Three differences between ABC and Traditional Cost Systems

 Activity pools instead of cost pools for overhead

 Causal or cause and effect cost driver or allocation bases
 Categorizing costs into overhead cost hierarchy’ levels

ABC Steps

1) Identify the activities that consume resources, and assign costs to those activities
2) Idenitfy the ‘casual’ (or cause-and-effect) cost driver(s) associated with each activity
3) Classify major categories of activities by ‘cost hierarchy’ level
4) Compute a cost driver rate per cost driver unit or transaction
5) Assign costs to products as follows: Cost driver rate*number of cost driver units
consumed by the product

Applied will depend on the system that is being used, for instance for standard costing, the total
overhead applied will be # of units produced x SI per unit (e.g. standard direct labor hours per unit if
overhead is applied on the basis of direct labor hours) x SP (the standard overhead rate). For actual
costing, it would be # of units produced x AI per unit x AP per unit. 
When calculating for finished goods do not calculate the
variance. BUT do this for calculating COGS
Account Exam II Variable (Direct) Costing: NOT allowed for GAAP, Contribution Margin Approach,
treats volume as the only cost driver ( as in CVP)
Product Costs- all costs of a product that GAAP rules allow you treat as an asset
(B/S) when incurred and then become cost of goods sold (I/S) when product sold Activity Based Costing(ABC): NOT allowed for GAAP (though could potentially
(direct costs and allocated indirect or overhead costs) incorporate of the principles into an absorption costing system), Breaks cost incurrence
into various activities that use resources, allows fir multiple cost drivers
 Product Cost = # of units (AO)* Cost per unit
 Cost per unit = Input per unit (AI or SI)*Price Paid for Input (AP or REMINDER:PRODUCTION=SALES, variable and absorption costing are the same
SP)
 Manufacturing company: all costs to manufacture the product Absorption Costing: Combines fixed and variable costs. Assigns both fixed and variable
 Merchandising company: COGS purchased for resale manufacturing (or operational) costs to the product or service. Reports the organization’s
gross margin (the difference between sales revenue and COGS)
 Service company: generally no inventoriable costs because no
inventories of product (exception for long-term service projects) Treatment of FOH- fixed manufacturing overhead is treated as a product
cost. It is believed that products can’t be produced w/o the resources provided by
Period Cost- all costs on the I/S other than COGS (non-inventoriable costs)
fixed manufacturing O/H
 General and administrative expenses-all costs incurred that period to
performing general administrative activities for the firm
 Selling expenses- all costs incurred during the period to obtain sales
and deliver the product or service; includes all sales and marketing
 Period costs are generally considered overhead costs, but cannot be
included in product costs

Overhead (Predetermined) Rate= Overhead Cost/ Total Amount of Allocation

Base

Actual Costing: all product costs (direct material, direct labor, and allocated indirect
costs) are applied to inventory using actual costs
Normal Costing- actual direct labor and direct material costs, but standard or
budgeted O/H costs
Standard Costing- all product costs (direct material, direct labor, and allocated
indirect costs) are applied to inventory using standard or budgeted costs ( literally
apply to all product cost)
*Note: Regardless of product costing method. SG&A is always total actual costs
( period expense).
Variable Costing: Separates fixed costs from variable costs. The cost of manufacturing a
product or service includes only variable manufacturing (or operational) O/H is a period
cost and is expensed on each period’s income statement. Reports the organization’s
contribution margin (the difference between sakes and ALL variable costs)
Treatment of FOH: Fixed manufacturing O/H is treated as a period
expense, It is believed that only variable costs are relevant for decision-making.
Fixed manufacturing O/H will be incurred regardless of whether there is production
or not.

Input is the amount of resource needed for each unit made.

Price is the cost per unit of resource ( Not per unit of product or service)

Actual Price (AP) is the actual price per unit of the resource or the actual O/H rate

Standard Price (SP) is the standard or budgeted price per unit of resource or
standard O/H

Actual Input (AI) is the actual amount of the resource per unit made

Standard input (SI) is the standard or budgeted amount of the resource per unit
made If Production > Sales, then AC profit > VC profit  In this case under absorption
costing, some factory overhead will be deferred as inventoried product costs.
Actual Resource input per unit*actual price of resource = Actual cost per unit
of output If Production < Sales, then AC profit < VC profit  In this case, previously deferred
factory overhead will be realised (from inventory) and charged as COGs
Standard resource input per unit* standard price of resource = Standard cost
per unit of output

Standard (Budgeted) overhead rates are the firms estimate of what actual overhead
rates will be during the period.

Over-applied: if applied overhead > actual overhead

Under-applied: if applied overhead < actual overhead

 Amount can be prorated or divided among inventory accounts and

COGS.
 If the amount is small (i.e. not material), it can be closed and written
off to COGS

Steps in Product Costing

1) Determine the cost object (product, jo, engagement, customer, etc.)

2) Trace direct cost to the cost object
3) Collect indirect or overhead costs in ‘cost pools’
4) Determine the ‘allocation base’ that will be used to allocate or assign the
overhead costs to the cost object
5) Compute overhead rates
6) Calculate product costs: direct material + direct labor + (O/H
rate*quantity of allocation base used)
Activity Based Costing: A company’s cost structure is determined by the collection of
Absorption Costing: Required by GAAP, Gross Margin Approach, Ignores activities the firm performs to achieve its objectives. Resources are acquired to carry out
economics of costs incurrence altogether these activities. Greater usage of an activity leads to greater consumption of resources.
Over time, resource spending can be adjusted on changes in activity usage.
Side Notes: God is with you!!