EMBA Session
November 15,2012
ACTIVITY BASED COSTING
Overview of Lecture
 Review of cost behaviors
 Rationale for ABC approach
 Factors supporting an ABC system
 Cost flows
 Steps in implementation
 Examples
 Level of acceptance of ABC costing
Types of Costs
 Fixed costs
 Variable costs
 Mixed costs
Relating Costs to Objectives
 Traceable costs
 Direct labor
 Direct material
 Allocated costs
 Fixed overhead
 Variable overhead
Traditional Allocation
Method
Warehousing
Product A
Engineering
Purchasing
Maintenance
Direct Labor Hours
Product B
Rational for ABC Approach
 Single allocation rate not sufficient
 Currently many firms must target price their
products
 ABC assists in target pricing
 Advent of high speed computing power made
ABC feasible
Environmental Factors
Supporting ABC Approach
 High levels of competition
 Very diverse product mix
 Low cost of measurement for additional data
required
ABC Cost Flow Schematic
Purchasing Purchase Orders
Warehouse
Product A
Number of Receipts
Product B
Engineering
Number of Hours
Maintenance
Number of Hours
Implementation Steps
 Identify the cost objectives
 Identify the direct costs of the products
 Identify the overhead cost pools
 Select the appropriate drivers
 Test the assumptions
 Install
Example of Product Costing
Raw Materials Department
$1,000,000
Raw Material
$150,000
15,000 Receipts
Product A
Purchased Parts
$600,000
1,000 Receipts
Product B
Material Movements
250,000
250 Setups
Product C
Product D
Allocation Using Single Driver
$1,000,000  16,000 Receipts = $62.50 per receipt
Product
A
B
C
D
No. of
Receipts
4,040
6,200
2,000
3,750
16,000
Rate
$62.50
$62.50
$62.50
$62.50
Allocated Cost
$252,500
387,500
125,000
235,000
$1,000,000
Calculation of Multiple Rates
Pool Dollars
No. of
Drivers
$ 150,000
15,000
$10 Per Receipt
Purchased Parts
600,000
1,000
$600 Per Receipt
Material Handling
250,000
250
Cost Pool
Raw Material
$1,000,000
Per
Driver
Driver
$1,000 Per Setup
Use of Activities by Products
Products
Raw Materials
Number Rate
Purchased Parts
Number Rate
Setups
Number Rate
A
4,000
$10
40
$600
50 $1,000
B
6,000
$10
200
$600
80 $1,000
C
1,500
$10
500
$600
70 $1,000
D
3,500
$10
260
$600
50 $1,000
Totals
15,000
1,000
250
Allocation to Products
A
Raw Materials
B
C
D
Total
$ 40,000 $ 60,000 $ 15,000 $ 35,000 $ 150,000
Purchased Parts
24,000
120,000
300,000
156,000
600,000
Material Handling
50,000
80,000
70,000
50,000
250,000
Totals
$ 114,000 $ 260,000 $ 385,000 $ 241,000 $ 1,000,000
Comparison of Two Methods
Product
Traditional
ABC Method
Variance
A
$ 252,500
$ 114,000
$ 138,500
Over
B
387,500
260,000
127,500
Over
C
125,000
385,000
260,000
Under
D
235,000
241,000
6,000
Under
$1,000,000
$1,000,000
Totals
$
0
Retail Example of ABC
Costing
Traditional Allocation
Soft
Drinks
Percent of Sale
Sales
19.30%
Operating Income as
Percent of Sales
51.20%
Package
Goods
Totals
29.50%
100.00%
$ 26,450
$ 70,020
$ 40,330
$ 136,800
20,000
5,790
25,790
50,000
15,360
65,360
30,000
8,850
38,850
100,000
30,000
130,000
660
$ 4,660
$ 1,480
Costs:
Cost of Goods Sold
Store Support Costs
Totals
Operating Income
Fresh
Produce
$
0.0250
0.0666
0.0367
$
6,800
0.0497
Identify Cost Pools and
Drivers
Activity
Driver
Ordering
# of P.O.
$5,200
52
$100
Delivery
# of Del.
$8,400
105
$ 80
Stocking
# of L.H.
$5,760
280
$ 20
$10,240
51,200
.20
Cust. Sup. # of Items
Bottle Return
Total
Cost Pool
No. of Cost per
Drivers
Driver
$400
$30,000
New Cost Drivers
Activity
Cost Per Driver
Soft Fresh Package
Drinks Produce Goods Totals
Ordering
$100 per P. O.
12
28
12
52
Delivery
$80 per delivery
10
73
22
105
Stocking
$20 per labor hour
18
180
90
288
Customer Support $.20 per item sold 4,200 36,800 10,200 51,200
Bottle Return
Direct allocation
$400
$400
Results Applying ABC
Soft
Drinks
Fresh
Produce
Package
Goods
Totals
Sales
Costs:
Cost of sales
Bottle return
Ordering
Delivery
Stocking
Customer support
Totals
$ 26,450
$ 70,020
$ 40,330
$ 136,800
20,000
400
1,200
800
360
840
23,600
50,000
30,000
2,800
5,840
3,600
7,360
69,600
1,200
1,760
1,800
2,040
36,800
100,000
400
5,200
8,400
5,760
10,240
130,000
Operating Income
$
Percent of Operating
Income to Sales
2,850
0.1078
$
420
0.0060
$
3,530
0.0875
$
6,800
0.0497
Acceptance of ABC Costing
 Approximately 60% of manufacturing firms in
the US have tried ABC
 10%-20% finally kept it in place
 Reasons for rejection:
 Cost of gathering information
 Complexity outweighs usefulness
 Disagreement on proper drivers
Copyright by Frank Ilett, 2012