ACTIVITY-BASED COSTING & BALANCE SCORECARD

ACTIVITY-BASED COSTING (ABC) – is a systematic costing method that mainly uses ‘activities’
as basis to allocate overhead and indirect costs to products. ABC provides reliable data for
product costing by using multiple cost drivers that are more reflective of the actual causes of
incurred overhead costs.

ABC vs. TRADITIONAL COSTING

Under the traditional costing, overhead costs are allocated to products by using a
single cost driver (usually labor hour). This costing is volume-based and suitable for labor-intensive,
low-overhead companies. Traditional costing (a.k.a. peanut-butter costing) is simple and
inexpensive to implement.
Under ABC, overhead costs are allocated to products using several cost drivers
associated with the identified cost pools. ABC is suitable for capital-intensive, product-diverse
and high-overhead companies. ABC often leads to accurate product costing and elimination
of non-value added activities.

STEPS IN IMPLEMENTING ACTIVITY-BASED COSTING

1. Identify cost drivers (activities), cost pools and activity centers.
 A cost driver is the particular activity that causes the incurrence of certain costs.
 A cost pool is a group of costs usually associated with a common cost driver.
 An activity center is a unit of organization that performs a set of tasks. It is part of the
production process for which management wants a separate reporting of the costs of
the activity involved. Level of activity centers can be classified into four general
categories:
 Unit-level activities performed each time a unit is produced.
 Batch-level activities performed each time a batch of goods is handled or processed.
 Product-level activities performed to support production (sales) of specific product
type.
 Facility-level activities performed to sustain a facility’s manufacturing process.
2. Calculate predetermined overhead rates for each identified activity.
Predetermined overhead rate = Estimated overhead costs ÷ estimated activity
level
NOTE: Estimated figures are used because actual figures are not yet known at the start of the
period.
3. Allocate overhead costs to the products on the basis of predetermined overhead rates.

In summary, ABC is a ‘two-stage’ allocation process. First, overhead costs are traced to
activities; then, overhead costs are allocated to products in proportion to their consumption of the
activities.

ACTIVITY-BASED MANAGEMENT (ABM) – integrates ABC with other concepts such as Total
Quality Management (TQM), process value analysis and target costing to produce a
management system that strives for excellence through cost reduction and continuous
process improvement. An important goal of ABM is to reduce or eliminate non-value-added
activities and costs:
 VALUE-ADDED activities are necessary activities that incur costs but increase the
perceived value of a particular product to the customer. Example: engineering designs
modification.
 NON-VALUE-ADDED activities are operations that are either (1) unnecessary or
dispensable, or (2) necessary, but inefficient and improvable. Example: rework of
defective units.

BALANCE SCORECARD – is an approach to performance measurement that combines traditional

financial measures with non-financial performance measures. Balanced Scorecard was
created by David Norton and Robert Kaplan in response to value-based management which is
a performance evaluation technique that focuses on traditional financial measures.

FOUR PERSPECTIVES OF THE BALANCE SCORECARD

1. FINANCIAL perspective – measures reflecting financial performance.
Examples: profit, return on investment (RoI), revenue growth
2. CUSTOMER perspective – measures having a direct impact on customers.
 Examples: customer satisfaction, customer retention, market share, customer
complaints
3. LEARNING & GROWTH perspective – measures describing the company employee’s
learning curve.
Examples: employee satisfaction, employee turnover, training and recreation
4. INTERNAL BUSINESS PROCESSES perspective – measures showing key business
processes performance.
Examples: manufacturing cycle efficiency, product quality, productivity measures,
throughput

COMPONENTS OF BALANCE SCORECARD

 STRATEGIC OBJECTIVES – a statement of what the strategy must achieve and what
is critical to its success.
 STRATEGIC INITIATIVES – key action programs required to achieve strategic
objectives.
 PERFORMANCE MEASURES – describe how success in achieving the strategy will be
measured.
 BASELINE PERFORMANCE – the current level of performance for the performance
measure.
 TARGETS – the level of performance or rate of improvement needed in the performance
measure.

Strategic objectives focus on WHAT is to be achieved. Strategic initiatives focus on HOW it will
be achieved. Performance measures, baseline performance and targets relate to how it will be
MEASURED.

