Activity Based Costing

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Activity Based Costing
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Activity Based Costing (ABC)
Both manufacturing and nonmanufacturing costs may
be assigned to products.
Some manufacturing costs may be excluded from
product costs.
Overhead rates may be based on activity at
capacity.
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Plantwide Overhead Rate
Companies tend to use direct labor as the
overhead allocation base. There is a belief that
direct labor and overhead costs are highly
correlated.
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Departmental Overhead Rates
Finishing Department
Many companies have a systemin which each
department hasits own overhead rate. In such
cases, the overhead driver also may differ across
departments.
Painting Department
Shipping Department
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Departmental Overhead Rates
Stage One Costs assigned to pools
Overhead
Department 1
Department 2
Department 3
Cost pools
Direct Labor Hours
Machine Hours
Raw Materials Cost
Stage Two Costs applied to products
Products

Departmental Allocation Bases
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Activity-Based Overhead Rates
Overhead
Stage One Costs assigned to pools
Activity 1
Activity 2
Activity 3
Cost pools
Engineering Change orders
Shipping Locations
Stage Two Costs applied to products
Customer orders
Products

Activity cost driver
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Designing of an ABC System

• Steps for Implementing ABC
• Identify and define activities and activity cost
  pools.
• Assign actual costs to activity cost pools.
• Calculate activity cost rates per driver unit.
• Assign costs to cost objects based on driver
  usage.

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?Identify and Define Activities and Activity Cost
Pools

• Each Activity Cost Pool is a bucket in which
  costs are accumulated that relate to a single
  activity measure in the ABC system.

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?Identify and Define Activities and Activity Cost
Pools

• Customer Orders - assigned all costs of resources
  that are consumed by taking and processing
  customer orders.
• Product Designs - assigned all costs of resources
  consumed by designing products.
• Order Size - assigned all costs of resources
  consumed as a consequence of the number of units
  produced.
• Customer Relations assigned all costs
  associated with maintaining relations with
  customers.
• Other assigned all overhead costs that are not
  associated with the other cost pools.

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Functional Listing of Overhead Costs
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?Determine the Distribution of Costs to Activity
Cost Pools
Assume that the following distribution of
resource consumption across activity cost pools
is determined.
Not included because they are directly traced
to customer orders.
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?Assign Costs to Activity Cost Pools
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?Calculate Activity Rates

• The ABC team determines that the company will
  have these total activities for each activity
  cost pool . . .
• 1,000 customer orders
• 200 new designs
• 20,000 machine-hours
• 100 customer relations activities

Now the team can compute the individual activity
rates by dividing the total cost for each
activity by the total activity levels.
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?Calculate Activity Rates

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Activity-Based Costing Stage 1
Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Cost Objects Products, Customer Orders, Customers
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Activity-Based Costing Stage 2
Overhead Costs
First-Stage Allocation
Order Size
Customer Orders
Product Design
Customer Relations
Other
Second-Stage Allocations
/MH
/Order
/Design
/Customer
Cost Objects Products, Customer Orders, Customers
Unallocated