Activity-Based Costing and Management

Chapter 5
Activity-Based
Costing and
Management
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McGraw-Hill Education.
Learning Objective 5-1 – Compute product costs under a
traditional, volume-based product-costing system.
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without prior written consent of 5-25-2
Traditional, Volume-Based
Costing System (1 of 2)
Costing System (2 of 2)
Product-Costing System – Target Selling Price
With these product costs, Dronze Inc. established target
selling prices (Cost × 120%).
496.00 x 1.20
Learning Objective 5-2 - Explain how an activity-based costing system
operates, including the use of a two-stage procedure for cost
assignment, the identification of activity cost pools, and the selection of
cost drivers.
Activity-Based Costing System (ABC)
ABC systems follow a two-stage procedure to assign
overhead costs to products.
Stage One:
Identify significant activities and assign overhead costs
to each activity in proportion to resources used.
Stage Two:
Identify cost drivers appropriate to each activity and
allocate overhead to the products.
Learning Objective 5-3 – Explain the cost hierarchy concept,
including unit-level, batch-level, product-sustaining-level,
and facility-level costs.
Activity Overhead Costs
must be Identification
Total budgeted cost = $4,896,000
done on of Activity
each unit Cost Pools
produced.
Activity
Cost
Pools
Unit- Batch- Product- Facility-

Level Level Sustaining- Level
Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,242,000 $210,000 $130,000 $2,300,000
Activity
Activities needed to support Activity required in order
performed
an entire product line for the production
on each
batch process to occur.
produced.
Overhead Cost Pools
Product-Sustaining- Facility-
Unit-Level Batch-Level Level Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,242,000 $210,000 $130,000 $2,300,000
Purchasing
cost pool 300,000
Material-Handling
cost pool $340,000
Quality-Assurance
cost pool $110,000
Packaging/Shipping
cost pool $264,000
Learning Objectives 5-4 – Compute product costs under an
activity-based costing system.
Stage One – Machinery Cost Pool
Various overhead
Maintenance Lubrication
costs related
to machinery Depreciation Electricity
Computer Support Calibration
Activity
cost Machinery Cost Pool
pool Total budgeted cost = $1,242,000
Stage Two – Machinery Cost Pool
Budgeted Machinery Costs $1,242,000
=
Budgeted Machine Hours 230,000
= $5.40/hour
ABC Pool Cost Calculations –
First 4 Activities
ABC Pool Cost Calculations – Last
4 Activities
Product Costs from ABC
These are the new product costs when ABC is used.
Learning Objective 5-5 – Explain why traditional, volume-
based costing systems tend to distort product costs.
Distorted Product Costs
Both original and ABC target selling prices are based
on (Cost × 120%).
Cost Distortion
Two Key Points
A
A large
large proportion
proportion of of non-
non- Product
Product diversity
diversity
unit-level
unit-level activities
activities When
When thethe consumption
consumption
A
A unit-level
unit-level cost
cost driver,
driver, such
such ratios
ratios differ
differ widely
widely
as
as direct
direct labor,
labor, machine
machine
hours, between
between activities,
activities, no
no
hours, or
or throughput,
throughput, willwill
not
not be
be able
able to
to assign
assign the
the costs
costs
single
single cost
cost driver
driver will
will
of
of non-unit-level
non-unit-level activities
activities accurately
accurately assign
assign the
the
accurately.
accurately. resulting
resulting overhead
overhead costs.
costs.
Learning Objective 5-6 – Explain three criteria for selecting
cost drivers.
Cost Drivers
A characteristic of an event or activity that results in
the incurrence of costs. In selecting a cost driver, we
must consider . . .
Degree of Cost of Behavioral

