Chapter 4
Activity-Based Costing
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Activity Based Costing
Volume-based
allocation methods
work best if the
manufacturing
environment includes
mostly unit-level costs
(costs that vary with
every unit produced or
the volume of
production).
Activity-based
costing provides an
alternative to
traditional methods.
By allocating overhead
costs on the basis of
activities that lead to
the overhead costs, this
method is effective in
automated, diverse
product environments.
Cost Levels
As an alternative to traditional costing
methods, ABC allocates overhead costs
on the basis of activities that drive
costs. To do this, it is important to
understand the level at which costs are
incurred.
UnitLEVEL
COSTS
BatchLEVEL
COSTS
ProductLEVEL
COSTS
FacilityLEVEL
COSTS
Unit-Level Costs
Unit-LEVEL COSTS are
incurred each time a unit
is produced.
Examples:
•Supplies for factory
•Depreciation of factory
machinery
BatchLEVEL
COSTS
ProductLEVEL
COSTS
FacilityLEVEL
COSTS
Batch-Level Costs
Unit-LEVEL COSTS are
incurred each time a unit
is produced.
Examples:
•Supplies for factory
•Depreciation of factory
machinery
Batch-LEVEL COSTS
are incurred for batches
of goods produced.
Examples:
•Salaries for purchasing
•Depreciation for setup
equipment
ProductLEVEL
COSTS
FacilityLEVEL
COSTS
Product-Level Costs
Unit-LEVEL COSTS are
Product-LEVEL COSTS
incurred each time a unit
is produced.
Examples:
•Supplies for factory
•Depreciation of factory
machinery
are incurred for each type
of product produced.
Examples:
•Salaries of engineers
•Product development
costs
Batch-LEVEL COSTS
are incurred for batches
of goods produced.
Examples:
•Salaries for purchasing
•Depreciation for setup
equipment
FacilityLEVEL
COSTS
Facility-Level Costs
Unit-LEVEL COSTS are
Product-LEVEL COSTS
incurred each time a unit
is produced.
Examples:
•Supplies for factory
•Depreciation of factory
machinery
are incurred for each type
of product produced.
Examples:
•Salaries of engineers
•Product development
costs
Batch-LEVEL COSTS
are incurred for batches
of goods produced.
Examples:
•Salaries for purchasing
•Depreciation for setup
equipment
Facility-LEVEL COSTS
sustain general facility
processes.
Examples:
•Insurance and taxes
•Salary of plant manager
Summary of Costs Levels
Unit-LEVEL COSTS are
Product-LEVEL COSTS
incurred each time a unit
is produced.
Examples:
•Supplies for factory
•Depreciation of factory
machinery
are incurred for each type
of product produced.
Examples:
•Salaries of engineers
•Product development
costs
Batch-LEVEL COSTS
are incurred for batches
of goods produced.
Examples:
•Salaries for purchasing
•Depreciation for setup
equipment
Facility-LEVEL COSTS
sustain general facility
processes.
Examples:
•Insurance and taxes
•Salary of plant manager
Assigning Overhead
Costs Under ABC
ABC in Service Environments
ABC is every bit as
important for service
providers as it is for
manufacturing
companies.
It has gained widespread
acceptance in the service sector
(i.e., U.S. Postal Service).
ABC in Service Environments
Limitation: Since the type of work done by
service companies tends to be
nonrepetitive, cost analysis can be difficult
with ABC.
Limitation: Service-oriented companies
tend to have proportionately more facilitylevel costs than do manufacturing firms.
Thus, facility-level costs are allocated
arbitrarily to goods and services (if at all).
ABC in Nonmanufacturing
Environments
Instead of applying ABC to the cost of a
product or service, it can be used to
determine the cost of providing a
particular nonmanufacturing activity,
like payroll services.
Should a company continue processing
payroll in-house or to outsource?
Benefits of ABC
Cost
Accuracy
Increases
Better Control
Through Identification
of Costs
Better Day-To-Day Decision
Making and Opportunities for
Continuous Improvement
Limitations of ABC
High
Measurement
Costs
Time Consuming
with Multiple Activity
Pools and Cost Drivers
If the market dictates prices, ABC
implementation costs may
exceed the expected benefits of
more accurate data.
Who Benefits from ABC?
Cost
Distortions
????
NonUnitLevel
Costs
Companies
Benefiting
From ABC
Diverse,
Complex
Products
Higher %
of
Overhead
End of Chapter 4