Chapter 8 - Activity-Based Costing

COST AND MANAGEMENT ACCOUNTING I
ACTIVITY-BASED
COSTING
AND
MANAGEMENT
Saturday, January 21, 2023 Cost & Management Accounting - I Instructor: Kassaye Tuji
Activity-Based Costing and Management
▓ Activity Based Costing (ABC) is a method of assigning

Overhead & Indirect Costs;
└ such as salaries and utilities— to Products and
Services.
▓ The ABC System of Cost Accounting is based on

activities,
└ which are considered any event, unit of work, or
task with a specific goal.
Activity-Based Costing System
▓ Activity-Based Costing
 Allocates overhead to multiple activity Cost Pools, &
 Assigns the activity cost pools to products or services by means of
Cost Drivers.
 Activity: any event, action, transaction, or work sequence that incurs cost
when producing a product or providing a service.
 Activity Cost Pool: the OH Cost attributed to a distinct type of activity;
such as: ordering materials or setting up machines.
 Cost Drivers: any factor or activity that have a direct cause-effect
relationship with the resources consumed.
 The more complex a product’s Mfg. Operation, the more Activities
and Cost Drivers likely to be present!
Activity-Based Management (ABM)
▓What is ABM?
 ABM is an extension of ABC from a product costing system to a

management function that focuses on:
 Reducing costs &
 Improving processes and decision making.
Value-Added Activities
▓ Activities
Non–Value-Added Activities
Activity-Based Management (ABM)…
Value-Added Activities
▼ Value-Added Activities are activities
that increases the worth of a product
or service such as:
 In Manufacturing Company  In Service Company

→ Assembly → Performing surgery
→ Painting → Legal research
→ Packaging → Delivering packages
Activity-Based Management (ABM)…
Non-Value-Added Activities
 An activity that:
 Adds cost to, or
 Increases the time spent on, a product/service;
↗ Without increasing its market value such as:
 In Manufacturing Company  In Service Company
→ Repair of machines → Taking appointments
→ Storage of inventory → Reception
→ Moving of inventory → Bookkeeping and billing
→ Building maintenance → Traveling
→ Inspections → Ordering supplies
→ Inventory control → Advertising
⁕ Keynote – Focusing on value adding activities!

7
Saturday, January 21, 2023 Cost & Mgt. Acct- I Instructor: Kassaye Tuji
Example of: ABC Costing System…
 Illustration:
▓Atlas Company produces two automobile antitheft devices:
The Boot: a high volume item with sales totaling 25,000 per year
The Club: a low volume item with sales totaling 5,000 per year
▓Each product requires 1 hour of direct labor
Total annual Direct Labor Hours (DLH) 30,000 (25,000+5000)
Direct labor cost $12 per unit for each product
▓ Expected annual Manufacturing Overhead Costs $900,000
▓ Direct Materials Cost:
The Boot - $40 per unit
The Club - $30 per unit
 Required: Calculate Unit Costs under ABC!
▓SOLUTION
ABC involves the following four steps:
1) Identify & Classify the major activities & allocate MOH Costs
to the appropriate Cost Pools.
2)Identify the Cost Driver that has a strong correlation to the
costs in the Cost Pool
3) Compute the OH Rates for each Pool.
4)Assign Overhead Costs for each costs to products using the
OH Rates.
 Solution:…
1) Identify & Classify Activities & Allocate OH

to Cost Pools (Step 1)
Activity Cost Pools Estimated Overheads

Setting up Machines $ 300,000
Machining $ 500,000
Inspection $ 100,000
Total $ 900,000
2) Identify Cost Drivers (Step 2)
Activity Cost Expected Use of Cost

Cost Pools Drivers Drivers Per Activity
Setting Up Machines Number of Setups 1,500 Setups
Machining Machine Hours 50,000 Machine Hours
Inspection Number of Inspections 2,000 Inspections
3) Compute Overhead Rates (Step 3)
Estimated Overhead Per Activity = Activity Based

Expected Use of Cost Driver Per Activity OH Rate
Activity Estimated Expected Use of Cost Activity Based

Cost Pools Overhead Driver Per Activity OH Rate
Setting Up Machines $ 300,000 1,500 Setups $ 200 Per Setups
Machining $ 500,000 / 50,000 Machine Hours = $ 10 Per Machine Hours
Inspection $ 100,000 2,000 Inspections $ 50 Per Inspections
Total $ 900,000
4) Assign Overhead Cost to Products (Step 4)
Activity Cost Expected Use of Expected Use of Cost

Cost Pools Drivers Cost Driver Driver Per Product
Per Activity The Boot The Club
Setting Up Machines No. of Setups 1,500 Setups 500 1,000
Machining Machine Hours 50,000 Machine Hours 30,000 20,000
Inspection No. of Inspections 2,000 Inspections 500 1,500
 In assigning OH Costs, it is necessary to know the expected use

of Cost Drivers for each product.
The Boot
Activity Expected Use of Activity Cost
 Assign OH Cost Pools Cost Driver Per Based Assignment
Product OH Rate =
Cost to Setting Up Machines 500 X $ 200 $ 100,000
Products Machining 30,000 $ 10 300,000
Inspecting 500 $ 50 25,000
…………….…. Total Cost Assigned (a) $ 425,000
Unit Produced (b) 25,000
OH Cost Per Unit (a / b) $ 17
Expected The Club

Activity Expected Use of Activity Cost
Annual Mfg. Cost Pools Cost Driver Per Based Assignment
OH Costs Product OH Rate =
Setting Up Machines 1,000 X $ 200 $ 200,000
$900,000 Machining 20,000 $ 10 200,000
Inspecting 1,500 $ 50 75,000
Total Cost Assigned (a) $ 475,000
Unit Produced (b) 5,000
OH Cost Per Unit (a / b) $ 95
Benefits and Limitations of ABC
▓Benefits of ABC
 More accurate product costing through:
⁕ Use of more cost pools to assign OH Costs
⁕ Enhanced control over overhead costs
⁕ Better management decisions
▓Limitations of ABC
⁕ Can be expensive to use
⁕ Some arbitrary (subjective or random) allocations
continue
When to Use ABC
▓To Use ABC,
 Factors to consider:
 When;
1) Product lines differ in volume & manufacturing complexity.
2) Product lines are numerous and diverse.
3) Overhead costs constitute a significant portion of total costs.
//=================//=================//=================//=================//
THE END
Thank You!!!
Saturday, January 21, 2023

17
Cost & Management Accounting - I Instructor: Kassaye Tuji

Chapter 8 - Activity-Based Costing

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 8 - Activity-Based Costing

Uploaded by

Copyright:

Available Formats

COST AND MANAGEMENT ACCOUNTING I

▓ Activity Based Costing (ABC) is a method of assigning

▓ The ABC System of Cost Accounting is based on

 ABM is an extension of ABC from a product costing system to a

 In Manufacturing Company  In Service Company

⁕ Keynote – Focusing on value adding activities!

1) Identify & Classify Activities & Allocate OH

Activity Cost Pools Estimated Overheads

2) Identify Cost Drivers (Step 2)

Activity Cost Expected Use of Cost

Estimated Overhead Per Activity = Activity Based

Activity Estimated Expected Use of Cost Activity Based

4) Assign Overhead Cost to Products (Step 4)

Activity Cost Expected Use of Expected Use of Cost

 In assigning OH Costs, it is necessary to know the expected use

Expected The Club

Saturday, January 21, 2023

You might also like