EXERCISES
1. Activity Levels
Determine the appropriate level for each of the following activities or costs. Indicate whether
the activity is unit-level (UL), batch-level (BL), product-level (PL), facility-level (FL):
A. Equipment setups
B. Plant supervision
C. Prime costs
D. Packaging and shipment
E. Design modification
F. Heating, lighting and security
G. Advertising
H. Product order processing

2. Traditional Costing vs. ABC

Fortuner Company incurs P800,000 in manufacturing overhead costs. The company has
been allocating overhead to individual product lines based on direct labor hours.
Cost Driver Amount in Cost Pool Amount of Activity
Direct labor hours P300,000 40,000
Number of batches 300,000 1,000
Number of shipments 200,000 500
Total overhead costs P800,000

Two products have the following characteristics:

Product X Product Y
Direct labor hours 2,000 1,000
Number of batches 20 100
Number of shipments 2 150
REQUIRED:
Determine the overhead costs to be allocated to each product (X and Y) using:
A. Traditional costing (based on direct labor hours)
B. Activity-based costing (ABC)

3. Application of Overhead Costs

A. Montero Company uses a predetermined overhead rate based on direct labor hours to apply
manufacturing overhead to jobs. Estimated and actual data for direct labor and manufacturing
overhead last year are as follows:
Estimated Actual
Manufacturing overhead P720,000 P620,000
Direct labor hours 600,000 hrs. 550,000 hrs.

What was the manufacturing overhead for Montero Company for last year?
a. Over-applied by P40,000 c. Over-applied by P20,000
b. Under-applied by P40,000 d. Under-applied by P20,000

B. Pajero Company uses activity-based costing to compute product costs for external reports. The
company has three activity centers and applies overhead using predetermined overhead rates for
each activity center. Estimated costs and activities for the current year are presented below:
Estimated Overhead Cost Expected Activity
Activity 1 P18,000 1,200
Activity 2 P57,600 2,400
Activity 3 P97,200 3,600
Actual costs and activities for the current year were as follows:
Actual Overhead Cost Actual Activity
Activity 1 P19,500 1,250
Activity 2 P67,500 2,500
Activity 3 P90,000 3,750
What was the amount of overhead applied for Activity 2 during the year?
a. P7,500 over-applied c. P7,200 over-applied
b. P7,500 under-applied d. P7,200 under-applied

C. The most common treatment of under-applied and over-applied overhead costs is to close it out
to
a. Work in process c. Cost of goods sold
b. Retained earnings d. Finished goods

4. Manufacturing Cycle Efficiency

Everest Company keeps careful track of the time related to orders and their production.
During the most recent quarter, the following average times were recorded for each unit or order:
Inspection time 1 day
Move time 2 days
Process time 3 days
Queue time 4 days
Wait time 5 days
REQUIRED:
1. How long in days is the manufacturing cycle time (throughput time)?
2. What is the manufacturing cycle efficiency ratio?
3. What percentage of the production time is spent on non-value-added activities?
4. How long in days is the delivery cycle time?

5. Quality Costs
5A. What are the four categories of quality costs?
a. Internal failure, external failure, carrying and ordering costs
b. Prevention, appraisal, internal failure, and external failure costs
c. Product liability, warranty, appraisal, and training costs
d. Training, testing, failure, and conformance costs

5B. Identify two (2) CONFORMANCE COSTS (i.e., costs incurred to keep defective products from
falling into the hands of the customers).
a. Prevention and appraisal costs c. Appraisal and internal failure costs
b. Prevention and internal failure costs d. Internal and external failure costs
5C. Identify the two (2) NON-CONFORMANCE COSTS (i.e., costs incurred because defects are
produced despite efforts to avoid them).
a. Prevention and appraisal costs c. Appraisal and internal failure costs
b. Prevention and internal failure costs d. Internal and external failure costs

6. Productivity Measures
CR-V Company manufactures and sells a single product. The following information was made
available:
2019 2020
Unit sales (P25 per unit) 10,000 15,000
Material usage 4,000 pounds 5,000 pounds
Material cost P5 per pound P10 per pound
Labor hours 2,000 hours 2,500 hours
Labor cost P20 per hour P25 per hour
6A. Determine the operational partial productivity of DIRECT MATERIAL for (1) 2019 and (2) 2020.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30

6B. Determine the operational partial productivity of DIRECT LABOR for (1) 2019 and (2) 2020.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30

6C. Determine the financial partial productivity of DIRECT MATERIAL for (1) 2019 and (2) 2020.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30

6D. Determine the financial partial productivity of DIRECT LABOR for (1) 2019 and (2) 2020.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30

6E. Determine the total productivity for 2019 as measured in both (1) units and (2) sales pesos.
a. (1) 0.667 (2) 16.667 c. (1) 1.667 (2) 41.67
b. (1) 0.167 (2) 4.167 d. (1) 6.667 (2) 166.67