Advanced Costing Systems
Costing
Advanced Costing Systems
Syllabus tag: KASNEB CPA | Advanced Level | CA34S3 Advanced Management Accounting | Topic 2 Advanced Costing Systems
Lesson objectives
By the end of this topic, you will be able to:
- Apply activity-based costing with multiple cost pools
- Distinguish the four levels of activity
- Apply activity-based management and budgeting
- Explain time-driven activity-based costing
- Select a costing system appropriate to an organisation
Why this matters
CA25 introduced activity-based costing with two pools and showed how volume costing subsidises complex products. This topic takes ABC further — into using the information rather than merely producing it.
The four levels of activity
The hierarchy determines the right driver, and choosing a driver from the wrong level is the commonest ABC error.
| Level | Driver relates to | Examples |
|---|---|---|
| Unit | Each unit made | Direct materials, machine power |
| Batch | Each batch, regardless of size | Set-ups, first-item inspection, materials handling |
| Product | Each product line, regardless of volume | Design, product specification, advertising a line |
| Facility | The whole plant | Rent, security, plant management |
Batch-level costs must not be driven by units. A set-up costs the same for a batch of 10 as for 10,000, so charging it per unit makes small batches look cheap and large ones expensive — the opposite of the truth.
Facility-level costs have no genuine driver. ABC does not solve this. They must still be apportioned arbitrarily or excluded from product cost and treated as a period cost, and an honest answer says so rather than inventing a driver.
A worked ABC computation
Overhead of KES 18,000,000 splits into three pools:
| Pool | Amount | Driver | Volume | Rate |
|---|---|---|---|---|
| Set-ups | 7,200,000 | set-ups | 240 | 30,000 per set-up |
| Ordering | 6,300,000 | orders | 420 | 15,000 per order |
| Quality | 4,500,000 | inspections | 300 | 15,000 per inspection |
Product P uses 30 set-ups, 60 orders and 45 inspections over 12,000 units:
Overhead = (30 × 30,000) + (60 × 15,000) + (45 × 15,000) = 900,000 + 900,000 + 675,000 = KES 2,475,000
Per unit = 2,475,000 / 12,000 = KES 206.25
The insight is not the number but its composition. Set-ups and ordering together account for 1,800,000 of the 2,475,000 — transaction costs, not volume costs. Producing P in fewer, larger batches would cut its cost substantially without changing a single unit of output.
Activity-based management
ABM uses ABC information to act, rather than only to report.
Operational ABM — doing things right: eliminating non-value-adding activities, improving efficiency, reducing set-up times.
Strategic ABM — doing the right things: changing the product mix, repricing loss-making products, redesigning products to use fewer activities, and reconsidering customers whose demands drive activity.
The distinction between value-adding and non-value-adding activities is central. Inspection, storage, movement and waiting add cost and no customer value. They cannot always be removed — inspection may be necessary while quality is poor — but the target should be removing the cause, not accepting the activity as permanent.
Activity-based budgeting reverses the normal sequence: forecast output, estimate the activity volumes required, then compute the resources needed. It gives a budget with a reasoning behind each figure rather than last year plus a percentage.
Time-driven ABC
Traditional ABC requires staff to estimate what proportion of their time each activity takes, which is costly to maintain and prone to the answers summing to 100% whether or not that is true.
Time-driven ABC uses two estimates: the cost per time unit of capacity and the time each activity takes.
Its practical advantage is that it exposes unused capacity. Where activities consume less time than is available, the difference is idle capacity shown explicitly rather than absorbed into product costs. Traditional ABC spreads the cost of idle time across products and makes them look more expensive than they are.
Choosing a system
| Circumstance | Suitable system |
|---|---|
| One product, simple process | Absorption costing; ABC changes nothing |
| Diverse products, high overhead, varied complexity | ABC |
| A clear bottleneck, short-term mix decisions | Throughput accounting |
| Repetitive process, stable standards | Standard costing |
| Design-stage decisions | Target and life cycle costing |
The judgement is cost against benefit. ABC requires continuing data collection, and where overhead is small or products are similar it produces a more expensive answer that is no better.
:::checkpoint A company applies ABC and finds a low-volume product costs far more than traditional absorption suggested. The sales director proposes discontinuing it. Identify two things you would check before agreeing, and explain what ABC does and does not tell you about that decision. :::
Limitations
- Cost. Identifying activities and collecting driver data is continuing work
- Facility-level costs remain arbitrary
- Historic. ABC explains what costs were caused, not what they will be
- Driver selection is judgemental, and a poorly chosen driver produces confident nonsense
- Not a decision rule. An ABC cost includes fixed costs that will not change in the short run, so relevant costing still governs a special order
:::checkpoint Explain why a product's ABC cost should not be used directly to decide whether to accept a one-off order at a low price, and state which technique applies instead. :::