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CHAPTER 6
Activity-Based
Costing
© 2009 Cengage Learning
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Introduction
Overhead costs have soared to 60 percent
or more of total product costs in heavily
automated manufacturing environments.
As overhead costs increase and make up a
larger portion of the total costs of products,
accuracy in overhead application has
become much more important.
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Activity-Based Costing
In this chapter we introduce a different
approach to overhead allocation using
Activity-Based Cost Drivers as
opposed to Volume-Based Cost
Drivers
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Categories of Overhead Costs
Unit-level costs are incurred each time a
unit is produced.
Examples:
Supplies for factory
Depreciation on factory machinery
Energy costs for factory machinery
Repairs and maintenance of factory
machinery
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Categories of Overhead Costs
Batch-level costs are incurred each time
a batch of goods is produced.
Examples:
Salaries related to purchasing and
receiving
Salaries related to moving material
Quality control costs
Depreciation of setup equipment
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Categories of Overhead Costs
Product-level costs are incurred as
needed to support the production of
each different type of product.
Examples:
Salaries of engineers
Depreciation of engineering
equipment
Product development costs (testing)
Quality control costs
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Categories of Overhead Costs
Facility-level costs simply sustain a
facility’s general manufacturing process.
Examples:
Depreciation or rent of a factory building
Salary of a plant manager
Insurance, taxes, etc.
Training
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Activities and Cost Drivers:
Unit Level
Activity
•Machining
Potential Cost Driver
•Machine hours, labor
hours or number of units
produced
•Maintenance of
•Machine hours
machines
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Activities and Cost Drivers:
Product Level
Activity
Potential Cost Driver
Product
Testing
Number of change orders,
number of tests, hours of
testing time
Supervision
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Number of supervision
hours
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Activities and Cost Drivers:
Batch Level
Activity
Potential Cost Driver
Purchasing
Number of purchase orders
or number of parts
Receiving
Machine setups
Amount of material or
number of receipts
Number of setups
Customer orders
Number of orders, number of
customers
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Activities and Cost Drivers:
Facility Level
Activity
Potential Cost Driver
Plant
Occupancy
Square footage, number of
employees, labor hours,
machine hours
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Unit-, Batch-, Product-, and FacilityLevel Costs
Key Concept
Unit-level costs are incurred each time a unit is
produced. Batch-level costs are incurred each time
a batch of goods is produced. Product-level costs
are incurred as needed to support the production of
each type of product. Facility-level costs simply
sustain a facility’s general manufacturing process.
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Activity-Based Costing
Key Concept
The key feature of an Activity-Based Costing system
is allocating overhead costs based on activities that
drive costs rather than on the volume or number of
units produced.
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Traditional Overhead Allocation and
ABC - An Example
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TopSail Construction
Modular-Home Builder
Builds 2 basic models and a fastdelivery Cottage
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Estimated Manufacturing
Overhead Costs for 2008
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Costs per Unit Using Volume-Based
OH Allocation
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Stage 1: Identification of Activities
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Stage 2: Identification of Cost
Drivers & Allocation of Costs
Activity
Cost Driver
Inspections
Number of inspections
Purchasing
Number of purchase
orders
Supervision
Hours of supervisor
time
Delivery & setup
Setup time (days)
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Estimated Cost Driver
Activity
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Calculation of Predetermined
Activity Rates
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Cost of Units Based on ActivityBased Costing
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Cost Comparisons between
Traditional and ABC Costing
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Price Comparison between
Traditional and ABC Costing
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Activity-Based Costing
Key Concept
Volume-based costing systems often
result in over-costing high volume
products and under-costing lowvolume products.
This cross subsidy is eliminated by the
use of ABC.
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ABC Systems in Service
Industries
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Although ABC was developed for
use primarily by manufacturing
companies, it has gained widespread
acceptance in the service sector.
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ABC Systems in Service
Industries
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Problems
Type of work performed in service
industries tends to be non- repetitive
Activities differ for each customer
service
or
Services have proportionately more
facility-level costs
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ABC Systems and
Nonmanufacturing Activities
ABC is used to determine the cost of
providing a selling or administrative
service.
Example: The U.S. Post Office used ABC to help
determine the costs and benefits of allowing customers
to pay using debit and credit cards.
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Benefits of Activity-Based
Costing
Using ABC in the budgeting process
provides more accurate estimates of
resources
Provides more accurate cost information
for day-to-day decision making
Costs that appeared to be indirect
using
volume-based costing systems are now traced
to specific activities using cost drivers
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Limitations of Activity-Based
Costing
High measurement costs
The higher the potential for cost
distortions, the more likely the
company will benefit from ABC
Distortions result from diverse products
Diverse products: products that consume
resources in different proportions
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Backflush Costing
Companies using JIT generally have little or no
inventory or finished goods.
All manufacturing costs are flushed directly
into
cost of goods sold
If the company has small amounts of
inventory
on hand at the end of the period, manufacturing costs
are backflushed into the appropriate
materials
inventory, WIP inventory or
finished goods
inventory
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