7-1

Activity–Based Costing (ABC)

ABC is designed to provide

managers with cost information for
strategic and other decisions that
potentially affect capacity, and
therefore, affect “fixed”
as well as variable costs.
 7-2

How Costs are Treated Under

Activity–Based Costing
An event that causes the
Activity consumption of overhead
resources.

A “cost bucket” in which

Activity costs related to a single
Cost Pool activity measure are
accumulated.
$$
$
$ $
$
 7-3

How Costs are Treated Under

Activity–Based Costing
The term cost driver is
Activity
also used to refer to
Measure
an activity measure.

An allocation base
in an activity-based
costing system.
 7-4

How Costs are Treated Under

Activity–Based Costing
Two common types of activity measures:

Transaction Duration
driver driver

Simple count A measure

of the number of of the amount
times an activity of time needed
occurs. for an activity.
 7-5

How Costs are Treated Under

Activity–Based Costing

ABC defines
five levels of activity
that largely do not relate
to the volume of units
produced.

Traditional
Traditional cost
cost systems
systems usually
usually rely
rely on
on volume
volume
measures
measures such
such asas direct
direct labor
labor hours
hours and/or
and/or machine
machine
hours
hours to
to allocate
allocate all
all overhead
overhead costs
costs to
to products.
products.
 7-6

How Costs are Treated Under

Activity–Based Costing
Unit-Level Batch-Level
Activity Activity

Manufacturing
companies typically combine
their activities into five
classifications.

Product-Level Customer-Level
Activity Organization- Activity
sustaining
Activity
 7-7

 Define Activities, Activity Cost

Pools, and Activity Measures
•• Customer
Customer Orders
Orders -- assigned
assigned allall costs
costs of
of resources
resources
that
that are
are consumed
consumed by by taking
taking and
and processing
processing
customer
customer orders.
orders.
•• Design
Design Changes
Changes -- assigned
assigned allall costs
costs of
of resources
resources
consumed
consumed by by customer
customer requested
requested design
design changes.
changes.
•• Order
Order Size
Size -- assigned
assigned all
all costs
costs of
of resources
resources
consumed
consumed as as aa consequence
consequence of of the
the number
number ofof units
units
produced.
produced.
•• Customer
Customer Relations
Relations –– assigned
assigned allall costs
costs associated
associated
with
with maintaining
maintaining relations
relations with
with customers.
customers.
•• Other
Other –– assigned
assigned all
all organization-sustaining
organization-sustaining costs
costs
and
and unused
unused capacity
capacity costs
costs
 7-8

Differences Between ABC and

Traditional Product Costs
There are three reasons why the
reported product margins for the two
costing systems differ from one another.

Traditional costing allocates all manufacturing

overhead to products. ABC costing only assigns
manufacturing overhead costs consumed by
products to those products.
 7-9

Differences Between ABC and

Traditional Product Costs
There are three reasons why the
reported product margins for the two
costing systems differ from one another.

 Traditional costing allocates all manufacturing

overhead costs using a volume-related allocation
base. ABC costing also uses non-volume related
allocation bases.
 7-10

Differences Between ABC and

Traditional Product Costs
There are three reasons why the
reported product margins for the two
costing systems differ from one another.

 Traditional costing disregards selling and

administrative expenses because they are
assumed to be period expenses. ABC costing
directly traces shipping costs to products and
includes nonmanufacturing overhead costs caused
by products in the activity cost pools that are
assigned to products.
 7-11

Targeting Process Improvement

Activity-based management is used
to identify areas that would benefit
from process improvements by
focusing on activities to eliminate
waste, decrease processing time,
and reduce defects.

Benchmarking
Benchmarking can
can be
be used
used to
to compare
compare activity
activity cost
cost
information
information with
with standards
standards of
of performance
performance achieved
achieved byby
other
other organizations.
organizations.
 7-12

Activity-Based Costing and External

Reporting

Most companies do not use ABC

for external reporting because . . .
1.
1. External
External reports
reports are
are less
less detailed
detailed than
than internal
internal
reports.
reports.
2.
2. ItIt may
may be
be difficult
difficult to
to make
make changes
changes to to the
the company’s
company’s
accounting
accounting system.
system.
3.
3. ABC
ABC does
does not
not conform
conform to to GAAP.
GAAP.