COLLEGE OF ACCOUNTANCY

C-AE22: Cost Accounting and Control

First Semester AY 2021-2022

A. Course Code – Title : C-AE22: Cost Accounting and Control

B. Module No – Title : M09 – Activity-Based Costing (ABC)
C. Time Frame : 1 week (Week 10) – 6 hrs

D. Overview
This learning material provides the learner about the different methods in
computing the cost of a product. This method will help the management identify the
accurate cost of a product or job especially if the company produces a variety of products or
services. This method is called Activity-Based Costing or ABC. This module will discuss and
differentiate the traditional costing and the ABC.

E. Desired Learning Outcomes

At the end of the learning session, you should be able to:
1. Differentiate traditional and activity-based costing (ABC).
2. Compute the unit costs under ABC Costing
3. Analyze the difference in unit costs between traditional costing and ABC

F. Values Integration
In studying this module, it is hoped that you will be able to develop and manifest the
following UA Core Value/s:

✓ Integrity
✓ Service Orientation
✓ Teamwork
✓ Obedience
✓ Open Communication

G. Interaction/Collaboration
You will be engaging in activities that would make use of:

✓ Google Sheets
✓ Google Forms

H. Content/Discussion

Lesson 1 – Traditional Costing versus Activity Based Costing

Under the traditional costing system, cost assigned to products or services are
estimated especially for the manufacturing overhead. In the previous module, a single
overhead rate called pre-determined overhead rate is used to estimate the overhead cost to
be charged to the product. Thus under this method, direct labor cost, direct labor hours or
machine hours were the relevant activity base used to allocate the overhead costs.

When the manufacturing process becomes complicated, the use of direct labor and
machine hours as basis for allocating overhead may result to inaccuracy. Consequently, a
new allocation method is needed – Activity Based Costing.

What is Activity Based Costing?

Activity-based costing identifies all of the specific overhead operations related to

the manufacture of each product. Not all products require the support of all overhead
costs, so it is not reasonable to apply the same overhead costs to all products.
Faculty: Elizabeth B. Boneo 1 | Page
 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

The ABC method was created to address the problem of inaccuracy from the
traditional costing method. Because this system supports that: product consume
activities; activities consume resources.

A fundamental difference between traditional costing and ABC costing is that ABC
methods expand the number of indirect cost pools that can be allocated to specific
products. The traditional method takes one pool of a company's total overhead costs to
allocate universally to all products.

To use activity-based costing, the following are the steps for assigning costs to
activities.

First, identify which activities are necessary to create a product. This is similar to
what we discussed in the previous module, where we allocate the cost of service
departments to producing departments using different allocation bases. Because those
activities are done, overheard costs will incur.

Then, separate each activity into its own cost pool, which is a group of individual
costs associated with an activity. Determine the total overhead of each cost pool. For
example, purchasing could be its own cost pool.

Next, assign activity cost drivers to each cost pool. Cost drivers are things (e.g.,
units, hours, parts, etc.) that control the changes in costs. For example, purchasing costs are
driven by the number of parts purchased.

Divide the total overhead in each cost pool by the total cost drivers to get your cost
driver rate.

Lastly, compute how many hours, parts, units, etc. that the activity used and
multiply it by the cost driver rate.

ABC systems can be complicated. Check out this example to help further illustrate
the process.

Example:

Assuming the company is spending on inspection to create a product. The estimated

that total inspection cost is P200,000 for the year.

Let us first identify the cost driver. Assuming that the inspection cost has an impact
on number of inspections. And the total number of inspections totaled 10,000 hours for the
year.

Divide now the total inspection cost by your cost driver (the number of inspections)
to get your cost driver rate. Thus the overhead application rate is P20/inspection
(P200,000 / 10,000 inspection).

If a particular product was inspected 3 times. The inspection costs to be charged for
that product amount to P60 (3x P20)

Below is a list of some common cost driver per activity.

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Lesson 2. Unit cost under ABC.

To compute the unit costs under ABC, the following three procedures are to be used.

Step 1. Identify the major activities that pertain to the manufacture of specific products
and allocate manufacturing overhead costs to activity centers.

