Uploaded by Ibrahim Mohamed


Activity-Based Costing
Cost Allocation
 The basic approach in product costing is to allocate costs in the cost pools to the individual cost
objects, which are the products or services of interest.
 We assign, or allocate, these costs to the individual cost objects by using appropriate cost
allocation bases or cost drivers.
Plantwide Allocation method
LO 1
Compare and contrast plantwide and
department allocation methods.
Plantwide allocation method
All overhead costs are recorded in one
cost pool and applied to products using
one overhead allocation rate.
One cost pool for the entire plant
 The cost pool is the entire plant.
 This method uses one overhead allocation rate, or one set of rates, to allocate overhead to
products for all departments in a particular plant.
 Companies using a single plantwide rate generally use an allocation base related to the volume
of output, such as direct labor-hours, machine-hours, units of output, or materials costs.
Department allocation method
Department allocation method
Overhead costs are traced to separate
departments and applied to products
using a department allocation rate.
One cost pool for each department
 A company has a separate cost pool for each department. The company establishes a separate
overhead allocation rate for each department.
 Each production department is a separate cost pool.
Example: Plantwide Vs. Department allocation
Main Street Ice Cream Company uses a plantwide allocation method to allocate overhead based on
direct labor-hours at a rate of $3 per labor-hour. Strawberry and vanilla flavors are produced in
Department SV. Chocolate is produced in Department C. Sven manages Department SV and Charlene
manages Department C. The product costs (per thousand gallons) follow:
a. If the number of hours of labor per 1,000 gallons is 50 for strawberry, 55 for vanilla, and 75 for
chocolate, compute the total cost of 1,000 gallons of each flavor using plantwide allocation.
b.Charlene’s department uses older, outdated machines. She believes that her department is being
allocated some of the overhead of Department SV, which recently bought state-of-the-art machines.
After she requested that overhead costs be broken down by department, the following information was
Using machine-hours as the department allocation base for Department SV and labor-hours as the
department allocation base for Department C, compute the allocation rate for each.
c. Compute the cost of 1,000 gallons of each flavor of ice cream using the department allocation rates
computed in requirement ( b ) if the number of machine-hours for 1,000 gallons of each of the three
flavors of ice cream are as follows: strawberry, 50; vanilla, 55; and chocolate, 150. Direct labor hours by
product remain the same as in requirement a.
Solution: Plantwide Vs. Department allocation
b. Department SV has an overhead allocation rate of $4.20 per machine-hour ($105,840 ÷ 25,200
machine hours). Department C has an overhead allocation rate of $1.32 per labor-hour ($23,760
÷ 18,000 labor-hours).
a$210 = 50 machine-hours x $4.20 per machine-hour.
b$231 = 55 machine-hours x $4.20 per machine-hour.
c$99 = 75 labor-hours x $1.32 per labor-hour.
Choice of Allocation Methods
Which method is appropriate?
 The choice of whether to use a plantwide rate or departmental rates depends on the products
and the production process.
 If the company manufactures products that are quite similar and that use the same set of
resources, the plantwide rate is probably sufficient.
 If multiple products use the manufacturing facilities in many different ways, departmental rates
provide a better picture of the use of manufacturing resources by the different products.
 Managers need to make a decision about plantwide versus departmental rates based on the
costs and benefits of the information inherent in each system.
 Selecting more complex allocation methods requires more time and skill to collect and process
accounting information. Such incremental costs of additional information must be justified by an
increase in benefits from improved decisions.
Two-Stage Cost Allocation
First stage:
Allocate overhead costs to departments.
Second stage:
Allocate department overhead costs
to the products or services.
Activity-Based Costing (ABC)
 Assume that you are thinking about going into business offering music to be downloaded
(legally) over the Internet.
 One of the first steps is to develop a business plan that includes a financial analysis.
 One aspect of the financial analysis is estimating the cost of downloads to help you assess the
profitability of your venture.
 Because you are not now in the business, you have no accounting records to use to help you.
Instead, you need to use the engineering approach to estimate cost. You would probably
proceed by identifying the activities that you would need to perform.
 The activities would include:
obtaining permission from various artists and studios to include their songs in your catalog.
 Negotiating a royalty payment for each download would be necessary.
 Buying and maintaining a Web site,
 processing orders, collecting payments,
 keeping records, and so on.
 Once you had identified each activity that you would have to accomplish, you would estimate
the cost of completing each one.
 In this description of the process you would follow, the italicized words are actions that
represent tasks that you would complete to make the product (service) available for sale. You
do not attempt to determine what department or what overhead account would be used. You
use activities.
 Applying this approach to the two-stage cost allocation system, you assign costs to activities, not
departments or buildings, in the first stage. In the second stage, you “allocate” costs to your
single product, downloads, using the appropriate cost drivers for each activity.
