Activity-Based Costing: © 2009 Cengage Learning

1
CHAPTER 6
Activity-Based
Costing
© 2009 Cengage Learning

2
Introduction
Overhead costs have soared
to 60 percent or more of total
product costs in heavily
automated manufacturing
environments.
As overhead costs increase
and make up a larger portion
of the total costs of products,
accuracy in overhead 2
application has become much
Activity-Based
3
Costing
In this chapter we
introduce a different
approach to overhead
allocation using Activity-
Based Cost Drivers as
opposed to Volume-Based
Cost Drivers
3
Categories of
4
Overhead Costs
Unit-level costs are incurred
each time a unit is produced.
Examples:
Supplies for factory
Depreciation on factory
machinery
Energy costs for factory
machinery
Repairs and maintenance of 4
Categories of 5
Overhead Costs
Batch-level costs are
incurred each time a batch
of goods is produced.
Examples:
Salaries related to purchasing
and receiving
Salaries related to moving
material
Quality control costs 5
Categories of 6
Overhead Costs
Product-level costs are
incurred as needed to
support the production of
each different type of
product. Examples:
Salaries of engineers
Depreciation of engineering
equipment
Product development costs 6
Categories of 7
Overhead Costs
Facility-level costs simply

sustain a facility’s general
manufacturing process.
Examples:
Depreciation or rent of a factory
building
Salary of a plant manager
Insurance, taxes, etc.
Training 7
Activities and Cost 8
Drivers:
Unit Level
Activity Potential Cost
Driver
•Machining
•Machine hours,
labor hours or
•Maintenan
number of units
ce of
produced
machines
•Machine hours
8
Drivers:
Product Level

Driver
Product
Testing Number of change
orders, number of
tests, hours of
testing time
Supervisi
on Number of
supervision hours 9
Drivers:
Batch Level
Activity Potential Cost Driver
Purchasing Number of purchase
orders or number of
parts
Receiving
Amount of material
Machine
or number of
setups
receipts
Number of setups
Customer 10
Drivers:
Facility Level
Driver
Plant
Occupanc Square footage,
y number of
employees, labor
hours, machine
hours
11
12
Unit-, Batch-, Product-,

and Facility-Level Costs
Key Concept
Unit-level costs are incurred each
time a unit is produced. Batch-level
costs are incurred each time a
batch of goods is produced.
Product-level costs are incurred as
needed to support the production
of each type of product. Facility-
level costs simply sustain a
facility’s general manufacturing 12
13
Activity-Based
Costing
Key Concept
The key feature of an Activity-Based

Costing system is allocating
overhead costs based on activities
that drive costs rather than on the
volume or number of units
produced.
13
Traditional Overhead 14
Allocation and ABC - An

Example
TopSail Construction
Modular-Home Builder
Builds 2 basic models
and a fast-delivery
Cottage
14
Manufacturing
15
Overhead Costs for

2008
15
Costs per Unit Using 16
Volume-Based OH
Allocation
16
17
Stage 1: Identification
of Activities
17
Stage 2: Identification 18
of Cost Drivers &

Allocation of Costs
Activity Cost Driver
Inspections Number of
inspections
Purchasing
Number of
purchase orders
Supervision
Hours of
supervisor time
Delivery &
Setup time 18
setup
19
Estimated Cost
Driver Activity
19
Calculation of 20
Predetermined Activity
Rates
20
Cost of Units Based 21
on Activity-Based
Costing
21
Cost Comparisons 22
between Traditional and

ABC Costing
22
Price Comparison 23
between Traditional and

ABC Costing
23
Activity-Based
24
Costing
Key Concept
Volume-based costing
systems often result in
over-costing high volume
products and under-
costing low-volume
products.
24
This cross subsidy is
ABC Systems in
25
Service Industries
Although ABC was

developed for use
primarily by
manufacturing
companies, it has gained
widespread acceptance in
the service sector.
25
ABC Systems in
26
Service Industries
Problems
Type of work performed in
service industries tends to be
non- repetitive
Activities differ for each
customer or service
Services have proportionately
more facility-level costs 26
ABC Systems and 27
Nonmanufacturing
Activities
ABC is used to determine the

cost of providing a selling or
administrative service.
Example: The U.S. Post Office used
ABC to help determine the costs and
benefits of allowing customers to pay
using debit and credit cards.
27
28
Benefits of Activity-
Based Costing
Using ABC in the budgeting
process provides more
accurate estimates of resources
Provides more accurate cost
information for day-to-day
decision making
Costs that appeared to be
indirect using volume-based
costing systems are now traced
to specific activities using cost 28
29
Limitations of Activity-
Based Costing
High measurement costs
The higher the potential for
cost distortions, the more
likely the company will
benefit from ABC
Distortions result from diverse
products
Diverse products: products that
consume resources in different 29
Backflush
30
Costing
Companies using JIT generally
have little or no inventory or
finished goods.
All manufacturing costs are flushed

directly into cost of goods sold
If the company has small amounts of
inventory on hand at the end of
the period, manufacturing costs are
backflushed into the appropriate
materials inventory, WIP 30

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1

© 2009 Cengage Learning

Facility-level costs simply

Activity Potential Cost

Unit-, Batch-, Product-,

The key feature of an Activity-Based

Allocation and ABC - An

Overhead Costs for

of Cost Drivers &

between Traditional and

between Traditional and

Although ABC was

ABC is used to determine the

All manufacturing costs are flushed

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