Activity-Based Activity-Based Costing SystemsCosting Systems
Chapter 4Chapter 4
Traditional overhead allocation system
Single predetermined rate is used to allocate overhead to productsEasy to useAssumes all overhead is correlated with the
activity baseAssumes all overhead costs are related to all
productsDoes not consider the product’s consumption
of resources other than the base
An ideal systemTreat indirect costs like direct costs
Accurate assignment of the resources consumed by the individual cost objectsDifferent types and amounts of overhead charged
to different cost objectsNo allocation based on estimates
Not possibleCost element shared by many cost objectsCost element not related to cost objectsNot cost effective to trace accurately
Activity-based costing
RecognizesNot all costs are related to the same cost
driver
Not all costs are incurred at the unit levelUnit level
Batch level
Product level
Customer level
Facility level
Activity-based costing
RecognizesThat activities are performed to produce or
support the cost object
Those activities consume resources
Can identify resources with the activities
Can identify the activities with the cost objects
Can be used for any cost objectNot GAAP for financial reporting
Activity-based costing
Traditional allocation method
Activity-based allocation method
Costs Products
Costs ProductsActivities
First stage Second stage
Implementation of an ABC system
Step 1 – Develop activity dictionary
List of activities related to the cost object
How precise?
Only major activities if purpose is better cost information
More detailed if purpose is process improvement
Will probably have an “other” activity
Implementation of an ABC system
Identify activities (cost pools)
Interview employees
Process flowcharts
Etc.
At which level do they occur?
Unit, batch, etc.
May not want to allocate facility level costs to products
Implementation of an ABC systemHow are the activities performed?
Inputs and outputs
What causes the activity to commence?
Production order, material requisition, etc.
What is the output of the activity?
Units produced, pieces assembled, time consumed, etc.
How can the activity be measured?
Transactions, time, etc.
For use as possible cost drivers
Implementation of an ABC system
Step 2 – Determine the significant costs related to each activityResources used
Employee timeWages and benefits
AssetsDepreciation, taxes, insurance, etc.
ConsumablesSupplies, utilities, maintenance, etc.
“Other”
Implementation of an ABC system
Material handling Set-up Assembly
Testing and inspection Rework Packaging
Breaks and meetings Other Total
Indirect labor 10% 15% 5% 50% 5% 5% 5% 5% 100%
Indirect materials 20% 45% 20% 10% 5% 100%
Depreciation 15% 5% 25% 15% 10% 30% 100%
Insurance and taxes 10% 5% 30% 20% 5% 30% 100%
Utilities 5% 5% 50% 5% 5% 30% 100%
Repairs and maintenance 25% 25% 20% 5% 25% 100%
Factory administration 10% 90% 100%
Other 100% 100%
Alpha Manufacturing CompanyFirst-stage allocation percentages
Exhibit 1
Implementation of an ABC system
CostMaterial handling Set-up Assembly
Testing and inspection Rework Packaging
Breaks and meetings Other Total
Indirect labor 1,600,000$ 160,000$ 240,000$ 80,000$ 800,000$ 80,000$ 80,000$ 80,000$ 80,000$ 1,600,000$ 10% 15% 5% 50% 5% 5% 5% 5% 100%
Indirect materials 250,000$ -$ 50,000$ 112,500$ 50,000$ 25,000$ 12,500$ -$ -$ 250,000$ 0% 20% 45% 20% 10% 5% 0% 0% 100%
Depreciation 500,000$ 75,000$ 25,000$ 125,000$ 75,000$ 50,000$ 150,000$ -$ -$ 500,000$ 15% 5% 25% 15% 10% 30% 0% 0% 100%
Insurance and taxes 225,000$ 22,500$ 11,250$ 67,500$ 45,000$ 11,250$ 67,500$ -$ -$ 225,000$ 10% 5% 30% 20% 5% 30% 0% 0% 100%
Utilities 800,000$ 40,000$ 40,000$ 400,000$ 40,000$ 40,000$ 240,000$ -$ -$ 800,000$ 5% 5% 50% 5% 5% 30% 0% 0% 100%
Repairs and maintenance 175,000$ 43,750$ -$ 43,750$ 35,000$ 8,750$ 43,750$ -$ -$ 175,000$ 25% 0% 25% 20% 5% 25% 0% 0% 100%
Factory administration 1,250,000$ -$ -$ -$ -$ -$ -$ 125,000$ 1,125,000$ 1,250,000$ 0% 0% 0% 0% 0% 0% 10% 90% 100%
Other 200,000$ -$ -$ -$ -$ -$ -$ -$ 200,000$ 200,000$ 0% 0% 0% 0% 0% 0% 0% 100% 100%
Total 5,000,000$ 341,250$ 366,250$ 828,750$ 1,045,000$ 215,000$ 593,750$ 205,000$ 1,405,000$ 5,000,000$
Exhibit 2Alpha Manufacturing Company
First-stage allocation
