Activity-based costing and management is a technique an enterprise uses to calculate the actual cost of bringing a product to the factory or performing an action. It provides clear, detailed cost information. Corporations utilize this approach to make more informed decisions and manage expenses. Simply put, activity-based costing and management determine the cost of each activity and then associate it with the product or service. This approach provides accurate cost information and supports the optimization of the business processes. It is helpful for planning, budgeting, and diagnosing cost issues.
Activity Based Costing
Activity-based costing has been formally introduced into management accounting.
Activity-based costing in management accounting focuses on planning, control, and achievement of goals. Managers rely on it to monitor expenses and plan.
- The company testing each mobile may find that it costs ₹100 to test each phone. Frequent returns of phones can indicate lousy tests.) The company can salvage the testing job with this data now and minimize wastage.
- It also helps to search for different types of activity-based costing. Product-level costing, batch-level costing, customer-level costing, etc., are some examples of them. The two types charge for different portions of the work.
- Activity-based costing is used in planning new projects. They can predict how much each task will cost before launching a new service.
- This is a method employed by Indian firms such as Infosys and Maruti Suzuki. They are quite useful for cost control and smart decision-making.
Activity-Based Costing Features
- Focus on activities
- Use of cost drivers
- Accurate product costing
- Support for planning
- Easy tracking of costs
This allows students and future accountants in India to relate to the concept of cost systems. It also teaches how to set budgets, establish prices and cut back on waste.
Therefore, these activity-based costing steps and the implementation of activity-based costing are really helpful in real life as well as in exams.
Activity Based Costing vs Traditional Costing
Activity-based costing and traditional costing serve as means of tracking costs for different products. But they operate in very different ways. In this section, we are going to compare these two methods and explain why activity-based costing provides more accurate cost information.
Traditional costing pools overhead costs and allocates them using a single driver, such as machine hours or labour hours. Yes, this way works in old factories with simple products. But it breaks down when products vary, or when services are complex.
Activity-based costing, in contrast, does not allocate costs evenly. The model analyzes every activity that costs money and assigns the cost according to how much of that activity is used by each product or job. That is what gets costing right and fair.
To highlight these differences, here’s a quick comparison table:
| Basis | Traditional Costing | Activity Based Costing |
| Cost Allocation | Based on one driver (like labor hours) | Based on multiple activities and drivers |
| Accuracy of Costing | Less accurate for complex products | More accurate and detailed |
| Use in Modern Industry | Less useful in services and modern work | Very useful in complex industries |
| Cost Drivers Used | Single cost driver | Many cost drivers |
| Decision-Making Help | Gives rough estimates | Gives correct cost insights |
Traditional costing assumes that overhead costs are all one big lump. It does not consider the number of hours or effort that individual tasks require. Normal costing still provides the same cost to that product as would any other product that basically needs no special work. This creates wrong data.
However, activity-based costing in management accounting solves this issue. It determines the expense of each task, such as packaging, testing, or customer service. Then, the tariff cost of those jobs is tied back to the product. This is why companies rely on activity-based costing to price products more effectively.
Many types of products are now made by modern businesses, especially in India. They also rely more on machinery and automation. The old costing fails in this context. This is when activity-based costing vs traditional costing comes into play significance. Artificial Intelligence in Marketing and other areas is a boon. This allows companies to reduce waste and save money.
Hence, traditional costing methods are easy to compare, whereas activity-based costing helps achieve transparent and fair cost data, which is why most companies use this method nowadays.
Pros and Cons of Activity-Based Costing
Activity-based costing helps companies due to various benefits. It gives you accurate cost information. It shows where the business is spending more money. But there are limits to this approach. Below is the List of the Benefits of Activity Based Costing and Drawbacks of Activity Based Costing.
Implementation of Activity Based Costing
The first advantage is improved cost accuracy. Let us understand ABC through activity-based costing, for example,, a car factory. Different car models may require different amounts of design work. Activity-based costing includes extra design costs. It will be ignored by traditional costing. Therefore, activity-based costing provides real costs.
- Second, activity-based costing assists in determining reasonable prices. When a business understands how much it really costs to make each product, it can set an all-inclusive price that accounts for all expenses and includes a profit margin.
- Third, this method aids in identifying waste. It highlights which jobs are more expensive but provide less value. Managers can then eliminate or fix those jobs.
