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Concept of Activity Based Costing


In the present globalisation era, each and every organisation will successfully compete its products in the international market only with the efficient application of Activity Based Costing. An organisation, to hold itself on the market, has to manage properly the value chain at each stage. Value added at all the stages are to be compared with the costs associated and on that basis decisions are implemented, which enables cutting of the unnecessary activities and adding the new activities. In order to improve the quality of managerial decisions, Activity Based Costing supplies exact cost information to the management.


The following are the important steps involved in implementing Activity based Costing to achieve the desired results.

(i)                 Identifying the functional areas involved in the organisation.

(ii)               To determine the key activities involved in all the functional areas.

(iii)             Allocating the common indirect cost to various activities at all the functional areas.

(iv)              To determine the most suitable cost driver in each activity under the functional areas of management.

(v)                To prepare activity wise expenditure statement. 


(i)                 Production Management

(ii)               Personnel Management

(iii)             Sales management

(iv)             Repairs maintenance

(v)               Administration

(vi)             Public Relation and

(vii)           Quality Control Management.


Some of the cost drivers in Activity Based costing system are as follows : 

(i)                 Number of receiving orders for the receiving department

(ii)               Number of despatch orders for the despatch department

(iii)             Number of units

(iv)              Amount of Labour cost incurred

(v)                Value of materials in a product

(vi)              Number of inspections

(vii)            Number of parts received per month

(viii)          Number of direct Labour hours

(ix)              Number of purchasing and ordering hours

(x)                Number of Labour transactions

(xi)              Number of Customers orders processed

(xii)            Number of employees


The following factors are to be considered while selecting cost drivers : 

(i)                 Cost of measurement ,and

(ii)                Degree of correlation between cost drivers and the actual consumption of overhead.