Instructional Module: Republic of The Philippines Nueva Vizcaya State University Bayombong, Nueva Vizcaya

Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY

Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.:IM-ACCTG2-2NDSEM-2018-2019
College: College of Business Education

Campus : Bayombong Campus
DEGREE COURSE NO.

PROGRAM BSBA ACCTG 2
SPECIALIZATION Financial COURSE TITLE
Management Managerial Accounting
YEAR LEVEL 3rd Year TIME FRAME WK NO. 8 IM 04
NO.
I. UNIT TITLE/CHAPTER TITLE: ACTIVITY-BASED COSTING AND MANAGEMENT
II. LESSON TITLE :

Lesson 1: Definition and Nature of Activity-based Costing
Lesson 2: Steps in applying Activity-based Costing
Lesson 3: Activity-based Costing Management
Lesson 4: Advantages and Disadvantages of ABC Costing
Lesson 5: Limitations of ABC Costing
Lesson 6: ABC Costing Management
III. LESSON OVERVIEW
The determination of the proper amount of overhead cost assign to each job is a difficult
part in computing the accurate unit cost of a product or service. Accountants recognize
that manufacturing and providing services are related activities. Thus they direct
attention to these activities. The activity-based management system links resource
consumption to the activities a company performs and charges the activities to products
or customers.
Activity-Based Costing (ABC) has been developed in response to the managers’ need
for more accurate product cost to make them more globally competitive.
ABC helps managers identify more clearly the costs involved in manufacturing a product
or providing a service and thereby provides more accurate unit cost information on which
to base pricing and other decision.
IV. DESIRED LEARNING OUTCOMES:
1. Discuss the nature of Activity-based Costing System

2. Enumerate the basic steps in applying ABC Costing
3. Allocate overhead cost to products using ABC Costing
4. Determine the product cost using ABC Costing
5. Discuss the advantages and disadvantages of using ABC costing
6. Discuss the limitations of ABC Costing
7. Discuss the benefit of employing ABC Costing Management
V. LESSON CONTENT
Lesson 1. Definition and Nature of Activity-Based Costing
Activity Based Costing was defined as a costing system in which multiple overhead cost pools
are allocated using bases that include one or more non-volume – related factors. Activity-based
Costing (ABC) also known as transaction costing is a costing methodology that identifies
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activities in an organization and assigns the cost of each activity with resources to all products
and services according to the actual consumption by each.
In activity-based costing, an activity is any event, action, transaction, or work sequence that
incurs cost when producing product or providing a service. An activity cost pool is any factor or
activity that has a direct cause-effect relationship with the resources consumed.
The reasoning behind ABC cost allocation is simple: Products consume activities, and activities
consume resources.
Traditional Costing System are characterized by their exclusive use of volume related , or unit
level, measures as bases for allocating overhead to output. Traditional systems are also called
unit-based system.
Differences between traditional and activity based costing
The traditional costing is used commonly by manufacturing companies to assign manufacturing

overheads to the units they produce. On the brighter side, the traditional costing is easy to use
especially for those companies that have one product.
On the other hand, the activity-based costing (ABC) is a more logical method of assigning
manufactured overhead costs to products.
The traditional costing method focuses on structure rather than on processes while the ABC is
more on the activities that on structure. Traditional costing method is already obsolete especially
with the changing technology trends such as the introduction of the business accounting
software. The ABC provides more accurate costs of products.
Costing Method First Stage Second Stage

Activity-Based Costing Activity cost pools are formed Costs of activities are
when resource cost are all allocated from activity cost
allocated to activities based pools to products or other
on resource drivers. final cost objects.
Traditional Costing Resources are allocated to Costs are then allocated from
costs centers. the costs centers to products.
Note:
Some traditional systems are single stage because they do not use separate costs centers but
there is no such thing as a single stage ABC system.
Lesson 2. Steps in Applying ACTIVITY-BASED COSTING
1. IDENTIFYING ACTIVITY CENTERS

One way of grouping actions is to classify them with different levels of activities; namely, unit –
level activities, batch – level activities; product – level activities, and facilities – level activities.
A. Units – level activities – are performed each time a unit is produced
B. Batches – level activities – are performed each time a batch of units is produced. The
costs of these activities vary according to the number of batches but remain fixed for all
units in the batch.
C. Products – level activities – are those performed as needed to support the production
of each different type of product.
D. Facilities – level activities – are those which sustain a facility’s general manufacturing
process.
2. ASSIGN COST TO ACTIVITY CENTERS

