost Managerial Emphasis, 12th edition:
calculated per unit of activity. Pearson Education, Upper Saddle River,
Cost Object- refers to anything to which New Jersey.
costs attach or are related. Horngren, C.T., G. Foster, S. Datar, M.
Rajan and C. Ittner, 2005. Cost
Accounting – A Managerial Emphasis,
What are the barriers to the adoption of 12th edition: Pearson Education, Upper
Activity-Based Costing Saddle River, New Jersey.
Rojas, E. The Disadvantages and
Advantages of Activity-Based costing.
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Rundora, R. and Selesho, J., 2014.
Determinants of and Barriers to the
Adoption of Activity-Based Costing for
Manufacturing SMEs in South Africa’s
Emfuleni Municipality. Mediterranean
Journal of Social Sciences. MCSER
Publishing, Rome-Italy.