Implementation of an ABC system
Step 3 – Determine cost drivers and ratesWhat activity measures correlate with each
cost?Measurable
Statistically or logically have a cause-and-effect relationship with the cost
Predict or explain the consumption of resources with reasonable accuracy
Based on practical capacity for the activityUnused capacity is its own “activity”
Implementation of an ABC system
Driver base A B C D E Total
Pounds moved 410 9,600 90 5,700 2,000 17,800
Set-up hours 10 60 6 44 40 160
Pieces assembled 3,500 108,000 800 54,000 21,700 188,000
Number of tests performed 14 120 10 90 31 265
Rework hours 80 400 30 48 42 600
Cubic feet of packaged goods 30 1,100 5 385 280 1,800
Total direct labor hours 4,000 85,000 500 34,000 26,500 150,000
Number of units produced 350 12,000 50 4,500 3,100 20,000
Job
Exhibit 3Alpha Manufacturing Company
Driver base quantities
Implementation of an ABC system
Activity Activity cost Driver base Driver quantity
Material handling 341,250$ Pounds moved 17,800 19.17$ per pound moved
Set-up 366,250 Set-up hours 160 2,289.06$ per set-up hour
Assembly 828,750 Pieces assembled 188,000 4.41$ per piece assembled
Testing and inspection 1,045,000 Number of tests performed 265 3,943.40$ per test performed
Rework 215,000 Rework hours 600 358.33$ per rework hour
Packaging 593,750 Cubic feet of packaged goods 1,800 329.86$ per cubic foot packaged
Breaks and meetings 205,000 Total direct labor hours 150,000 1.37$ per direct labor hour
Other 1,405,000 Number of units produced 20,000 70.25$ per unit produced
Total 5,000,000$
Driver rate
Exhibit 4Alpha Manufacturing Company
Driver rate calculations
Implementation of an ABC system
Step 4 – Assign costs to cost objects
Determine the amount of each activity consumed by the cost object
Multiply by the rate for that activity
Total the activity costs for each cost object
Divide total by quantity of the cost object to determine unit cost
Implementation of an ABC system
ActivityActivity quantity
Cost assigned
Activity quantity
Cost assigned
Activity quantity
Cost assigned
Activity quantity
Cost assigned
Activity quantity
Cost assigned
Activity quantity
Cost assigned
Material handling 19.17$ per pound moved 410 7,860$ 9,600 184,045$ 90 1,725$ 5,700 109,277$ 2,000 38,343$ 17,800 341,250$
Set-up 2,289.06$ per set-up hour 10 22,891 60 137,344 6 13,734 44 100,719 40 91,563 160 366,250
Assembly 4.41$ per piece assembled 3,500 15,429 108,000 476,090 800 3,527 54,000 238,045 21,700 95,659 188,000 828,750
Testing and inspection 3,943.40$ per test performed 14 55,208 120 473,208 10 39,434 90 354,906 31 122,245 265 1,045,000
Rework 358.33$ per rework hour 80 28,667 400 143,333 30 10,750 48 17,200 42 15,050 600 215,000
Packaging 329.86$ per cubic foot packaged 30 9,896 1,100 362,847 5 1,649 385 126,997 280 92,361 1,800 593,750
Breaks and meetings 1.37$ per direct labor hour 4,000 5,467 85,000 116,167 500 683 34,000 46,467 26,500 36,217 150,000 205,000
Other 70.25$ per unit produced 350 24,588 12,000 843,000 50 3,513 4,500 316,125 3,100 217,775 20,000 1,405,000
Total job cost 170,004$ 2,736,034$ 75,015$ 1,309,735$ 709,212$ 5,000,000$
Units in job 350 12,000 50 4,500 3,100
Cost per unit 485.73$ 228.00$ 1,500.31$ 291.05$ 228.78$
Driver rate
Job A Job B Job C Job D Job E Total
Exhibit 5Alpha Manufacturing Company
Second-stage allocation
Advantages of ABC
Better allocation of costsNot perfect
Useful for estimating costs of future projects
Can be extended to activity-based management“Now that we know what it costs, how can we
do it more efficiently?”
Advantages of ABC
Cost object can be anythingProductServiceProcessCustomerEmployeeLocationEtc.
Advantages of ABC
Aids in recognizing, measuring and controlling complexity
Promotes understanding of why costs are incurred
Shifts focus from managing costs to managing activities
When to use ABC
High proportion of indirect costs
Complex products or processes
High volume vs. low volume products
Diverse indirect costs
Cost accounting system hasn’t evolved
Distrust of current system
Different products place different demands on resources
Disadvantages of ABC
Costly to implement
Costly to maintain
Likely to meet substantial resistance
Not the “real” system
“Why do you want to know what I do?”
Top Related