Step 2. Identify the costs drivers that accurately measure each’s activity’s contribution
to the finished product and compute the activity –based overhead rate.

Step 3. Allocate manufacturing overhead costs for each activity centers to products
using the activity based overhead rates.

To illustrate, we will use the following information:

Sunny Company manufactures two different levels of bicycle: the Regular Bike and
Mountain Bike. The total overhead of P600,000 has traditionally been allocated by direct
labor hours, with 30,000 hours for the Regular Bike and 10,000 hours for the Mountain
Bike. The direct labor cost is P60/hour After analyzing and assigning costs to two cost
pools, it was determined that machine hours is estimated to have P450,000 of overhead,
with 30,000 hours used on the Regular Bike and 15,000 hours used on the Mountain Bike
product. It was also estimated that the inspection cost pool would have P150,000 of
overhead, with 20,000 hours for the Regular Bike and 10,000 hours for the Mountain Bike.
What is the overhead rate per product, under ABC costing if the number of products
produced is 800 and 200 for Regular Bike and Mountain Bike respectively? What is the cost
of the Regular Bike and Mountain Bike if it needs direct materials of P2,000 and P3,000
respectively?

Step 1. Identify the major activities and allocating overhead to Activity Centers

Step 2. Identifying Cost Drivers and Computing Overhead Rates

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Step 3. Allocating Overhead Costs to Products

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Total Unit Cost of Sunny Company’s Products

Lesson 3 – Analyze the difference in unit costs between traditional costing

Now that you have learned how to compute for product unit cost using ABC Method.
Let us now try to compare ABC method with Traditional Method in computing the product
unit cost.

Using the example given above on Sunny Company, let us try to compute the unit
cost using the traditional method.

Sunny Company manufactures two different levels of bicycle: the Regular Bike and
Mountain Bike. The total overhead of P600,000 has traditionally been allocated by direct
labor hours, with 30,000 hours for the Regular Bike and 10,000 hours for the Mountain Bike.
The direct labor cost is P60/hour…- products produced is 800 and 200 for Regular Bike and
Mountain Bike respectively. What is the cost of the Regular Bike and Mountain Bike if it need
direct materials of P2,000 and P3,000..

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

First compute the predetermined overhead rate.

P600,000/40,000 = P15/Direct labor Hour

Then, allocate the overhead to the product

Finally, compute the Manufacturing Cost per Unit.

Comparing Unit Cost

Let us compare the manufacturing costs under traditional costing and ABC
using the above example .

As presented above, the unit costs under traditional costing are significantly
distorted. The cost of producing Regular Bike is overstated by P63 per unit (P4,813-
P4750), and the cost of producing Mountain Bike is understated by P250 per unit (P7,000-
P6,750). The differences are due entirely to how manufacturing overhead costs is allocated.

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

I. Assessment of Learning/ Progress Check

Pinoy’s Kitchen makes two types of food smokers: Gas and Electric. The company
expects to manufacture 20,000 units of Gas smokers, which have a per-unit direct material
cost of P375 and a per-unit direct labor cost of P1,250. It also expects to manufacture
50,000 units of Electric smokers, which have a per-unit material cost of P50 and a per-unit
direct labor cost of P1,125. Historically, it has used the traditional allocation method and
applied overhead at a rate of 1,500 per machine hour. It was determined that there were
three cost pools, and the overhead for each cost pool is as follows:

a) What is the per-unit cost for each product under the traditional allocation
method?
b) What is the per-unit cost for each product under ABC method?

J. References
Guerrero, Pedro P., (2018) Cost Accounting: Principles and Procedural Application,
2018 Edition, Manila, Philippines: GIC Enterprises & Co., Inc.

De Leon, Norma D., De Leon, Ellery D., & De Leon, Guillermo M, Jr., (2019) Cost
Accounting and Control 2019 Edition, Manila, Philippines: GIC Enterprises & Co., Inc.

Vanderbeck, Edward J. & Mitchell, Maria R., Principles of Cost Accounting 17 th Edition,
Taguig City, Philippines: Cengage Learning Asia Pte Ltd (Philippine Branch).

Modules prepared by : Elizabeth B. Boneo

Reviewed/updated by : Elizabeth B. Boneo

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