ABC Software Development
Part 1
Summit Business Consultants
Cost Structure of Manufacture
Direct labor
cost
Direct
materials cost
Manufacturing
overhead
Manufacturing
cost
Traditional Costing System
• Utilize a single, volume-based cost driver
Direct
Costs
Overhead
(Allocated based on
direct labor
hour/dollar etc.)
Product
Cost
ABC Costing System
• Assign costs based on consumption of the
resources caused by activities
Direct
Costs
Overhead
(Allocated based
on activities that
drive the overhead)
Product
Cost
ABC Costing System
• Resource driver is a measure of the quantity
of resources consumed by an activity.
• Activity driver is a measure of frequency and
intensity of demands placed on activities by
cost objects.
ABC Costing System
Overhead Costs
Setting Up
Machine Cost Pool
Machining
Cost Pool
……….
Supervising
Cost Pool
Resource
Drivers
Number of Setups
Machine
Hours
……….
Direct Labor
Hours
Activity
Drivers
Products
Example
Company makes Product A and Product B
Product A
400
100
50
Direct labor hours
Machine hours
Purchase orders
Product B
600
150
50
Overheads = $11,250 in total
Payroll taxes
$1,000
Machine maintenance
$500
Purchasing Dept. labor
$4,000
Fringe benefits
$2,000
Purchasing Dept. Supplies
$250
Equipment depreciation
$750
Electricity
$1,250
Unemployment insurance
$1,500
Total
1,000
250
100
Example – Traditional Costing
• The rate would be:
– OH Rate = Overhead/Direct Labor Hours
– $11,250/1,000 = $11.25 per hour.
• Applying overhead using this rate:
– Product A: 400 hours x $11.25 = $4,500
– Product B: 600 hours x $11.25 = $6,750
Example – ABC Costing
Direct Labor
Overhead Allocation
Payroll taxes
$1,000
Machine maintenance
$500
Purchasing Dept. labor
$4,000
Fringe benefits
$2,000
Purchasing Dept. Supplies
$250
Equipment depreciation
$750
Electricity
$1,250
Unemployment insurance
$1,500
Calculated Rates
Direct Labor
$4.5 per hour
Machine Hours
$10 per hour
# of Purchase Orders
$42.5 per order
$1,000
2,000
1,500
$4,500
Machine Hours
$ 500
750
1,250
$2,500
# of Purchase Orders
$4,000
250
$4,250
Example – ABC Costing
Product A
Direct labor hours
Machine hours
Purchase orders
Total
Base
400
100
50
Rate
$ 4.50
$ 10.00
$ 42.50
Allocated
$ 1,800.00
$ 1,000.00
$ 2,125.00
$ 4,925.00
Product B
Direct labor hours
Machine hours
Purchase orders
Total
Base
600
150
50
Rate
$ 4.50
$ 10.00
$ 42.50
Allocated
$ 2,700.00
$ 1,500.00
$ 2,125.00
$ 6,325.00
Benefits of ABC Costing System
Accuracy of
Product Cost
Accuracy of
Cost
Management
Improved Decisionmaking
Limitations of ABC Costing System
Expensive
and Timeconsuming
Omission
of Costs
Allocation
Impractical
Problems with Traditional ABC System
Non-linear
links between
resources and
activities are
ignored
Do not cater
for unknowns
such as
Carbon Tax
Non-financial
aspect is
completely
ignored
Need for tailor made solution
Stage 1 Sample
Stage 1 Sample