Assign cost to the activity centers where they are accumulated while waiting to be applied to
products. Costs that are traceable to the activity center should be assigned directly to activity
centers. Others costs shared by two or more activity centers should be assigned according to
some cost driver that controls the utilization of the involved.
3. SELECT THE COST DRIVER

The cost drivers are the links between cost, activity, and product. Cost drivers are not needed
for direct costs because these can be traced immediately to a production. However, indirect
costs such as factory overhead need links or drivers to link a pool of costs in an activity center
to the product.
4. CALCULATE A COST FUNCTION

A cost function is used to translate the pool of costs and cost driver data into a rate percentage
of other cost amounts, just like the plant-wide or departmentalized factory overhead rate. For
example, if the costs of the setup activity center is P25,000 and the selected cost driver is 500
hours, then the cost function will be P50.00 per setup hour (P25,000/500 hrs).
5. ASSIGN COST TO THE COST OBJECTIVE

The last step is to allocate the costs to the different users of the resource. This is done by
multiplying the rate determined in Step 4 by the actual data of the cost driver. If actual setup
hours used is 40 hours, then the allocated cost will be P2,000 (40 hrs × P 50).
Illustrative Problem. Computing Product Cost using ABC Costing
NADAL Company has three products – C, D, and E, and three related overhead activities;
namely, product line setups, number of handles and number of parts.(Overhead activities
means, ito yung mga ginagawang activities na dahilan kaya nagkakaroon ng expenses.) The
numbers of setups refer to the number of times each product line readied for production. The
number of handles refers to the number of times each product is moved from one work station
to another. The number of parts refers to the number of parts that is used in making each
product.
The production, overhead activities and their corresponding costs are shown on the
table below:
Product Units Total Total Total No. of No. of No. of

Produced
Direct Direct Direct Setups Handles Parts
labor Labor Mat. Cost
hours Cost
C 20 30 P 300 P 600 2 2 1
D 100 150 1,500 3,000 1 1 1
E 100 70 700 3,000 3 3 2
Total cost of each activity P 2,500 P 6,600 P 6,200 P 3,300 P 3,000
In Traditional Costing, let us assume that overhead rate is based on direct labor hours for the
products.
The total overhead costs for the above example is P 12,500 (6,200 + 3,300 + 3,000). The
overhead application rate using direct labor hours, as base, would be computed as
Factory overhead rate = P 12,500/250 Direct Labor Hrs.
= P 50.00/DL Hrs.
(Lest us now compute for the total applied overhead cost per product using the computed
factory overhead rate by multiplying the direct labor hours work per product by P50. Why do we
use direct labor hours? It is because the problem stated that direct labor hours is the basis in
computing the applied factory overhead for all the products)
Overhead Cost Applied to Products
Product Direct Labor Total Applied Applied to Applied per

Hours per Overhead Units Unit
Product Costs
C 30 hrs x P 50 P 1,500 20 units P 75
D 150 hrs x P 50 7,500 100 units P 75
E 70 hrs x P 50 3,500 100 units P 35
Using direct labor hours as the base, factory overhead will be applied to the three products as
shown below:
Product Cost Computation
The Applied factory overhead when combined with the prime costs of each product will show
the following:
Product C Product D Product E
Direct Materials P 600 P 3,000 P 3,000
Direct labor 300 1,500 700
Factory Overhead 1,500 7,500 3,500
Total Cost P 2,400 P 12,000 P 7,200
Cost per Unit P 120/unit P 120/unit P 72/unit
Under activity based-costing the factory overhead rate are determined by dividing the total
costs of each overhead activity by the total frequency (or kung ilang beses ginawa ang isang
activity) for each activity,
Setup (P6,200/6) = P 1,033.33 per setup*
Handling (P3,300/6) = P 500.00 per handling
Part numbers (P3,000/4) = P 750.00 per part
(*Total Cost ng ‘Set-up Activity’ para sa lahat ng product ay P6,200. Idivide natin yung amount
kung ilang beses ginawa ang pag set-up, sa given ay anim na beses ginawa ang set-up kaya i-
divide natin sa 6 yung total cost of set-up. Ang cost per set-up ay P1,033.33. Ganun din ang
proseso sa handling and parts numbers.)
The applied overhead costs of the products were determined as follows:
Total Overhead of Product C

Product C
Setups 2 at P 1,033.33 P 2,066.67
Handling 2 at P 550.00 1,100.00
Part numbers 1 at P 750.00 750.00
Total overhead P 3,916.67
Total Overhead of Product D

