MANAGERIAL ACCOUNTING

Dr. Oanh (Helen) Nguyen - VNU_IS

oanhntk@isvnu.vn
 CHAPTER 5
Activity-Based Costing and Management
How to calculate COGM
 Job costing
 Process costing
1. Building-Block Concepts of Costing
Systems
 Cost object: all items that the organisation must
calculate COGM
 Direct costs of a cost object: all costs that the
organisation can directly trace to the cost object
(Direct materials and Direct labour)
 Indirect costs of a cost object: all costs that the
organisation cannot directly trace to the cost
object (MOC – overheads)
 cost assignment
◦ Cost tracing is a term used for direct costs
◦ cost allocation is a term used for indirect costs

Dr.Oanh Nguyen - VNU_IS 4

1. Building-Block Concepts of Costing
Systems

Dr.Oanh Nguyen - VNU_IS 5

Calculate COGM for a Movie
 Suppose the organization produces 02
movies per year.
◦ Direct materials
◦ Direct labour: contract with actors and actress
for each movie
◦ Overheads: Movie equipment (cameras, lighting
systems, movie directors, camera man): Allocate
these costs to each movie

Dr.Oanh Nguyen - VNU_IS 6

1. Building-Block Concepts of Costing Systems
 A cost pool is a grouping of individual indirect
cost items. Cost pools are often organized in
conjunction with cost-allocation bases (cost
drivers).
 The cost-allocation base is a systematic way to
link an indirect cost or group of indirect costs to
cost objects
◦ Financial cost-allocation base: E.g. direct labor costs
◦ Non-financial cost allocation base: e.g. the number of
machine-hours.

Dr.Oanh Nguyen - VNU_IS 7


An example of eating out
Three persons went out for dinner (Nam, Mai and Nga). Each has their own dish:
◦ Nam chose one bow of beef noodles at price of 50,000 VND
◦ Mai chose one bow of chicken noodles at price of 40,000 VND
◦ Nga chose one bow of porridge at price of 45,000 VND
Besides, they together selected a plate of salad at price of 60,000 VND
After finish the dinner, they calculate the amount of money they need to pay for their dinner.
Nam must pay his own for a bow of beef noodles: 50,000 VND. Cost of a bow of beef noodles is a direct cost
because Nam knows from beginning how much he had to pay for his bow of beef noodles. It was the same for Mai and Nga.
For the salad, they must do cost allocations because they do not know from beginning how much they had to pay for
the salad. This is called indirect cost.
(1) If they ate equally, they would allocate the cost based on the number of people: 3 persons. (60,000/3) = 20,000
VND each.
(2) If they ate unequally, the plate of salad was divided into 04 equal portions. Nam ate 2 portions, Mai ate one portion
and Nga ate one portion. The salad cost was allocated based on the number of salad portions.
- We needs to calculate how much people must pay for one portion: 60,000/4 = 15,000 (per portion)
- We calculate the amount each person must pay for salad:
+ Nam: 2 x 15,000 = 30,000 (VND)
+ Mai: 1 x 15,000 = 15,000 VND
+ Nga: 1 x 15,000 = 15,000 VND
In cost accounting, “the number of people or the number of salad portions” are called “cost allocation base” ( tiêu
thức phân bổ).
20,000 per person or 15,000 per portion are called: overhead rate
60,000 was the total overhead cost
Nam had to pay for the dinner: (1) 50,000 + 20,000 = 70,0000; (2) 50,000 + 30,000 = 80,000
Mai had to pay for the dinner: (1) 40,000 + 20,000 = 60,0000; (2) 40,000 + 15,000 = 55,000
Nga had to pay for the dinner: (1) 45,000 + 20,000 = 65,0000; (2) 45,000 + 15,000 = 60,000
 Nam, Mai and Nga took a taxi to the restaurant:
210,000
 They allocated the taxi cost based on the
number of people.
 They allocated the salad cost based on the
number of people.
A cost pool includes taxi cost and salad cost
because they have the same cost-allocation base
(the number of people).
 For fun
 Allocating salad cost based the amount of money in the pocket
of each person.
◦ Nam: 1,000,000
◦ Nga: 600,000
◦ Mai: 400,000
Cost-allocation base: the amount of money in the pocket of each person
Total amount of money = 1 tr + 0.6 + 0.4 = 2,000,000
Rate = 60,000/2,000,000 =0.03 (per dong)
Nam had to pay for salad = 0.03 x 1,000,000 = 30,000. Nam dinner =
50,000 + 30000 = 80,000
Nga = 0.03 x 600,000 = 18,000. Nga Dinner = 45,000 + 18,000 =63,000
Mai: 0.03 x 400,000 = 12,000
 Possible cost-allocation bases for the salad cost:
 (2)The number of people
 (1)The number of salad portions – selected: Cost driver because
the number of salad portions are positively correlated (ty le
thuan) with the salad cost.
 The amount of money in the pocket of each person

