In today’s competitive business landscape, accurate cost information is pivotal for strategic decision-making. Traditional costing methods often fall short in allocating overheads precisely, leading to distorted product costs. Activity-Based Costing (ABC) emerges as a robust methodology that assigns costs to activities based on their consumption of resources, and subsequently to products or services based on their utilization of these activities.
Understanding Activity-Based Costing
ABC focuses on identifying and evaluating activities that incur costs in the production of goods or services. By analyzing these activities, businesses can allocate overheads more accurately, leading to better pricing, budgeting, and financial strategies.
Key Tools and Techniques in ABC
1. Activity Identification and Classification
- Unit-level activities: Drilling, assembling.
- Batch-level activities: Machine setup, quality checks.
- Product-level activities: Product design, advertising.
- Facility-level activities: Plant maintenance, security.
2. Cost Driver Analysis
Cost drivers are factors that cause changes in the cost of an activity. Common drivers include:
- Number of purchase orders
- Machine hours
- Number of setups
- Inspection hours
Driver Rate = Total Activity Cost / Total Cost Driver Units3. Cost Assignment to Products
4. Formation of Cost Pools
Example: A consumer electronics company in Mumbai created cost pools for packaging, testing, and warehousing, reducing cost distortion by 15%.
5. Benchmarking and Continuous Improvement
ABC in Indian and International Standards
- India: Mandated in telecom, electricity, and pharma sectors under CRA-1 by ICMAI.
- International: Supported by IFAC and CIMA UK standards.
Real-World Case Studies
1. Textile Export House in Ludhiana
Challenge: Uncompetitive pricing due to inaccurate costing.
Outcome: INR 1.2 crore savings and 4% increase in profit margins.
2. Pharmaceutical Firm in Hyderabad
Challenge: Misclassification of R&D documentation.
Outcome: Enhanced budgeting and cost visibility in R&D.
3. XYZ Electronics
Challenge: Traditional costing failed to reflect true overheads.
Outcome: Improved profitability and pricing strategies.
Strategic Advantages of ABC
- Enhanced Cost Accuracy
- Improved Pricing Strategies
- Efficient Resource Allocation
- Better Budgeting and Forecasting
- Informed Decision-Making
Challenges in Implementing ABC
- Time-consuming data collection
- Requires management commitment
- Initial setup cost
Recommendation: Start with a pilot and train staff adequately.
Conclusion
Activity-Based Costing helps organizations achieve accurate cost insights, better pricing, and strategic growth. Aligning with national and global standards ensures long-term success.
Author:
CMA Jeewan Chandra
Treasurer – Northern India Regional Council, ICMAI
Founder – J Chandra & Associates
www.cmajca.com