Product D
Setups 1 at P 1,033.33 P 1,033.33
Handling 1 at P 550.00 550.00
Part numbers 1 at P 750.00 750.00
Total Overhead of Product E

Product E
Setups 3 at P 1,033.33 P 3,099.99
Handling 3 at P 550.00 1,650.00
Part numbers 2 at P 750.00 1,500.00
On the presentation above, it can be seen that Product E has the highest cost followed by
Product C. Product D has the lowest allocated overhead because D consumes less overhead
activities than the other two products. By concentrating on each product’s consumption of the
major cost component (overhead), activity costing avoids the problem of overstating costs of
products that are low level consumers of overhead activities and under costing those that are
high level consumers.
Stated in simple manner, the allocated overhead cost to a product depends on the number of
activities perform to produce that product.
The full cost per unit of each product will be determined as follows:
Product C Product D Product E

Direct materials P 600 P 3,000 P 3,000
Direct labor 300 1,500 700
Factory Overhead 3,917 2,333 6,250
Total Cost P 4,817 P 6,833 P 9,950
Cost per Unit P 240.83/unit P 63.33/unit P 99.50/unit
(Let us always remember that a cost of a product is basically composed of 3 types of cost,
Direct Materials, Direct Labor and Factory Overhead. When we add these three costs, it will
be equal to Product Cost.)
Lesson 3. Advantages and Disadvantages of Activity Based Costing System

Advantages:
1. More accurate costing of products/services, customers.
2. Better understanding overhead.
3. Easier to understand for everyone.
4. Utilizes unit cost rather than just total cost.
5. Integrates well with Six Sigma and other continuous improvement programs.
6. Makes visible waste and non-value added activities.
7. Supports performance management and scorecards
8. Enables costing of processes, supply chains, and value streams
9. Activity Based Costing mirrors way work is done
10. Facilitates benchmarking
Disadvantages
1. More time consuming to collect data

2. Cost of buying, implementing and maintaining activity based system
3. Makes waste visible which some executives and managers don't want their boss to see
Lesson 4: Limitations of ABC System
1. Cost of activity pools: Identifying activities and estimating costs of activity pools is
difficult and expensive.
2. Measurement of cost drivers: To identify and measure cost drivers for such chosen
activity pools is a difficult exercise and costly affair.
3. More clerical work: ABC systems require many calculations to determine the costs of
products and services. Such calculations are complex, time-consuming and costly.
4. Misidentification of costs: ABC system requires more activities—more activity pools.
Hence more allocations are needed to compute activity costs for each cost pool. This
exercise results in misidentification of costs of different activity cost pools. This will
provide inaccurate results.
5. Huge measurement errors: When the number of cost pools is large, it is natural that
measurement errors will be large. In such a scenario, activity-cost information may be
misleading.
Lesson 5: Activity-Based Management - ABM
A procedure that originated in the 1980s for analyzing the processes of a business to identify
strengths and weaknesses. Specifically, activity-based management seeks out areas where a
business is losing money so that those activities can be eliminated or improved to increase
profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead
and other factors in a business to determine and allocate activity costs.
Activity-based Management is a management tool that involves analyzing and costing activities
with the goal of improving efficiency and effectiveness. It aims to improve the value of products
or services to customers and increase the firm’s profit.
VI. LEARNING ACTIVITIES
Elle Inc. has two types of handbags: standard and custom. The controller has decided to use a
plantwide overhead rates based on direct labor costs. The president has heard of activity-based
costing and wants to see how results would differ if this system were used. Two activity cost
pools were developed: machining and machine set up. Presented below is the information
related to the company’s operations.
Standard Custom
Direct labor costs Php 50,000 Php100,000

Machine hours 1,000 1,000
Setup hours 100 400
Total estimated overhead costs are Php300,000. Overhead cost allocated to the machining
activity cost pool is Php200,00 and Php100,000 is allocated to machine setup activity cost pool.
Required:
A) Using the Traditional Costing System, how much is the allocated overhead
cost to each product?
B) Using ABC Costing, how much is the allocated overhead cost to each product?
VII. ASSIGNMENT
Zack Manufacturing has four categories of overhead. The four categories and expected
overhead costs for each category for next year are listed below:
Maintenance P200,000
Materials handling 32,000
Set-ups 100,000
Inspection 120,000
Currently, overhead is applied using a predetermined overhead rate, based on budgeted direct
labor hours. Fifty thousand direct labor hours are budgeted for next year.
The company has been asked to submit a bid for a proposed job. The plant manager feels that
getting this job would result in new business in future years. Bids are based on full
manufacturing cost plus 20 percent.
Estimates for the proposed jobs are as follows:
Direct Materials P 6,000