- Fourth, it enhances in implementation of activity-based costing in control of cost. So if the reason is high delivery costs, the business can know why and can resolve it.
- Finally, it assists in more efficient planning and budgeting. This allows managers to view each activity and predict future costs with greater clarity.
The Pros And Cons Of Activity Based Costing
Despite the great benefits, there are also some issues.
- First of all, implementing activity-based costing requires additional time and resources. You have to list every activity, the cost of those activities and how they relate to products. This requires trained personnel and tools.
- Secondly, it requires tremendous amounts of data. Smaller companies might not have the documentation to track each job so closely.
- Third, it is more expensive to implement. From time to time, you will need software, reports, and updates.
- Fourth, company folks may resist change. It can be difficult for them to transition from basic traditional costing to this new concept.
- Fifth, if the company has only one product, or if all the jobs entail the same action, it may not add value.
So we do have arguments in favour of activity-based costing, like more accurate cost data and intelligent pricing. The advantage of activity-based costing is that you can process optimistic estimation. Still, such a system also becomes a disadvantage since it has a higher setup cost and more data is needed. Companies have to do what they think works best for them.
Process of Activity Based Costing in Management Accounting
At this point, a leap of faith is needed, and this activity-based costing will not be difficult if carried out stepwise. This chapter covers all the activity-based costing steps in management accounting. Additionally, we will study the practical use of activity-based costing in enterprises.
The process of Activity Based Costing
- The first step involves identifying key activities. A business should specify which jobs are performed to produce a product or service. Such as designing producing testing packing..
- The second step is to aggregate all costs for each activity. This is called a cost pool. For instance, the costs of testing can all be in the testing cost pool.
- The third step is to identify Cost Drivers These are all reasons an activity will make you pay. One potential driver for packing is the number of boxes used. Design The hours spent can be a driver.
- The fourth step is gathering data. They also include how often each activity takes place and how much it costs.
- The fifth step is to share expenses. That is, using the driver data to associate activities — costs — with products. This shows what it actually requires in terms of cost per product or job.
Use this data to decide what the final step is. That means adjusting prices, trimming waste or scheduling work to reflect actual costs.
Relevance to ACCA Syllabus
Activity based on costing and its management is one of the most applicable and practical concepts that align with ACCA-Up to the level of Practical and Strategic Busness Papers in Paper(PM) and (SBL). That is, it teaches students how costs behave and how to assign them. The methodology helps ACCA professionals facilitate decision making, strategic planning and optimal resource utilization, which are their key skills.
Activity-Based Costing and Management ACCA Questions
Q1: The three statements below describe Activity-Based Costing (ABC), but only one of them is correct, which one is it?
A) Reducing direct labour costs
Question 5 of 19 Points 17: C) Cost Allocation only on the Machine hours
C) Asking overhead costs to specific tasks
D) Fixed costs are excluded from product costing
Ans: C) Overhead cost assignment to activity
Q2: Which of the following is the best description of a cost driver in activity-based costing?
A) A fixed cost of operations
B) Activity cost driver
D) A measure of financial ratio planning
D) A direct material cost
Ans: (B) The activity cost variation factor
Q3: Activitybased costing is: Which of the following about activity-based costing vs traditional costing is true?
A) A good fit for complicated processes Traditional costing
B) Service industries are less appropriate to use Activity-based costing
C) Multiple cost drivers are used in activity-based costing
D) Jobs assign costs based on the standard job duties
Ans: C) Activity-based costing accounts for multi-level cost driver
Q4: What does a cost pool mean in the ABC method?
A) Finished goods warehouse
B) A type of indirect labour expense
C) Group of types of expenses for an activity
D) A contingency fund for able bodied workforce
Ans: C) Group of similar costs related to an activity.
Q5: The benefits of activity-based costing are all of the following EXCEPT?
A) Improved pricing decisions
B) Better insight into overheads
C) The cost system implementation lead time is lower.
D) Enhanced decision-making
Ans: C) Lesser time to implement costing systems
Relevance to US CMA Syllabus
Activity-based costing is covered in Part 1 – Financial Planning, Performance, and Analytics of the USA CMA syllabus. Managing Of Costs & Performance of Business (Indirect & Overheads) is One Of the Ways How CMAs Can Do! The area of cost management that CMAs can oversee is in areas of accurate costing.
