Post on 22-Dec-2015
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Activity-Based Costing
Managerial Accounting
Prepared by Diane TannerUniversity of North Florida
Chapter 36
Activity-Based Costing
• What is activity-based costing?– A system of allocating indirect costs to cost objects– Utilizes multiple cost pools– Is used with normal costing– Based on activities that drive costs rather than on volume-
based denominators
• Primarily used to allocated manufacturing overhead– Sometimes used to allocate support department costs to
divisions
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Underlying PremisesActivities underlie costs.
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Comparing ABC and Traditional Costing
Advantages of ABC over traditional costing ABC results in more accurate costing. ABC helps managers control costs better. ABC considers the fact that only products that use
particular resources are assigned costs. ABC mitigates overcosting and undercosting of cost
objects. Disadvantages of ABC
Very expensive to implement No separation of fixed and variable costs which makes
incremental analysis difficult
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Setting Up an ABC System
Step 1: Determine the cost object. Step 2: Form cost pools.
The costs of performing a particular activity are grouped into a cost pool.
All costs in a pool should have the same cause. Step 3: Select a cost driver that has a cause-
and-effect relationship with the costs to be allocated.
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How to Perform ABC
Step 1: Calculate the rate for each cost pool. Estimated Cost / Estimated Activity = RateStep 2: Multiply each cost pool rate times the
respective actual activity to determine allocated costs.
Step 3: Total up the allocated costs from step 2. This results in the applied overhead cost.
Step 4: Add the allocated costs to the direct costs of each cost object to obtain the total cost of each cost object.
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Considerations of ABC
Complete analysis requires allocation beyond manufacturing costs to include nonmanufacturing
Activity can be measured on practical capacity, actual capacity, or other estimate Practical capacity preferred over actual capacity
because Does not hide the cost of idle capacity within product
costs Gives a truer cost of activities used to produce the
product
ABC Implementation Issues
After switching to ABC, companies may find that only 10 to 15% of their products are profitable Causes management to alter the product mix by
minimizing unprofitable products which causes profits to increase
Implementation mirrors the complexity of the organization
Complete conversion to ABC requires auditors to accept the system when used for financial reporting
Activity-Based Management A tool in which managers analyze activities that cause
indirect costs of products or services Goal is to improve efficiency and effectiveness of the
activities in order to reduce costs Serves as the basis for numerous process
improvement programs of companies Helps focus managerial attention on what is most
important among the activities performed to create value for customers
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Overcosting and Undercosting Occurs due to broad, equal costs allocated to all
products
Undercosting
Overhead allocated under ABC is greater than if traditional is
used
A product consumes a relatively high level of resources but is reported to have a relatively
low total cost
Overcosting
Overhead allocated under ABC is less than if traditional is used
A product consumes a relatively low level of resources but is reported to have a relatively
high total cost
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ABC Vs. Traditional Costing Example
A complete walk through problem using Excel is presented in a separate video.
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The End