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Activity Based Costing

- Activity based costing (ABC) assigns indirect costs to products based on their use of activities, rather than traditional volume-based measures like direct labor hours. ABC uses cost pools and activity drivers to allocate costs. - Traditional costing assigns all manufacturing costs to products using volume measures like direct labor hours. ABC does not assign all costs and uses multiple cost pools. It defines activities that do not directly relate to production volume. - ABC involves identifying activities, cost drivers, and cost pools to allocate indirect costs to products. It provides managers with more strategic cost information than traditional costing.

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Maria Via Cristian Mauricio
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139 views

Activity Based Costing

- Activity based costing (ABC) assigns indirect costs to products based on their use of activities, rather than traditional volume-based measures like direct labor hours. ABC uses cost pools and activity drivers to allocate costs. - Traditional costing assigns all manufacturing costs to products using volume measures like direct labor hours. ABC does not assign all costs and uses multiple cost pools. It defines activities that do not directly relate to production volume. - ABC involves identifying activities, cost drivers, and cost pools to allocate indirect costs to products. It provides managers with more strategic cost information than traditional costing.

Uploaded by

Maria Via Cristian Mauricio
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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ACTIVITY BASED COSTING (ABC)

- Job order costing is using the traditional which is the “Method of getting the
predetermined overhead rate using the labor cost, labor hours and Machine hours. Only
one activity based costing that we are using. In order to get predetermine overhead
rate.
Units cost computing costs is allocated must add to direct labor and direct materials.
- In activity based costing in allocating the Indirect costs is based is more than 1 and the
allocation method that we are using is relies upon the activity.
 DIFFERENT TREATED OF COST BETWEEN THE TRADITIONAL PRODUCT
COSTING VS ABC PRODUCT COSTING

TRADITIONAL PRODUCT COSTING ACTIVITY BASED COSTING


 All manufacturing costs  ABC assigns both types of costs
to products.
 It is used Joint costs  ABC does not assign all
manufacturing costs to products.
 It is usually relies on the volume  It uses more cost pools
measures such as direct labor
hours and or/ machine hours to
allocate all overhead costs to
products.
 It relies upon the allocation  ABC defines five level of activity
based that we are using to that largely do not relate to the
allocate the overhead costs. It volume of the units produced.
can

- In activity based costing we must know the difference between the direct and indirect
costs.
- BOTH PERIOD AND PRODUCT COST CAN CONSIDERED AS DIRECT COSTS.
- COST POOL- This is the storage we are going to combine all of the costs. It is used to
allocate the every activity costs. It is used in ABC.
- COST DRIVER- This is the reason why the cost is changing or varies.
- Manufacturing process if there is complex you will use the activity based costing system
- If the manufacturing process if it’s not complex you may you the traditional costing.
- ABC does not assign all manufacturing cost to product.
- ABC uses more cost pools.
- Each ABC cost pool has its own unique measure of activity.
- Indirect costs are allocated through difference activity costing.
- ABC is designed to provide managers with cost information for strategic and other
decision that potentially affect capacity and therefore affect the fixed as well as the
variable costs.
- ACTIVITY- An overhead that causes the consumption of overhead resources.
- ACTIVITY POOL- A “Cost bucket” in which costs related to a particular activity measure
are accumulated.
- THE TERM COST DRIVER- Is also used to refer to an activity measure.
- An allocation based in an activity- based costing system.

TWO COMMON TYPES OF ACTIVITY MEASURES


TRANSACTION DRIVER DURATION DRIVER
 Simple count of the number of an  A measurement of an amount or the
activity occurs. Times or count of an time needed for an activity.
activity occurs.

MANUFACTURING COMPANIES TYPICALLY COMBINED THEIR ACTIVITIES INTO


FIVE CLASSIFICATIONS

1. Unit level activity- This is activity volume based cost driver because it is related
no. of units produced. Best example is direct materials and direct labor. You may
see it in the lowest level. Every unit has additional cost. It supports only one part of
the product. It also required a large amount of costs in order to produce. In short,
costly
Example: Wall paintings, providing power to run processing equipment.

2. Batch level activity- It is production of a batch of 1 product. We have given costs


because of that we can make a large portion of product with it. It has little costs
incurred hence, we can make a large product. These activities are performed by
batch is handled and processed, regardless how many units are produced.

