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Sample Activity Based Costing System

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Text Preview Activity-Based
Costing System
A presentation by

Ahmad Tariq Bhatti
FCMA, FPA, MA (Economics), BSc

Dubai, United Arab Emirates

Activity-Based Costing

Activity-Based Costing System

2

The
Concept
Activity-Based Costing

In contrast to traditional/absorption costing system, ABC
system first accumulates overheads costs for each
organizational activity, and then assigns the costs of the
activities to the products, services, or customers (cost
objects) causing that activity.
Activity-Based Costing System

3

Origin

During 1980’s, the limitations of absorption
costing system were felt with severity. Companies
were looking for a system that could reflect true
product cost in order to fight competition. The
absorption costing system was designed decades
ago, when most companies produced narrow
range of products. Further, overhead costs were
small enough to make a big difference in the
identification of cost of a product. This criticism of
absorption costing led to generation of the idea of
ABC system. David Cooper and Robert Kaplan
wrote articles on the idea of ABC system in 1990
and 1992. The new system was accepted widely
and became reality of the day. Now ABC system
has become part of every management
accounting text book
and being implemented the
Activity-Based Costing System
world over.

4

Definitions
ABC is a cost attribution to cost units on the basis of benefit received from indirect activities.
-- Cima Official Terminology
An activity is an event that incurs costs.
A cost object is defined as anything for which a separate
measure of cost is desired/required.
An activity cost pool: The overheads cost allocated to a
distinct type of activity or related activities.
A cost driver is any factor or activity that has a direct cause and effect relationship with the resources consumed.
Cost Unit: An item of production or a service for which it is useful to have cost information.
Cost accounting: The process of identifying, analyzing,
summarizing, recording and reporting costs associated with
business operations.
Direct costs: Those costs that are directly associated with
the manufacturing process.
Indirect/overheads costs: Those costs that are not directly
identifiable with a unit of production.
Activity-Based Costing System

5

Related Concepts
Direct Costing System

A system of costing the products where direct costs (also referred to as variable costs) are assigned to products only. It reflects the contribution to indirect costs. The system is considered
appropriate for decision-making purposes. It is recommended in the circumstances where indirect costs are a low proportion of a company’s total costs.

Traditional or Absorption Costing System
It reflects full cost pertaining to a product. It is easy to use and, therefore, is practiced widely. The allocation of overhead costs under the system is based on a rate determined by either a
percentage of direct labor cost or number of labor hours
worked or another. Therefore, the reported allocation of overheads for a given product may be incorrect. It is the main defect of absorption costing.

Activity-Based Costing System
It also reflects full cost pertaining to a product. ABC system establishes relationships between overheads costs and
activities so that we can better allocate overheads costs. It reflects the more accurate use of overheads costs based on their relevant activity levels achieved.
The System
system has eliminated the
Activity-Based Costing
defects of traditional/absorption costing system.

6

The Defect of Traditional
Costing System
Spreads overheads cost over entire product range. A single
overheads recovery rate (also known as predetermined
overheads rate or overheads absorption rate) is used to
absorb total overheads cost to all production. For instance, For job order costing, overheads cost absorption rates are normally based on direct labor cost or direct... Show More

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