 LO 2
Explain how activity-based costing and
a two-stage product system are related.
ABC is a costing method that first assigns costs
to activities and then assigns them to products
based on the products’ consumption of activities.
Stage 1:
Assign costs to activities.
Stage 2:
Assign costs to products based
on the use of each activity
Why ABC?
Step 1: Identify the activities that consume resources
and assign costs to them.
Step 2: Identify the cost driver(s) associated with
each activity.
Step 3: Compute a cost rate per cost driver unit
or transaction.
Step 4: Assign costs to products by multiplying the
cost driver rate by the volume of cost driver
units consumed by the product.
Identifying Activities That Use Resources
 Often the most interesting and challenging part of the exercise is identifying activities that use
resources because doing so requires understanding all the activities required to make a product.
 Example, the activities involved in making a bottle of water:
 Ordering;
 receiving and inspecting materials;
 bottling the water;
 packing the cases;
 shipping the cases.
Choosing Cost Drivers
Cost drivers are factors that cause or “drive”
an activity’s costs.
The best cost driver is one that is
causally related to the cost being allocated
 Computing a Cost Rate per Cost Driver
 In general, predetermined rates for allocating indirect costs to products are computed as
 Costs are allocated to a product by multiplying each activity’s predetermined rate by the volume
of activity used in making it.
 In the ABC two-stage cost system, the first stage consists of activities, not departments. Instead
of a department rate, activity-based costing computes a cost driver rate for each activity center.
Assigning Costs to Products
 The final step in the activity-based costing system is to assign the activity costs to products.
 We multiply the cost driver rates by the number of units of the cost driver in each product.
Cost Hierarchies
This is the classification of cost drivers
into general
levels of activity; volume, batch, product, and so on.
LO 3
Compute product costs using activity-based costing.
 Janis, she’s the cost accountant at Joplin—interviews the production managers to determine the
major activities used to produce cameras in the Port Arthur facility. She learns that the Assembly
building has three major activities—setting up, handling material, and assembling—and that the
Packaging building has two major activities—inspecting and packing, and shipping.
 Step 1: Identify the activities that consume resources and assign costs to them.
 setting up
 handling material
 assembling
 inspecting and packing
 shipping.
Step 2: Identify the cost driver(s) associated with each activity.
Step 3: Compute a cost rate per cost driver unit or transaction.
Step 4: Assign costs to products by multiplying the cost driver rate by the volume of cost driver
units consumed by the product.
Cost Flow Diagram – ABC System
Match each of the following activities with the appropriate category
‫طالب جميع الفرق برجاء قراءه البوست جيدا (مواعيد االسبوع القادم المراجعه)‬
‫الفرقه االولي المجموعه االساسيه‬
‫الحصه االولي السبت الساعه ‪ 1‬تعاد االحد الساعه ‪ 1‬او ‪2:30‬‬
‫الحصه الثانيه الثالثاء الساعه ‪11:30‬‬
‫الحصه الثالثه االربعاء الساعه ‪11:30‬‬
‫الحصه الرابعه الخميس الساعه ‪11:30‬‬
‫الحصه الخامسه الجمعه الساعه ‪ 9‬تعاد الساعه ‪1:30‬‬
‫الفرقه االولي المجموعه الجديده (المراجعه)‬
‫الحصه االولي االحد الساعه ‪ 11:30‬تعاد االثنين الساعه ‪2:30‬‬
‫الحصه الثانيه الثالثاء الساعه ‪11:30‬‬
‫الحصه الثاثه االربعاء الساعه ‪1‬‬
‫الحصه الرابعه الخميس الساعه ‪1‬‬
‫الحصه الخامسه الجمعه الساعه ‪2:30‬‬
‫الفرقه االولي ‪ BIS‬مراجعه ‪report‬‬
‫البدايه يوم الخميس الساعه ‪1‬‬
‫الفرقه الثانيه‬
‫الحصه االولي السبت الساعه ‪9‬‬
‫الحصه الثانيه الثالثاء الساعه ‪9‬‬
‫الفرقه الثالثه‬
‫الحصه االولي االحد الساعه ‪9‬‬
‫الحصه الثانيه االثنين الساعه ‪11:30‬‬
‫الحصه الثالثه الثالثاء الساعه ‪1‬‬
‫الفرقه الرابعه‬
‫الحصه االولي االثنين الساعه ‪9‬‬
‫الحصه الثانيه االربعاء الساعه ‪9‬‬
‫الفرقه الثانيه ‪Bis‬‬
‫يوم السبت الساعه ‪ 11:30‬تعاد الساعه ‪ 2:30‬وباقي الموعيد في الحصه‬