ACTIVITY-BASED COSTING
TRADITIONAL COSTING SYSTEM (also known as Peanut-Butter Costing, Conventional
Costing System, or Broad Averaging) – is a costing approach that uses broad averages for
assigning the cost of resources uniformly to cost objects when the individual products or services,
in fact, use those resources in non-uniform ways. This often results to product cost crosssubsidization.
ACTIVITY-BASED COSTING (ABC) – is a costing method that identifies activities in an
organization and assigns the cost of each activity to all products and services according to the
actual consumption by each. This model assigns more indirect costs (overhead) into direct costs
compared to traditional costing.
ACTIVITY BASED COSTING vs. TRADITIONAL COSTING SYSTEM
Focal application
Number of overhead cost pools
Cost driver (usual)
Manner of allocation
Use in decision making
ABC
Indirect costs
Multiple
May vary based on activity
Logical
More reliable
TRADITIONAL
Direct costs
Single
Unit volume or DLH
Uniform
Less reliable
ABC-RELATED MANAGEMENT DISCIPLINES
ACTIVITY-BASED MANAGEMENT – application of activity-based costing and value-chain
analysis in analyzing and evaluating business activities to achieve operational and strategic
improvement.
VALUE-CHAIN ANALYSIS – is an approach used to analyze a company's business activities to
see how the company can create a competitive advantage for itself. Value chain analysis helps a
company understands how it adds value to something and subsequently how it can sell its product
or service for more than the cost of adding the value, thereby generating a profit margin.
ACTIVITY-BASED COSTING PROCESS
1. Identify activities, activity cost pools, and activity drivers.
2. Assign overhead costs to activity cost pools.
3. Calculate activity cost application rates
4. Assign overhead costs to cost objects using the activity cost application rates and activity
drivers or through the use of consumption ratio
5. Prepare management reports.
ACTIVITY LEVEL HIERARCHY
HIERARCHY
DEFINITION
EXAMPLE
Unit-level activities
occur every time a service is performed, or
a product is made.
Direct material, direct labor
Batch-level activities
performed each time a batch is handled or
processed, regardless of how many units
are in the batch.
Purchase order placements,
Equipment set-up, shipments to
customers
Product-sustaining activities
activities related to specific products and
carried out regardless of how many batches
or units of product are produced or sold.
Product design, advertisements,
research and development
Customer-support activities
activities related to specific customers
sales calls, catalog mailings, and
general technical support
Facility-sustaining activities or
Organizational-level activities
carried out regardless of which customers
are served, which products are produced,
how many batches are run, or how many
units are made.
cleaning executive offices,
providing a computer network,
arranging for loans, preparing
annual reports to shareholders
PROBLEM 1
E-goals Corporation has the following sets of activities in its operations
1. Packaging
2. Research and development
3. Cleaning workplace
4. Depreciation of machinery
5. Materials purchase order
6. Receiving shipments
7. Cutting Direct Materials
8. Quality inspection
9. Security services
10. Factory maintenance
REQUIRED: Determine the proper classification of activities whether its unit-level, batch-level,
product-sustaining or facility sustaining activities.
PROBLEM 2
Archon Limited makes three types of figurines – Venti (V), Zhongli (Z) and Raiden (R). The
company currently uses broad averaging as the basis for allocating overhead; although an activity
based costing (ABC) system is being considered. Details of the three products for a typical period
are:
Labor hour
per unit
0.50
1.50
1.00
Product V
Product Z
Product R
Machine hour
per unit
1.50
1.00
3.00
Material cost
per unit
15
10
20
Production
units
1,000
1,500
5,000
Total production overheads are P900,000 which are divided as follows:
ReSOURCe DRIVeR%
Set-ups
Machining
Materials handling
Inspection
35
20
15
30
The following total activity levels are associated with each product line for the period as a whole:
ACTIVITY
DRIVeRS
Product V
Product Z
Product R
Number of
inspections
150
250
600
Number of
set-ups
50
100
480
Number of
material moves
12
28
80
Direct labor costs P60 per hour and production overheads are absorbed on a machine hour basis.
