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Activity Based Costing

Template by Kenneth McCulloch

Dan Andrews

on 10 October 2017

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Transcript of Activity Based Costing

Simple Job Costing
Historically, firms produced a limited variety of goods while their indirect costs were relatively small.
Allocating overhead costs was simple:
use broad averages to allocate costs uniformly
regardless of how they are actually incurred.

Peanut-butter costing
Modern companies have a greater amount of product diversity and larger indirect costs
The CL5
Complex lens
Multiple Colors
Difficult to produce

The S3
Simple lens
Single color
Easy to produce

Step 1: Identify the products that are the chosen cost objects.
15,000 CL5 Lenses
60,000 S3 Lenses
Step 2: Identify the direct costs of the products
Step 3: Select the cost allocation bases to use for allocating indirect (or overhead) costs to the products
Direct manufacturing labor hours is used as an allocation base
39,750 direct manufacturing labor hours
Step 4: Identify the indirect costs associated with each cost-allocation base
The total of these indirect costs, $2,385,000 are grouped into a single, overhead cost pool
Step 5: Compute the rate per unit of each cost-allocation base
Budgeted indirect-cost rate
Budgeted total costs in indirect-cost pool
Budgeted total quantity of cost-allocation base
39,750 direct manufacturing labor-hours
$60 per direct manufacturing labor-hour
Step 6: Compute the indirect costs allocated to the products
39,750 direct manufacturing labor hours
60,000 S3 Lenses
15,000 CL5 Lenses
30,000 labor hours X $60 = $1,800,000

9,750 labor hours X $60 = $585,000
Step 7: Compute total costs
Rationale for a Refined Costing System
Increase in
product diversity
Increase in
indirect costs
Advances in info technology
Increase in competition
How to Refine a cost system:
1. Direct cost tracing
Identify direct costs
2. Indirect cost pools
Increase number of homogeneous cost pools
3. Cost allocation bases
Cost driver (cause)
Indirect cost (effect)
Class HO1
Comparing Alternative Costing Systems
Simple costing system using a single indirect cost pool
ABC system using six indirect cost pools
Cost per unit of simple S3 lens
Cost per unit of complex CL5 lens
Telltale Signs ABC is Needed
High costs allocated to
one or two pools
Most or all OVHD is considered
unit level
Products consume different amounts of resources
Profit margins don't make sense
disagrees with accounting about reported costs
Increase in Product Diversity
Output unit-level costs
Cost Hierarchy
Costs of activities performed on each individual unit of product or service
Machine operations- electricity
Batch-level costs
Costs of activities related to a group of units of a product or service
Set up machines
Product-sustaining costs
Costs of activities that support individual products or services regardless of the number of units or batches produced
Facility-sustaining costs
Costs of activities that cannot be traced to individual products or services but that support the organization as a whole
Administration, Rent, Security
Activity Based Management
Pricing and Product Mix Decisions
Design Decisions
Cost Reduction and Process Improvement Decisions
How can any organization use this information?
Activity based costing and department costing systems
Example with Alumni Group in text
Limitations of ABC
Measurements Necessary
Management must
estimate costs
of activity pools and ID and
measure cost drivers
for these pools
Activity cost rates need to be
updated regularly
Very detailed ABC systems are
and difficult to understand

ABC in Service or Merchandising
Sharkey, CPA
Full transcript