 Choosing cost-allocation bases is very important because they

affect the amount of indirect costs allocated to the cost object.
 In management accounting, in order to calculate COGM
accurately, cost-allocation bases should be cost drivers.
 Machining costs
 Direct labour hours
 Machine hours
Traditional costing system versus Activity-based
costing (ABC)
 Traditional costing system allocates MOC based on cost-
allocation bases that might not be cost drivers.
 ABC allocates MOC based on Cost drivers related to
activities.
1. Traditional,Volume-Based Product-
Costing System

➢ Patio Grill Company, a manufacturer of

barbeque grills and accessories. The
company’s Denver plant manufactures
three product lines: the Patio Standard
(STD), the Deluxe (DEL), and the Ultimate
(ULT).

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Trouble in Denver
The STD price and the DEL price are below the its target price while
the ULT is sold at a much higher price than its target one.

487.00 586.3 867.80

487 x 120% = 584.4 703.56 1,041.36

Traditional,Volume-Based Product Costing System

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2. Activity-Based Costing System
ABC systems follow a two-stage procedure
to assign overhead costs to products.
Stage One
Identify significant activities and assign overhead costs
to each activity in proportion to resources used.
Stage Two
Identify cost drivers appropriate to each activity and
allocate overhead to the products.

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Excercises: 5.27&5.28
 Overhead Costs
Activity Total budgeted cost = $4,896,000
must be Identification
done on of Activity
each unit Activity
Cost
Cost Pools
produced.
Pools

Product-
Unit- Batch- Sustaining- Facility-
Level Level Level Level

Machinery Setup Engineering Facility

cost pool cost pool cost pool cost pool
$1,242,000 $210,000 $130,000 $2,300,000
Activity Activities needed to support Activity required in order
performed an entire product line for the production
on each process to occur.
batch
produced.
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Exercise 5-26
Homework
3. Interpreting the ABC Product Costs
Comparison of Product Costs and Target Prices from
Alternative Product-Costing Systems: Patio Grill Company

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Distorted Product Costs
 4. Cost Drivers
A characteristic of an event or activity that results in
the incurrence of costs. In selecting a cost driver,
we must consider . . .

Degree of Behavioral
Correlation Effects

Cost of
Measurement

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 5. COLLECTING ABC DATA
INTERVIEWS AND PAPER TRAILS - The information
for ABC systems initially comes from interviews with
employees in the support departments and a review of each
department’s records.

STORYBOARDING - A procedure used to develop a

detailed process flow chart, which visually represents activities
and the relationships among activities.

MULTIDISCIPLINARY ABC PROJECT TEAMS – To

gather information from all facets of an organization’s
operations, it is essential to involve personnel from a variety of
functional areas. A typical ABC project team includes
ACCOUNTING, FINANCE, PRODUCTION, OPERATIONS,
ENGINEERS, MARKETING, etc.
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6. Activity-Based Management

The use of
ABC costing
information
to help
management
make decisions
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Activity-Based Management
Activity-based costing establishes relationships
between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs.

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 Two-Dimensional ABC and Activity-
Based Management
Cost Assignment View

Resource costs
Process View
Activity Analysis Activity Evaluation

Root Activity Performance

Causes Triggers Activities Measures

Cost Objects
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 7.1 Elimination of Non-Value-Added
Costs
Activities

Non-value-
added
activities
Unnecessary Necessary

Reduce or Continually Evaluate

Eliminate and Improve
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 Using ABM to Eliminate Non-Value-
Added Activities and Costs
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root Causes, and
Triggers.

Inspect Rework
Specify Select Receive Produce
finished defective
parts vendor parts goods
goods products

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

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7.2 Customer Profitability Analysis

Customer profitability analysis uses

activity-based costing to determine
the activities, costs, and profit associated
with serving particular customers.

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Customer Profitability Analysis
Required
special
packaging

Orders Demand
small fast
quantities service

Often
Orders
changes
frequently
orders

A costly customer
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