ABC - 1
ActivityBased
Costing
Systems
ABC - 2
Activity-Based Costing
Activity-based costing (ABC) involves determining
the cost of activities and tracing their costs to cost
objectives on the basis of the cost objectives
utilization of units of activity.
Part of “Activity-Based Analysis”
ABC - 3
FAULTY COST SYSTEM
Symptoms
 Competitive analysis is confusing
 Conflicting signals from functional
areas and the accounting system
 Accounting system problems
ABC - 4
WHY ABC NOW?
 Competitive demands for diverse
products/services
 Increased significance of overhead costs
– Growth of nonunit-based overhead
– Consumption ratios of unit-based and nonunitbased overhead items differ
 Improved information technology
 Significance of strategic decisions
ABC - 5
Activity-Based Costing
Activities performed to fill customer needs
consume resources that cost money.
Customer
Served
by
activities
Costs
Activities
Resources
cost
money
Activities
consume
resources
Resources
ABC - 6
Activity-Based Costing
The cost of resources consumed by activities
should be assigned to cost objectives.
Costs
Assigned
to
resources
Cost
objectives
Resources
Reassigned
to cost
objectives
Assigned to
activity cost
pools
Activities
ABC - 7
Activity-Based Costing
Operationalizing the two-stage model requires:
 Identifying activities.
 Assigning costs to activities.
 Determining the basis for assigning the
cost of activities to cost objectives.
 Determining the cost per unit of activity.
 Reassigning costs from the activity to the
cost objective on the basis of the cost
objective’s consumption of activities.
ABC - 8
Two-Stage Activity Based Costing
Method
First stage: Costs assigned to resources are
reassigned to activities.
Cost of
Resource 1
Activity
1
Cost of
Resource 2
Cost of
Resource n
Activity
Activity
Activity
2
3
4
Continued on next slide
Activity
n
ABC - 9
Two-Stage Activity Based Costing
Method
Second stage: Costs assigned to activities are reassigned to
cost objectives using an activity cost driver.
Activity
1
Objective
1
Activity
2
Activity
3
Objective
2
Activity
4
Objective
3
Activity
n
Objective
n
ABC - 10
Manufacturing Cost Hierarchy
 Unit level activities
 Batch level activities
 Product level activities
 Facility level activities
ABC - 11
Manufacturing Cost Hierarchy
This activity is
performed for each
unit of product
produced and sold.
Unit Level
Examples
 Cost of raw materials
 Cost of inserting a
component
 Utilities cost of
operating equipment
 Some costs of
packaging
 Sales commissions
ABC - 12
Manufacturing Cost Hierarchy
Examples
Batch Level
 Cost of processing
sales order
 Cost of issuing and
tracking work order
 Cost of equipment
setup
 Cost of moving batch
between workstations
 Cost of inspection
This activity is
performed for each
batch of product
produced or sold.
ABC - 13
Manufacturing Cost Hierarchy
Product Level
Examples
 Cost of product
development
 Cost of product
marketing, such as
advertising
 Cost of specialized
equipment
 Cost of maintaining
specialized
equipment
This activity is
performed to support
each different product
that can be produced.
ABC - 14
Manufacturing Cost Hierarchy
Facility Level
Examples
This activity is
 Cost of maintaining general
performed to maintain
general manufacturing
capabilities.





facilities
Cost of nonspecialized
equipment
Cost of maintaining
nonspecialized equipment
Cost of real property taxes
Cost of general advertising
Cost of general
administration
ABC - 15
Changing Composition of Total
Manufacturing Costs
Volume-Based Unit
Level Analysis
Activity-Based
Multiple-Level
Analysis
Variable: Only one type
of variable cost is
considered:
Variable: Many types of
variable cost drivers are
considered, including:
Unit level
Unit level
Batch level
Product level
ABC - 16
Changing Composition of Total
Manufacturing Costs
Volume-Based Unit
Level Analysis
Fixed: Costs that do not
vary with the number of
units
Activity-Based
Multiple-Level
Analysis
Fixed: Costs that do not
respond to change in
variable cost drivers are
considered:
Facility level
ABC - 17
Customer Cost Hierarchy
A merchandising organization or the sales
division of a manufacturing organization
might use the following hierarchy:
 Unit level activities
 Order level activities
 Customer level activities
 Facilities level activities
ABC - 18
Customer Cost Hierarchy
An organization that sells to distinct
market segments might have the
following cost hierarchy:
 Unit level activities
 Order level activities
 Customer level activities
 Market segment level activities
 Facility level activities
ABC - 19
Benefits Of Activity Based
Costing
 Greater understanding of the nature of
operations
 More accurate product costing
 Improvement in cost control
 Integration with strategic management
accounting
ABC - 20
Limitations Of Activity Based
Costing
 Costly implementation process
 ABC is NOT a guarantee of becoming a
“world-class” company
ABC - 21
Practical Advice for Implementing ABC
1. Capture the attention of top management.
2. Don’t shoot the customer.
3. Decide the form ABC will take.
4. Supplement the ABC measures creativity where appropriate.
5. Be careful in costing bottlenecks that create excess capacity.
6. Challenge managers who believe their costs are fixed.
7. Calculate costs top-down and bottom-up.
8. Account for cost of capital.
9. Use multi-functional teams.
10. Don’t underestimate the need for managing change.