Activity-Based Costing and Management CMA Questions
Q1: What area is improved by activity-based costing as a way of cost management?
A) Legal risk control
B) Overhead cost tracing
C) Direct sales optimization
D) Tax compliance
Ans: B) Overhead cost tracing
Q2: In CMA practices, how is ABC able to deliver higher accuracy than a traditional costing systems?
A) It excludes indirect costs
B) For simplicity, it uses flat cost rates
C) It links costs to their cost drivers
D) It does not differentiate between activities
Ans: C) This links expenses to changes in cost drivers
Q3: What sort of business context does ABC work best in?
A) Production 1 with 1 product
B) Indirect expenses are not many.
C) Companies with multiple products or services
D) Sole proprietorships
Ans: Soap & detergent or service-based B2B companies.
Q4: An example for a batch-level activity in ABC is:
A) Customer billing
B) Machine setup
C) Staff salaries
D) Company-wide advertising
Ans: B) Machine setup
Q5: What is the single most important thing you require from ABC?
A) Strong branding strategy
B) Simple cost structure
C) Detailed activity analysis
D) A high-profit margin
Ans: C) Activity analysis explained well
Relevance US CPA Syllabus
Activity-based costing is part of the Cost Measurement and Performance Management sections of the US CPA exam. The CPA candidate would learn how to utilize the ABC approach to make profitability assessments and determine proper resource allocation while auditing and engaging in financial reporting. TagBusinessProcess Management . Business Process Management Business process management (BPM) explores methods to discover, model, analyze, measure, improve and optimize business processes.
Activity-Based Costing and Management CMA Questions
Question1: What is the practical advantage of ABC in monetary reporting?
A) Does not includes overheads at all
B) Enhances cost transparency
C) No need to track inventory
D) Uses estimated budgets only
Answer: B) [[Improves cost transparency]]
Q2: Which section of the CPA exam is ABC likely to show up?
A) Regulation
B) Auditing and Attestation
C) Business Environment & Conceptual Framework
D) Department of Treasury — Accounting and Financial Reporting
Ans: C) Business Environment and Concepts
Q3: Please state the reasons why ABC is suitable for CPA in performance management?
A)It does not take indirect expenses into account.
B) It simplifies compliance standards
C) It improves monitoring of the cost of resources
D) It is subject to tax-based depreciation
Ans: C) This aids in tracing resource cost
Q4: What is a unit-level activity in ABC?
A) Machine maintenance
B) Product inspection
C) Assembly of each product unit
D) CEO’s salary
Ans: C) You assemble each unit of product
Q5: What role do cost drivers play on CPA’s ABC analysis?
A) Help finalize tax rates
B) Discuss factors that lead cost to differ
C) Changes in customer cravings
D) Record asset revaluation
Ans: B) Define the sources of cost differences
Relevance CFA Syllabus
Activity based costing thus, assists a candidate in evaluating a firm based on this analytical criterion, which, when studied in the CFA syllabus and parts of the CFA syllabus including Financial Reporting and Analysis (FRA) and Corporate Finance.
Activity-Based Costing and Management CFA Questions
Q1: Which of the following is the main objective of variance analysis in cost accounting?
A) Predicting market trends
B) Discovering cost inefficiencies
C) Calculating dividend yield
DISCLOSURE: This article is for informational purposes only.
Ans : B) identifying cost inefficiencies
Q2 ABC is closest to which CFA topic?
A) Adjunct for Alternatives Investments and Derivatives
B) Preparing financial statements on and run analysis.
C) Ethics and Professional Standards
D) Equity Investments
Ans: B) Financial Reporting and Analysis
Q3: In what ways could ABC model helpful to an equity analyst?
A) Help in establishing bond season
B) Gives Micro-level Product Cost Information
C) This makes capital budgeting easy
D) Identifies forex exposure
Ans: B) Product cost information that is relevant and detailed
Q4: Product-level activity in ABC means
A) Factory lighting
B) Product design
C) Staff training
D) Warehouse rental
Ans: B) Product design
Q5: Why would a CFA suggest ABC to be the basis for performance evaluation?
A) It does not take into account the time value of money
B) It facilities skills regulation to the activities that produces them
C) It has focused on shareholders equity
D) It helps in IPO valuation
Ans: B) It associates costs with the activities that create them