REQUIRED:
1. Calculate the cost per unit for each product using peanut-butter costing on the basis of
machine hours
P120/UNIT FOR V
P150/UNIT FOR Z
P230/UNIT FOR R
2. Calculate the cost per unit for each product using activity-based costing
P139/UNIT FOR V
P209.33/UNIT FOR Z
P208.40/UNIT FOR R
3. Determine the over – under costing per unit of products
P19/UNIT UNDR COSTING FOR V
P59.33/UNIT UNDR COSTING FOR Z
P21.60/UNIT OVR COSTING FOR R
PROBLEM 4
Velzard Inc. manufactures air conditioners for condominium offices. The gross margin for each
product is P30,000.
In addition, the company incurs commercial expenses of P320,800. The company wishes to
assign these costs to its three major customers, Milim Enterprise, Velgrinde Corporation, and
Veldanava Incorporated. These expenses are related to three major nonmanufacturing activities:
customer service, contract bidding, and engineering design. The activity cost pool and activity
bases associated with these activities are:
Activity Cost Pool
Customer service
Contract bidding
Engineering design
Total
Cost Driver
Number of service requests
Number of bids
Number of customer design changes
Cost
P 133,000
69,000
118,800
P320,800
Activity-base usage and unit volume information for the three customers is as follows:
Unit volume
Number of customer design changes
Number of service requests
Number of bids
Milim
10
150
220
28
Velgrinde
20
50
70
24
Veldanava
30
70
90
40
Total
60
270
380
92
REQUIRED:
1. Determine the profit from each customer under traditional costing on the basis of unit volume
2. Determine the profit from each customer using activity-based costing
PROBLEM 6
Harigold Corporation, a cement manufacturer, has been in operations since 2017. It has the
newest and largest integrated cement facility in the country which enabled it to produce 100 million
metric tonnes (MT) of cement annually. Its sales had constantly increase for the last 3 years due
to its low cement prices for every 40 kg-bag. It has two main products: Type 1 and Type 1P. Type
1, which has a higher concentration of limestone and much stronger than Type 1P, are being sold
directly to construction companies for use in the construction of high-rise building. On the other
hand, Type 1P are being sold to wholesalers and retailers for the construction of households.
In the past years, the Company had been using a traditional costing system which uses the
number of bags in allocating overhead. However, review of cost structure across the products
showed that such may not be appropriate anymore. Karen Orosco, the vice president for
productions, suggested for the implementation of Activity-based costing system which was
supported by the president, Kaye Formento, and approved by the board of directors.
It was later determined that the Company has four relevant activities: Packaging, Order
Processing, Machine Processing and Production inspection. Data relevant to these activities and
the related cost drivers follow:
Packaging
Order Processing
Machine Processing
Product inspections
Activity
P75,000,000
70,000,000
120,000,000
85,000,000
P350,000,000
Cost driver
Number of batches of cement packaged
Number of orders processed
Machine hours spent
Number of bags inspected
Other cost data and resources consumed by the Harigold’s product are as follows:
Direct materials
Direct labor
volume (MT)
number of orders
machine hours
number of bags per batch
Type 1
P1.50/bag
1.00/bag
40,000,000
15,000
2,500
5,000
Type 1P
P1.00/bag
0.80/bag
60,000,000
50,000
3,500
3,750
The company sells Type 1 and Type 1P for P12 and P10 per bag, respectively.
REQUIRED:
1. Number of bags produced during the year for Type 1 and Type 1P
2. Overhead application rate under traditional cost accounting system
3. Cost per bag for Type 1 and Type 1P under traditional cost accounting system
4. Cost per bag for Type 1 and Type 1P under activity-based costing system
5. Over(under) costing between the use of traditional cost accounting system and activity-based
costing system.
6. Profit per unit for Type 1 and Type 1P under activity-based costing system
Answer key:
1.
2.
3.
4.
5.
6.
Type 1 = 1 billion bags; Type 1P = 1.5 billion bags
Overhead application rate = 0.14 per bag
Cost per bag under PBC: Type 1 = P2.64; Type 1P = P1.94
Cost per bag under ABC: Type 1 = P2.63; Type 1P = P1.95
Over (under) costing = P14,846,154
Profit per unit under ABC: Type 1 = P9.37; Type 1P = P8.05