Activity-Based /

Traditional
Steps of ABC

Managerial Accounting

Cost Pools

Second Edition

Cost Drivers

Weygandt / Kieso / Kimmel

Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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EL

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4-1

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Activity-Based Costing

Costing Products...
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Direct materials and direct

labor costs are easy to trace
Overhead cannot be traced
easily and must be assigned
with estimates

Traditional Costing Methods...

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Spreads overhead cost over

entire customer base
Each order appears to cost
the same
Orders with high profit
margins subsidize orders with
low profit margins

Traditional Costing Methods...

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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A single or plantwide rate called

a predetermined overhead rate
is used:
Job Order = Direct Labor Costs
Process Cost = Machine Hours

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Need for a New System

Amount of direct labor used in
many industries has decreased
Total overhead from
depreciation on equipment,
utilities, repairs, maintenance
has increased

Activity-Based Costing (ABC)

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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An overhead cost allocation

system that allocates overhead
to multiple activity cost pools
and assigns the activity cost
pools to products or services
by means of cost drivers that
represent the activities used.

Activity
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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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

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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The overhead cost allocated to

a distinct type of activity or
related activities.

Illustration 4-2

Activities and Related Cost Drivers

Reasoning for ABC

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Cost Driver
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Any factor or activity that has a

direct cause-effect relationship
with the resources consumed.
In ABC cost drivers are used to
assign activity cost pools to
products or services.

Illustration 4-3

Activity-Based Costing (ABC)

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Calculate unit cost

Identify activities
Identify cost driver
Compute overhead rate
Assign overhead costs

Benefits of Activity-Based Costing

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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More accurate product costing

which necessitates:
More cost pools used to
assign overhead
Enhanced control over
overhead
Better management
decisions

Limitations of Activity-Based Costing

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Can be expensive to use.

Some arbitrary allocations
continue.

Switch to ABC when...

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Products differ greatly in volume and

manufacturing complexity
Products lines are
numerous
diverse
require differing degrees of support
services
Overhead costs constitute a significant
portion of total costs
The manufacturing process or number
of products has changed significantly
Production or marketing managers are
ignoring data provided existing system

Activity-Based Management
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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An extension of ABC from a

product costing system to a
management function that
focuses on reducing costs and
improving processes and
decision making.

Value-Added Activities
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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An activity that increases the worth of

a product or service such as...
engineering design
machine set-ups
machining
assembling
painting
packaging

Nonvalue-Added Activity
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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An activity that adds cost to, or increases the time

spent on, a product/service without increasing
its market value such as:
Repair of machines
Storage of inventory
Moving of materials
Building maintenance
Inspections
Inventory Control

Just-In-Time Processing (JIT)

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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A processing system dedicated

to having the right amount
of materials, products, or
parts arrive as they are
needed, thereby reducing
the amount of inventory.

Illustration 4-18

Just-In-Time Processing (JIT)

Just-In-Time Processing (JIT)

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Requires
Dependable suppliers
A multiskilled work force
A total quality control
system

Just-In-Time Processing (JIT)

Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Reduced inventory
Enhanced product quality
Reduced rework and
storage costs
Savings from improved
flow of goods

Unit-Level Activities
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Activities performed for each

unit of production.

Batch-Level Activities
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Activities performed for each

batch of products.

Product-Level Activities
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Activities performed for and

identifiable with an entire
product line.

Facility-Level Activities
Activity-Based /
Traditional
Steps of ABC
Cost Pools
Cost Drivers
Limitations/
Benefits of ABC
Value-Added
ABC-Service Ind.
Just-In-Time
Hierarchy Levels

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Activities required to support

or sustain an entire
production process and not
dependent on number of
products, batches, or units
produced.

Activity-Based /
Traditional
Steps of ABC

CostCopyright
Pools

COPYRIGHT

2002, John Wiley & Sons, Inc. All rights reserved.

or translation of this work beyond that permitted in
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Drivers
Section 117 of the 1976 United States Copyright Act without the
Limitations/
Benefits
of ABC written permission of the copyright owner is unlawful.
express
Value-Added
Request for further information should be addressed to the
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Levels
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