Activity based costing
Under supervision of:
Dr.Mohamed
Abdelfattah
By: Marian Nashaat
Fawzy
1. Definition of Activity-Based Costing (ABC)
Activity based costing
Activity-Based Costing is a cost allocation method that assigns
overhead and indirect costs to products and services based on
the activities they require.
Instead of spreading overhead evenly across all products (as in
traditional costing), ABC identifies cost drivers (factors that
cause costs to be incurred) and assigns costs proportionally to
products based on their usage of these activities.
Key Idea:
Products consume activities, and activities consume resources.
2. Objective of ABC
Improve Cost Accuracy: Provide a more precise understanding of
the true cost of products, services, or customers.
Identify Inefficiencies: Highlight non-value-added activities to
reduce waste.
Better Decision-Making: Help management in pricing, product
mix, outsourcing, and process improvement.
Profitability Analysis: Show which products or customers are
actually profitable.
3. Steps for Implementing ABC
1. Identify Activities
List major activities that consume resources (e.g., machine
setup, quality inspection, packaging).
2. Assign Costs to Activity Cost Pools
Group costs into cost pools for each activity.
3. Determine Cost Drivers
Activity based costing
Identify measurable factors that cause each activity’s cost (e.g.,
number of setups, inspection hours).
4. Calculate Activity Rates
Activity Rate = Total Cost in Activity Pool ÷ Total Activity Driver
Units.
5. Assign Costs to Products or Services
Multiply the activity rate by the actual amount of the driver
consumed by each product.
6. Analyze Results
Compare the ABC cost to traditional cost, identify high-cost
activities, and take action.
4. Real-World Example – Implementation in a Manufacturing
Company
Company Bio
Company Name: Alpha Furniture Co.
Industry: Furniture manufacturing (chairs, tables, office desks)
Location: Ontario, Canada
Size: 250 employees, annual revenue $20 million.
Challenge:
Under traditional costing, Alpha used direct labor hours to
allocate overhead. This led to inaccurate product costing — high-
volume, low-complexity products were overcosted, and low-
volume, high-complexity custom orders were undercosted.
Objective of ABC Implementation
Accurately determine the cost of each product.
Improve pricing decisions.
Identify and eliminate non-value-added activities.
Increase profitability by focusing on high-margin products.
Activity based costing
Implementation Steps
Step 1: Identify Activities
Machine setup
Quality inspection
Material handling
Packaging & shipping
Customer service
Step 2: Assign Costs to Activity Pools
Activity Annual Overhead Cost
Machine setup. $300,000
Quality inspection $200,000
Material handling $250,000
Packaging & shipping $150,000
Customer service $100,000
Total $1,000,000
Step 3: Determine Cost Drivers
Activity. Cost Driver Driver Volume
Machine setup Number of setups 600 setups
Quality inspection. Inspection hours 4,000 hours
Material handling No. of material moves 5,000 moves
Packaging & shipping No. of shipments. 3,000shipments
Customer service. Service hours 2,000 hours
Step 4: Calculate Activity Rates
Example: Machine setup rate = $300,000 ÷ 600 setups = $500 per
setup.
Similarly:
Activity based costing
Quality inspection = $200,000 ÷ 4,000 hrs = $50/hr
Material handling = $250,000 ÷ 5,000 moves = $50/move
Packaging & shipping = $150,000 ÷ 3,000 shipments =
$50/shipment
Customer service = $100,000 ÷ 2,000 hrs = $50/hr
Step 5: Assign Costs to Products
Example for Custom Desk (low volume):
10 setups × $500 = $5,000
60 inspection hours × $50 = $3,000
40 material moves × $50 = $2,000
20 shipments × $50 = $1,000
15 service hours × $50 = $750
Total Overhead via ABC = $11,750 (versus $6,000 in traditional
costing)
Step 6: Analyze & Compare
Product Traditional Costing ABC Costing Difference
Standard Chair. $50/unit. $45/unit –$5
Office Table $80/unit $85/unit +$5
Custom Desk $600/unit $1,175/unit +$575
5. Comparison – Before & After Implementation
Aspect Before ABC (Traditional) AfterABC
Cost accuracy Overhead averaged by labor hours Overhead
linked to real activities
Pricing decisions Low-complexity products overpriced
Pricing reflects actual resource use
Activity based costing
Profitability focus Focus on high-volume products Focus on
high-margin products
Waste identification Difficult to traceNon-value-added activities
visible
Customer insights Limited Identified unprofitable custom
orders
Result:
*Dropped two unprofitable custom products.
*Increased production of high-margin chairs.
*Annual profit increased by 12%.
Thank you.
