Hi All…
My first blog..!!!
Before I pen down further just a disclaimer :P…
You may not find anything new in here but I being an amateur
in ABC will start things from the scratch. This I guess will be helpful for people
like me to get through this fancied concept of ABC (Activity Based Costing) and
the related stuff.
So here we begin…
What is
ABC?? – A Primary Introduction
Shakespeare says ‘What is in the name?’ but I disagree. If
we look precisely at the name ‘Activity Based Costing’, the name certainly
bears the meaning of what it is.
ABC as the name suggests is the costing system which is based
on activities performed by an
organization.
First, why do we need costing?
Ans. The first and primary need of costing is to correctly
calculate the cost of product/ service (to be precise the cost of ‘cost object’)
of our organization so as to find the right price for the same.
Cost Object is anything for which or whom the work is
done is called a cost object i.e. the reason for which or for whom the cost are
incurred are cost objects. Ex. Product / service / customer / internal customer
etc.
What do I mean when I say costing ‘Based on Activities’?
Normally, what we are used to doing in traditional costing is
to directly allocate the expenses to the cost object. This method fails when we
try to allocate indirect expenses i.e. the expenses which are not directly
attributable to a cost object.
In ABC, we first convert the expenses into the cost of
various activities performed and then we link these activities to various cost
objects. This way we just add a layer to our allocation process of allocating
the expenses to the cost objects. But this layer helps create a proper cause
and effect relation between the expenses and the cost objects and thus adds
greater transparency and accuracy to the whole costing system.
Example:-
Let’s say we have an employee ‘A’ who has a weekly wage of
Rs.100 and produces two types of products ‘X’ and ‘Y’.
What we normally do is something as follows:-
Allocating the weekly wage to the two products on the basis
of ‘Number of Units Produced’ for each type of product.
-
|
Product
X
|
Product
Y
|
Number of Units Produced
|
10
|
30
|
The same case will be handled in ABC as follows:-
1.
Find the activities done by this employee.
To keep it simple, let’s assume he does
only 2 activities viz. ‘Setup Machine’
and ‘Assemble Product’.
2.
He has 40 hours per week out of which he took 10
hours in machine setup and 30 in assembling the products.
3.
This way we have converted the expenses into
activity cost.
4.
We will now allocate this activity cost to the two
products on the basis of the quantum of activity done for each product.
Assuming the quantum of activity was as follows:-
-
|
Product X
|
Product Y
|
Setup
Hours
|
4
|
6
|
Assembling
Hours
|
5
|
25
|
5.
So, the activity cost allocation will be as
follows:-
-
|
Product X
|
Product Y
|
Setup
Cost
|
= 25*(4/10)
= Rs.10
|
= 25*(6/10)
= Rs.15
|
Assembling
Cost
|
= 75*(5/30)
= Rs.12.5
|
= 75*(25/30)
= Rs.62.5
|
Final
Product Cost
|
= 10 + 12.5
= Rs.22.5
|
= 15 + 62.5
= Rs.77.5
|
Thus we can say, there is a difference in the cost allocated to
the two products in traditional costing and in ABC costing. The difference may
seem small in our example but the same difference when multiplied by the scale
of a company’s activity will be huge.
This was a first and a very raw look at the concept of ABC.
Next we will uncover this concept through the CAM-I model.
