Activity-Based Costing

Cost Accounting
Christoper Sinaga
MR IT Del
2020
 Learning Objectives
• Explain the concept of activity-based cost management
• Use the hierarchy of costs to manage costs
• Describe how the actions of customers and suppliers affect a firm’s
costs
• Use activity-based costing methods to assess customer and supplier
costs
• Distinguish between resources used and resources supplied
• Design cost management systems to assign capacity costs
• Describe how activities that influence quality affect costs and
profitability
• Compare the costs of quality control to the costs of failing to
control quality
 Using Activity-Based Cost
Management to Add Value
• Activity-based cost management uses activity analysis in
decision making
• Activity-based costing focuses on activities in allocating
overhead costs to products
• Activity-based management focuses on managing activities to
reduce costs
 Using Cost Hierarchies
Hierarchy Level Cost Example Cost Driver Example
Volume related Supplies Direct labor cost
Lubricating oil Machine-hours
Machine repair Number of units
Batch related Setup costs Setup hours
Material handling Production runs
Shipping costs Number of shipments
Product related Compliance costs Number of products
Design and
specification costs
Facility related General plant costs Direct costs
Plant admin. costs Value added
 Managing the Costs of Customers
and Suppliers
Information on customer profitability is important for managers,
so they can make decisions that will improve firm performance.

Time = Money
 Using ABC Costing:
Customers and Suppliers
Use the same four-step ABC product costing process to assess
customers and suppliers.

Step 1: Identify the activities that consume resources.

Step 2: Identify the cost driver associated with each activity.
Step 3: Compute a cost rate per cost driver for each unit or
transaction.
Step 4: Assign costs to customers by multiplying the cost driver
rate by the volume of cost driver units consumed by the
activity or transaction that occurred.
 Cost of Customers
Step 1: Identify the Activities
What activities consume resources for Red’s delivering service?

Process Flow of the Delivery Service – Red's Lumber

Enter Pick Deliver

order order order
 Cost of Customers
Step 2: Identify the Cost Drivers

Activity Cost Driver

Entering order Number of orders entered
Picking order Number of items picked
Delivering order Number of deliveries made
Delivery administration Order value
 Cost of Customers
Step 3: Compute the Cost Driver Rates
Computation of Cost Driver Rates – Red's Lumber

Activity Cost Driver Cost Driver

Activity Cost Volume Rate
Entering order $100,000 ÷ 10,000 orders = $10 per order
Picking order $150,000 ÷ 75,000 items = $ 2 per item
Delivering order $300,000 ÷ 12,500 deliveries = $24 per delivery
Delivery administration $250,000 ÷ $5,000,000 order value = 5% of value
 Cost of Customers
Step 4: Assign Costs Using ABC (1)

Cost Driver Information by Customer – Red's Lumber

Cost Driver Jack Jill

Number of orders 150 50
Number of items 750 750
Number of deliveries 200 50
Order value (total sales) $50,000 $50,000
 Cost of Customers
Step 4: Assign Costs Using ABC (2)

Estimated Customer Delivery Costs – Red's Lumber

Activity Jack Jill

Entering order (@ $10 per order $ 1,500

$ 500
Picking order (@ $2 per item) 1,500
1,500
Delivering order (@ $24 per delivery 4,800
1,200
Delivery administration 2,500
2,500
Total delivery costs $10,300
$5,700
 Cost of Customers
Step 4: Assign Costs Using ABC (3)
 Using and Supplying Resources
• Resources used:
Cost driver rate multiplied by the cost driver volume

• Resources supplies:
Expenditures or the amounts spent on a specific activity

• Unused capacity:
Difference between resources used and resources
supplied
 Computing the Cost of Unused Capacity
• Actual activity:
Actual volume for the period

• Theoretical capacity:
Amount of production possible under ideal conditions
with no time for maintenance, breakdowns, or
absenteeism.
 Computing the Cost of Unused Capacity
• Practical capacity:
Amount of production possible assuming only the
expected downtime for scheduled maintenance and
normal breaks and vacations

• Normal activity:
Long-run expected volume.
 Managing the Cost of Quality
Total Quality Management (TQM)

• Quality as defined by the customer

• Organization is managed to excel on all dimensions
 Cost of Quality
Conformance costs
• Prevention: Costs incurred to prevent defects in the products or services being
produced
– Materials inspection
– Process control
– Quality training
– Machine inspection
– Product design

• Appraisal: Costs incurred to detect individual units of products that do not

conform to specifications
– End-of-process sampling
– Field testing
 Cost of Quality
Nonconformance costs
• Internal failure: Costs incurred when nonconforming products and services
are detected before being delivered to customers
– Scrap
– Rework
– Re-inspection/Retesting

• Appraisal: Costs incurred when nonconforming products and services are

detected after being delivered to customers
– Warranty repairs
– Product liability
– Marketing costs
– Lost sales
THE END