Activity-Based Costing

Topics: Costs, Manufacturing, Activity-based costing Pages: 17 (1360 words) Published: August 14, 2014
Chapter 4

Activity-Based Costing

4-1

4-2

Traditional Costing and Activity-Based Costing
Traditional Costing Systems


Allocates overhead using a single predetermined rate.


Job order costing: direct labor cost may be the relevant
activity base.



Process costing: machine hours may be the relevant
activity base.



Assumption was satisfactory when direct labor was a major
portion of total manufacturing costs.


Wide acceptance of a high correlation between direct labor
and overhead costs.

4-3

LO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based Costing

The Need for a New Approach


Tremendous change in manufacturing and service
industries.



Decrease in amount of direct labor usage.



Significant increase in total overhead costs.



Inappropriate to use plant-wide predetermined
overhead rates when a lack of correlation exists.



Complex manufacturing processes may require
multiple allocation bases; this approach is called
Activity-Based Costing (ABC).

4-4

Illustration 4-1
Traditional one-stage
costing system

Traditional Costing and Activity-Based Costing

Activity-Based Costing


Allocates overhead to multiple activity cost pools and



Assigns the activity cost pools to products or services by
means of cost drivers.

4-5

Traditional Costing and Activity-Based Costing

Activity-Based Costing


Activity: any event, action, transaction, or work
sequence that causes a cost to be incurred in producing a
product or providing a service.



Activity Cost Pool: a distinct type of activity. For
example: ordering materials or setting up machines.



Cost Drivers: any factors or activities that have a direct
cause-effect relationship with the resources consumed.

4-6

LO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based Costing

Activity-Based Costing


ABC allocates overhead costs in two stages:
Stage 1: Overhead costs are allocated to activity cost pools. Stage 2: Assigns overhead allocated to the activity cost
pools to products, using cost drivers.



4-7

The more complex a product’s manufacturing operation, the
more activities and cost drivers are likely to be present.

Traditional Costing and Activity-Based Costing

Activity-Based Costing

4-8

Activities and related cost drivers

Traditional Costing and Activity-Based Costing

Activity-Based Costing
ABC system design—Lift Jack Company

4-9

Example of ABC Versus Traditional Costing

Activity-Based Costing
Involves the following four steps.
1. Identify and classify the activities involved in the manufacture of specific products, and allocate overhead to cost pools.

2. Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool.
3. Compute the activity-based overhead rate for each cost
driver.
4. Assign overhead costs to products, using the overhead rates determined for each cost pool (cost per driver).

4-10

Example of ABC Versus Traditional Costing

Illustration:


Atlas Company produces two products (abdominal trainers):





Ab Bench: a high volume item with sales totaling 25,000 units annually. Ab Coaster: a low volume item with sales totaling 5,000 units annually.

Each product requires 1 hour of direct labor.


Total annual direct labor hours (DLH) 30,000 (25,000 + 5,000)



Direct labor cost $12 per unit for each product



Expected annual manufacturing overhead costs $900,000.



Direct materials cost:



4-11

Ab Bench - $40 per unit
Ab Coaster - $30 per unit

Required: Calculate unit
costs under ABC.

Example of ABC Versus Traditional Costing

Illustration:

Manufacturing costs

Ab Bench

Ab Coaster

$40

$30

Direct labor

12

12...
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