Example: Machine set-up, quality testing, maintenance and purchase order, setting
up equipment and, shipping customer orders, inspection.

3. Product- level activities- To support the specific product. The cost is only
allocated to only specific units. These costs are incurred to different product. More
than 1 supported. Mag bebenefit ay different product. It relates to specific product
and must be carried out regardless on batch runs or how many is sold or produced.

Example: Inventory management, Designing or advertising products.

4. Customer- level activities- Relates to specific customers and are not tied to any
specific product. It is an activity that relates or supports to a specific customer rather
than specific product. We are evaluating the feedbacks and specifications of
customers.

Example: Sales calls, catalogs mailings, customer satisfaction.

5. Organization sustaining activity- Are carried out regardless of which customer are
served, which product are produced, it supports as a whole. Action taken to
maintain the operation of business. It operates to maintain and sustain the operation
of business. It is usually belong to fixed costs.
Example:
Electricity, insurance, water, bill utilities, rent Straight line depreciation, cleaning
Executives officers, heating a factory.

STRONG TOP MANAGEMENT SUPPORT ABC IMPLEMENTATIONS

- Strong top management support


- Link to evaluations and rewards
- Cross-functional involvement
FORMULA: ACTIVITY RATE X ACTIVITY CONSUMED= ABC COST
 CUSTOMERS ORDERS- Assigned all costs resources that are consumed by taking
processing customer orders.
 PRODUCT DESIGNS- Assigned all costs resources consumed by designing products.
 ORDER SIZE- Assigned all costs of resources consumed as a consequences of the
number of units produced.
 CUSTOMER RELATIONS- Assigned all costs associated with maintaining relations with
customers.
 OTHER- Assigned all other costs are not associated with the other cost pools.
1st ASSIGNED COSTS TO COST POOLS USING FIRST STAGE ALLOCATION
 We are allocating the overhead costs to specified percentage consumed in the cost
pool
 Hence, overhead costs (Indirect costs) x Estimated percentage of cost consumed to
related specific product= Overhead rate
2nd COMPUTE THE ACTIVITY RATE COST POOLS
 To assign the cost pool to activity rate
 FORMULA: TOTAL COST ALLOCATED TO COST POOL PRODUCT COSTS/
ACTIVITY LEVELS
3rd COMPUTE THE ASSIGNING COST TO A COST OBJECT USIGN SECOND STAGE
ALLCOATION BASED ON ABC
 FORMULA: ACTIVITY RATE X ACTIVITY LEVEL DEPENDS ON CONSUMED
AND DETAILS.
4th USED THE ACTIVITY-BASED COSTING TO COMPUTE PRODUCT AND CUSTOMER
MARGINS
PRODUCT MARGIN CALCULATIONS
 STEP 1: Get the TOTAL COST= DIRECT COST+ TOTAL ASSIGNMENT OF
PRODUCT COST (CUSTOMERS ORDERS, ORDER SIZE, PRODUCT DESIGN)
 STEP 2: Deduct TOTAL SALES and TOTAL COST

TOTAL COST means both period and product


TOTAL PRODUCT COST means only the product produced.
The Intention of separation of both
Product margin means in total.
In usual manner- the reason why because of the difference between
Much more desirable to use the activity based than traditional costing system-
In usage of activity based costing system and traditional- It’s really upon the business
organization or how business works.
DIFFERENCE BETWEEN TRADITIONAL COSTING AND ACTIVITY BASED COSTING
SYSTEM
Non-volume depende sa activity na gagamitin.
Process improvements- It is a looking forward to opportunities to reduce the cost.
Theory of constrainst- It is scanning if the certain cost can be reduced.
Benchmarking can be used to compare activity cost information with world-class standards of
performance achieved by other organizations.
MOST COMPANIES DO NOT USE ABC EXTERNAL REPORTING BECAUSE,
External reports- outside of the organization such as investors, stockholders,
Internal reports- It’s inside of the organization.
2. It may be difficult to make changes to the company’s accounting system.
3. ABC does not conform to GAAP.
4. Auditors may be subject of the subjective allocation process based on interview on the
employees.
ABC LIMITATIONS
 Substantial resources required to implement and maintain.
 Desire to fully allocate all costs to product
 Potential misinterpretation of unfamiliar numbers.
 Resistance of unfamiliar numbers and reports.
 Does not conform to GAAP. Two costing may be

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