Direct Labor (1,000 hours) P 10,000
Number of Material moves 12
Number of Inspections 10
Number of Set-ups 2
Number of Machine hours 500
In the past, full manufacturing cost has been calculated by allocating overhead using a volume-
based cost driver, direct labor hours. The plant manager has heard of a new way of applying
overhead that uses cost pools and cost drivers.
Expected activity for the four activity-based cost drivers that would be used are:
Machine Hours 20,000

Material moves 1,600
Set-ups 2,500
Quality inspections 41,000
Required:
1. (a) Determine the amount of overhead that would be allocated to the proposed job if
direct labor hours is used as the volume-based cost driver.
(b) Determine the total cost of the proposed job.
(c)’Determine the company’s bid if the bid is based on full manufacturing cost plus 20
percent.
2. (a) Determine the amount of overhead that would be applied to the proposed project if
activity-based cost drivers are used.
(b) Determine the total cost of the proposed job is activity-based costing is used.
(c) Determine the company’s bid if the activity-based costing is used and the bid is
based on full manufacturing cost plus 20 percent.
(You may use the format presented in the module for easy computation.)
VIII. EVALUATION (Quiz/Exam will be given via Google Classroom)
IX. REFERENCES
Agamata, F. (2019). Managerment Services, 2019 Edition, A Comprehensive Guide.

Conanan Educational Supply
Barfiled, J., Raiborn, C., Kinney, M. (2013). Cost Accounting: Traditions & Innovations,
5Th Edition. Singapore: Thomson Learnings Asia
Cabrera, Ma. Elenita and Cabrera, G. (2017). Management Accounting- Concepts and
Applications, 2017 Edition. Conanan Educational Supply
Harina, Ricardo M. (2012). Management Accounting for Informed Business Decisions.

Madaluyong City, Philippines: National Bookstore
Weygandt, J., Kieso, D., Kimmel, P., (2005). Managerial Accounting: Tools for Business
Decision Making, 3rd Edition. USA: Susan Elbe

Instructional Module: Republic of The Philippines Nueva Vizcaya State University Bayombong, Nueva Vizcaya

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Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

College: College of Business Education

DEGREE COURSE NO.

I. UNIT TITLE/CHAPTER TITLE: ACTIVITY-BASED COSTING AND MANAGEMENT

II. LESSON TITLE :

III. LESSON OVERVIEW

IV. DESIRED LEARNING OUTCOMES:

1. Discuss the nature of Activity-based Costing System

Lesson 1. Definition and Nature of Activity-Based Costing

Differences between traditional and activity based costing

The traditional costing is used commonly by manufacturing companies to assign manufacturing

Costing Method First Stage Second Stage

Lesson 2. Steps in Applying ACTIVITY-BASED COSTING

1. IDENTIFYING ACTIVITY CENTERS

A. Units – level activities – are performed each time a unit is produced

2. ASSIGN COST TO ACTIVITY CENTERS

3. SELECT THE COST DRIVER

4. CALCULATE A COST FUNCTION

5. ASSIGN COST TO THE COST OBJECTIVE

Illustrative Problem. Computing Product Cost using ABC Costing

Product Units Total Total Total No. of No. of No. of

Factory overhead rate = P 12,500/250 Direct Labor Hrs.

Overhead Cost Applied to Products

Product Direct Labor Total Applied Applied to Applied per

Product Cost Computation

The applied overhead costs of the products were determined as follows:

Total Overhead of Product C

Total Overhead of Product D

Total Overhead of Product E

Product C Product D Product E

Lesson 3. Advantages and Disadvantages of Activity Based Costing System

1. More time consuming to collect data

Lesson 4: Limitations of ABC System

Lesson 5: Activity-Based Management - ABM

VI. LEARNING ACTIVITIES

Direct labor costs Php 50,000 Php100,000

Estimates for the proposed jobs are as follows:

Direct Materials P 6,000

Machine Hours 20,000

VIII. EVALUATION (Quiz/Exam will be given via Google Classroom)

Agamata, F. (2019). Managerment Services, 2019 Edition, A Comprehensive Guide.

Harina, Ricardo M. (2012). Management Accounting for Informed Business Decisions.

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