Study Unit 2
ABC – Activity-Based Costing
LCC – Life-Cycle Costing
Activity-based costing
 Traditional
costing system: OH is simply
dumped into a single cost pool
 Under ABC, indirect costs are attached to
activities and then rationally allocated
 ABC may be used by manufacturing
service or retailing
Traditional Costing System
 Peanut-butter
costing = product-cost crosssubsidization  inaccurate allocation of
indirect costs over products or service units
 DL + DM are traced to products/services
 A single pool of indirect costs is allocated
based on a single rate (overhead)
How much resources did I use to product X?
ABC key terminology
 Activities
 Resource
Drivers
 Cost Pools
 Cost Objects
 Cost Drivers
Steps in ABC process
1)
2)
3)
Activity Analysis: understand the different steps
and process from DM to Finished Goods
Assign Resource Costs to Activities: first-stage
allocation. Identify resource costs: a separate
Accounting System may be necessary to track
resource costs separately from the GL. Then we
need to define resource drivers to allocate it.
Allocate Activity Cost Pools to Cost Objects:
allocating the activity cost pools to final cost
objects = second-stage allocation
 What are my activity drivers?
Activity Analysis
 Unit
level activities
 Batch level activities
 Product-sustaining / Service Sustaining
 Facility-sustaining activities
Cost Drivers
 Cause-&-effect
relationship
 Cost object may be a job, product, process,
activity, service or anything else for which a
cost measure is desired
 Process value analysis: Organization flow


Value-adding Vs. Non Value-adding
Product costing / continuous improvement
ABC used to obtain full-absorption cost (US GAAP)
ABC
Advantages/Disadvantages








Product costing is improved, better decision making
Process value analysis (non-value adding activities can be
removed)
More cost assignment of OH
Better cost control and more efficient operations
Maintain a separate Accounting System to capture resource
costs
Design and implement drivers and cost pools
ABC-derived costs of products or services may not conform
with GAAP
Cost of implementing an ABC system
Organizational Benefits
 Significant
variance in volume, diversity of
activities, complexity of operations, relatively
high OH costs…
 ABC difficult for service organizations: high
facility-level costs hard to assign to service
 DL as a base for allocating OH
 No benefit for a single product and average
regular volume of activity
 Real benefits for high level of FC + wide
variety of products and level of production
Life-cycle costing
 Estimate
revenues & expenses
 Over the entire sales life cycle
 Upstream costs (R&D, Design)
 Manufacturing
 Downstream costs (Mktg & Distribution,
Customer Service)
 Great value for Pricing Decision
Potential Benefits
 Relationships
among costs incurred at different
value-chain stages
 Incurring costs vs. locking in costs (SUNK)
 Focus on cost control Vs. cost reduction
 After-purchase costs (operating, support, repair,
disposal…)
 Life-cycle and whole-life cycle  target costing
 Value engineering: minimize cost without
reducing customer satisfaction
Internal & External Reporting
 For
external financial statement purposes,
costs during the upstream phase must be
expensed in the period incurred
 IFRS
 For
allows development costs to be capitalized
internal purposes, the costs (R&D) must be
capitalized in a life-cycle costing
 Organizations must develop an accounting
system consistent with GAAP
Advantage
 Better
measure for evaluating the
performance of Product Managers
 Life-cycle
costing combines all costs and
revenues for all periods to provide a
better view of a product’s overall
performance