Correlation Measurement Effects
Learning Objective 5-7 – Discuss several implementation
processes in activity-based costing, including data collection
and storyboarding.
COLLECTING ABC DATA
INTERVIEWS AND PAPER TRAILS - The information
for ABC systems initially comes from interviews with
employees in the support departments and a review of each
department’s records.
STORYBOARDING - A procedure used to develop a

detailed process flow chart, which visually represents activities
and the relationships among activities.
MULTIDISCIPLINARY ABC PROJECT TEAMS - To

gather information from all facets of an organization’s
operations, it is essential to involve personnel from a variety of
functional areas. A typical ABC project team includes
ACCOUNTING, FINANCE, PRODUCTION, OPERATIONS,
ENGINEERS, MARKETING, etc.
Learning Objective 5-8 – Explain the concepts of activity-
based management and two-dimensional activity-based
costing.
Activity-Based Management
The use of
ABC costing
information
to help
management
make decisions
Activity-Based Management (ABM)
Activity-based costing establishes relationships

between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs .
Two-Dimensional ABC and
Activity-Based Management (1 of 2)
Activities
Two-Dimensional ABC and Activity-
Based Management (2 of 2)
Cost Assignment View
Resource Costs
Activities
Cost Objects
Two-Dimensional ABC and
Activity-Based Management – Process View
Cost Assignment View
Resource Costs
Process View
Activity Analysis Activity Evaluation
Root Activity Performance

Causes Triggers Activities Measures
Cost Objects
Elimination of Non-Value-Added Costs
Activities
Non-value-
added
activities
Unnecessary Necessary
Reduce or Continually Evaluate

Eliminate
and Improve
Using ABM to Eliminate Non-Value-
Added Activities and Costs (1 of 2)
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root Causes, and
Triggers.
Inspect Rework
Specify Select Receive Produce
finished defective
parts vendor parts goods
goods products
4. Establish Performance Measures.

5. Report Non-Value-Added Costs.
Using ABM to Eliminate Non-Value-
Added Activities and Costs (2 of 2)
Inspection time Process time
Move time Storage time
Waiting time
Learning Objective 5-9 – Explain and execute a customer-
profitability analysis.
Customer Profitability Analysis (1 of
2)
Customer profitability analysis uses

activity-based costing to determine
the activities, costs, and profit associated
with serving particular customers.
Customer Profitability Analysis (2 of
2)
Requires
special
packaging
Orders
small Demands
quantities fast
service
A costly
customer
Often Orders
changes frequently
orders
Customer Profitability Analysis
(Costs)
Cost Drive
Customer-Related Activities Cost Driver Base Rate
Order processing Purchase orders $ 150
Sales contacts (phone calls, faxes, etc.) Contacts 100
Sales visits Visits 1,000
Shipment processing Shipments 200
Billing and collection Invoices 160
Design/engineering change orders Design changes 4,000
Special packaging Units packaged 40
Special handling Units handled 60
A company may use these customer

related costs to help determine the
profitability of each customer.
Customer Profitability Analysis
(Graph)
Customer Profitability
Cumulative Operating Income as a % of Total
125.0%
100.0%
Operating Income
75% of actual operating income

75.0%

50.0%

25.0%
0.0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Learning Objective 5-10 – Understand and discuss how
activity-based costing and its variant time-driven activity-
based costing are used in service-industry organizations.
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ABC Costing in the Service
Industry
The overall objectives of ABC in service
firms are no different than they are in
manufacturing companies.
Identify the activities.
Create activity cost pools.
Identify activity cost drivers.
Follow similar steps discussed in chapter.
End Chapter 5
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Activity-Based Costing and Management

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Chapter 5

Unit- Batch- Product- Facility-

Computer Support Calibration

Degree of Cost of Behavioral

STORYBOARDING - A procedure used to develop a

MULTIDISCIPLINARY ABC PROJECT TEAMS - To

Activity-based costing establishes relationships

Root Activity Performance

Reduce or Continually Evaluate

4. Establish Performance Measures.

Inspection time Process time

Move time Storage time

Customer profitability analysis uses

A company may use these customer

75% of actual operating income

50% of actual operating income

25% of actual operating income

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