Page 253 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting

Notes 14.1 Activity based Costing

Activity-based costing is defined as follows: “It is a technique which involves identifi cation of

cost with each cost-driving activity and making it the basis for apportionment/assignment of
costs over different cost objects/jobs/products/ customers/services.”

Figure 14.1

Cost of the Product

Cost Driver

The concept of activity-based costing was evolved on the following set of assumptions:
The cost has to be assigned to the individual activity: How the cost can be assigned to the
individual activity? The cost of any activity is determined on the basis of the volume of
consumption of resources. The identification or determination of the volume of resources

consumed is only for the determination of the cost of an activity, which is known as
resource-driver.
In ABC, the cost is assigned to activity but in the traditional cost system cost is classifi ed
and apportioned on the basis of functions of the enterprise viz Factory, Administrative,
Selling & Distribution and so on.
The second important assumption is the assignment of cost to cost objects: How can the cost
be assigned to cost object? Before understanding the methodology of the cost assignment,
every one should know about the meaning of the terminology of cost object. It is defi ned as
an item for which the cost measurement is required for the product, job and customer.

The assignment of cost to cost object only on the basis of activity drivers clearly determines the
real consumption of the activity.
The activity cost of any object is subject to the number of activities involved. The activity
cost of mounting the circuit board of the small transistor involves placing the circuit board

appropriately, fitting the screws, checking the quality of mounting and finally checking the
process of working.
Figure 14.2

Cost Driver

Resource Driver Activity Driver
+

The above-enlisted activity requires labourers to carry out process of mounting, which are normally
denominated in terms of labour hours. The speciality of ABC is the number of hours consumed
by the labourers and the cost involvement of every activity at every level, but the traditional
costing system gives only in the form of direct labour hours without any information.

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