CIMA Official Terminology describes activity-based costing as an approach to the costing and monitoring of activities, which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objects. The latter use cost drivers to attach activity costs to outputs. Show
ABC was first defined in the late 1980s by Kaplan and Bruns. It can be considered as the modern alternative to absorption costing, allowing managers to better understand product and customer net profitability. This provides the business with better information to make value-based and therefore more effective decisions. ABC focuses attention on cost drivers, the activities that cause costs to increase. Traditional absorption costing tends to focus on volume-related drivers, such as labour hours, while activity-based costing also uses transaction-based drivers, such as number of orders received. In this way, long-term variable overheads, traditionally considered fixed costs, can be traced to products. The activity-based costing process: 
What benefits does ABC provide?Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them. ABC enables effective challenge of operating costs to find better ways of allocating and eliminating overheads. It also enables improved product and customer profitability analysis. It supports performance management techniques such as continuous improvement and scorecards. Questions to consider when implementing ABC
In practice:Activity-based CostingHow Xu Ji achieved standardisation in working practices and processes The Chinese electricity company Xu Ji used ABC to capture direct costs and variable overheads, which were lacking in the state-owned enterprise’s (SOE) traditional costing systems. The ABC experience has successfully induced standardisation in their working practices and processes. Standardisation was not a common notion in Chinese culture or in place in many Chinese companies. ABC also acts as a catalyst to Xu Ji’s IT developments – first accounting and office computerisation, then ERP implementation. Prior to the ABC introduction in 2001, Xu Ji operated a traditional Chinese state-enterprise accounting system. A large amount of manual bookkeeping work was involved. Accounting was driven predominantly by external financial reporting purposes, and inaccuracy of product costs became inevitable. At this time, Xu Ji underwent a series of flotations following China’s introduction of free market competition. The inaccuracy of the traditional costing information seriously impeded Xu Ji’s ability to compete on pricing. The two main tasks for the ABC system were to: trace direct labour costs directly to product and client contracts; and allocate manufacturing overheads on the basis of up-to-date direct labour hours to contracts. Lessons learned The common ‘top-down’ management style and organisational culture among SOEs worked well when instigating innovative ideas and inducing corporate-wide learning. Top management’s commitment to trying out new management ideas and investing in new technology has been the unique feature. This accounting method of costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than traditional costing methods. What is the primary benefit of activity-based costing?Managers and employees may resist the change to activity-based costing. ABC procedures produce numbers that do not match traditional costing. ABC requires substantial resources. What is the primary benefit of activity-based costing?What is the primary benefit of activity-based costing? How does Activity-based costing improve business processes?Activity-based costing improves control over overhead costs, setting up equipment is a batch-level activity, in activity-based costing each cost pool has its predetermined overhead rate, and activity-based costing is less expensive to implement than traditional costing. What are the steps in Activity-based costing?First, identify the products that are the chosen cost objects, then identify the direct costs of the products, next, identify the direct prices of the products, and lastly, select the activities and cost-allocation bases for allocating indirect costs to the consequences for giving indirect costs to the products. What Is Activity-Based Costing (ABC)?Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. This accounting method of costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than traditional costing methods. However, some indirect costs, such as management and office staff salaries, are difficult to assign to a product. Activity-Based Costing (ABC)How Activity-Based Costing (ABC) WorksActivity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process. Key Takeaways
ABC is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy. This costing system is used in target costing, product costing, product line profitability analysis, customer profitability analysis, and service pricing. Activity-based costing is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy. The formula for activity-based costing is the cost pool total divided by cost driver, which yields the cost driver rate. The cost driver rate is used in activity-based costing to calculate the amount of overhead and indirect costs related to a particular activity. The ABC calculation is as follows:
As an activity-based costing example, consider Company ABC that has a $50,000 per year electricity bill. The number of labor hours has a direct impact on the electric bill. For the year, there were 2,500 labor hours worked, which in this example is the cost driver. Calculating the cost driver rate is done by dividing the $50,000 a year electric bill by the 2,500 hours, yielding a cost driver rate of $20. For Product XYZ, the company uses electricity for 10 hours. The overhead costs for the product are $200, or $20 times 10. Activity-based costing benefits the costing process by expanding the number of cost pools that can be used to analyze overhead costs and by making indirect costs traceable to certain activities. Requirements for Activity-Based Costing (ABC)The ABC system of cost accounting is based on activities, which are any events, units of work, or tasks with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. Activities consume overhead resources and are considered cost objects. Under the ABC system, an activity can also be considered as any transaction or event that is a cost driver. A cost driver, also known as an activity driver, is used to refer to an allocation base. Examples of cost drivers include machine setups, maintenance requests, consumed power, purchase orders, quality inspections, or production orders. There are two categories of activity measures: transaction drivers, which involves counting how many times an activity occurs, and duration drivers, which measure how long an activity takes to complete. Unlike traditional cost measurement systems that depend on volume count, such as machine hours and/or direct labor hours to allocate indirect or overhead costs to products, the ABC system classifies five broad levels of activity that are, to a certain extent, unrelated to how many units are produced. These levels include batch-level activity, unit-level activity, customer-level activity, organization-sustaining activity, and product-level activity. Benefits of Activity-Based Costing (ABC)Activity-based costing (ABC) enhances the costing process in three ways. First, it expands the number of cost pools that can be used to assemble overhead costs. Instead of accumulating all costs in one company-wide pool, it pools costs by activity. Second, it creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures, such as machine hours or direct labor costs. Finally, ABC alters the nature of several indirect costs, making costs previously considered indirect—such as depreciation, utilities, or salaries—traceable to certain activities. Alternatively, ABC transfers overhead costs from high-volume products to low-volume products, raising the unit cost of low-volume products. Which of the following statements is true about activityAnswer and Explanation: The correct option is (a). The statement saying "activity-based costing can be applied to products but not to customers " is true. Which of the following statements is true with respect to an activityAnswer and Explanation: The correct option is C. In the activity-based costing system, the cost driver follows the cause-and-effect relationship with the cost incurred by the company. The total cost of the activity should be analyzed to ensure a proper allocation base is used. Which of the following statements best describes activityWhich of the following statements most accurately describes Activity-Based Costing? Costs are accumulated in cost pools and allocated based on a single driver for each pool. Which of the following steps are part of the activityStep 1: Identify the products that are the chosen cost objects. Step 2: Identify the direct costs of the products Step 2: Identify the direct costs of the products. Step 3: Select the activities and cost-allocation bases to use for allocating indirect costs to the products for allocating indirect costs to the products. Which of the following statement is true about activityWhich of the following is true about activity-based costing? Explanation: ABC assumes that the resource-consuming activities that generate costs are activities and not outputs. ABC is appropriate for all types of cost accumulation systems, including both job order and process costing.
Which of the following statements about activityExplanation: Statement 1: It is not necessary that ABC costing always provides more benefits than the cost associated with its implementation. Thus, this statement is incorrect.
Which of the following is a characteristic of activityAnswer and Explanation: The correct answer is option b. aid to managers in determining product cost.
Which of the following statements is true of a normal costing system quizlet?Which of the following statements is true of a normal costing system? In a normal costing system, only the costs incurred for direct materials are used to determine unit cost.
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