ACTIVITY BASED

COSTING SYSTEM-P2
OCTOBER 19, 2021
ACTIVITY BASED COSTING SYSTEM
Activity-based costing (ABC) is a costing method that is designed to
provide managers with cost information for strategic and other
decisions that potentially affect capacity and therefore “fixed” costs.
ABC is ordinarily used as a supplement to, rather than as a replacement
for the company’s usual costing system.
TRADITIONAL COSTING

BROAD AVERAGING OR PEANUT BUTTER COSTING SYSTEM-

describes a costing approach that used broad averages
For assigning the cost of resources uniformly to cost objects when
the individual products or services, in fact, use those
Resources in non-uniform ways.

The name comes from how peanut butter is spread – uniformly

over an entire piece of bread.
DESIGN OF AN ACTIVITY-BASED COSTING SYSTEM

1. Process Value Analysis (PVA)

a) Analyze activities required to make the product or perform the service. This can be done through the
preparation of a flowchart detailing each in the manufacturing process from the receiving of materials
to the final inspection of the completed product. This requires walking through an operation and
documenting every activity observed as well as the time involved. An activity is any event or
transaction that is a cost driver- that is, it causes the incurrence of cost in an organization.
b) Classify each activity as value-added or non-value added.
c) Identify ways either reduce or eliminate the non-value-added activities.

2. Identifying Activity Centers

An activity center can be defined as a part of the production process for which
management wants a separate reporting of the cost of the activity involved.
Generally, the levels of activities can be classified into four as follows:
d) Unit-level activities- which are performed each time a unit is produced.
e) Batch-level activities – which are performed each time a batch of goods is handled or processed;
f) Product-level activities – which are performed as needed to support the production of each different
type of product
g) Facility-level activities – which simply sustain a facility’s general manufacturing process.
DESIGN OF AN ACTIVITY-BASED COSTING SYSTEM

3. Assign Cost to Activity Centers

Assign costs 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. Other costs shared by two or more activity
centers should be assigned according to some cost driver that controls the utilization
of the costs involved.

4. Select Cost Drivers

This involves assigning costs from the activity center to the product using
appropriate cost drivers. When selecting a cost driver, one must consider the
following factors:
a) The case of obtaining data relating to the cost driver
b) The degree to which the cost driver measures actual consumption by products
of the activity involved.
 Unit -Level Activities
Activity Centers Cost Drivers Traceable Costs
Machine-related activities, such as milling, Machine- Hours Power costs
cutting, and maintenance. Labor-hours Maintenance costs
Labor related activities including fringe Number of units of output Labor costs
benefits Factory supplies
Depreciation of general-use machines and
equipment
Depreciation of maintenance equipment

Batch Level Activities

Activity Centers Cost Drivers
Purchase order processing Number of orders processed
Production order processing Number of material receipts
Equipment setups Pounds of material handled
Material handling Number of setups
Quality inspection Hours of setup time
Number of inspections
Hours of inspection time
Traceable Costs
Clerical costs
Supplies consumed
Labor set up costs
Labor cost to handle material
Depreciation of office, setup, and material-
handling equipment
Quality control costs
 Batch Level Activities

Activity Centers Cost Drivers Traceable Costs

Product testing Number of tests
Parts inventory management Hours of testing time
Product design Number of part types
Hours of design time
Number of engineering change orders
Testing facility costs
Parts administration costs
Parts carrying costs
Product engineering costs
Design costs

Facility Level Activities

Activity Centers Cost Drivers Traceable Costs
General Factory Machine hours Plant management salaries
Plant occupancy Labor-hours Plant deprecation
Personnel administration and training* Number of employees Property taxes & insurance
Hours of training time Personnel administration costs
Employee training costs
Work recreational facilities
TRUE OR FALSE

1. Activity-based costing method is also known as transaction based

costing. TRUE
2. The cost driver is used to link a given activity’s pool of costs.
TRUE
3. Traditional costing systems use multiple predetermined overhead
rates.
FALSE
4. To achieve accurate costing, a high degree of correlation must exist
between the cost drive and the actual consumption of the activity cost pool.

TRUE
TRUE OR FALSE

5. ABC is always a better product costing method and could be used by

all companies in any situation
FALSE
6. ABC is particularly useful when product lines differ greatly in volume
and manufacturing complexity
TRUE
7. To apply activity based costing, an organization must first engaged in
activity analysis.
FALSE
8. Batch-level activities are performed each time a batch of goods is
handled or processed.
TRUE
 MULTIPLE CHOICE

1. Which of the following measures is appropriate as a cost driver for

machine set up activity costs?
a) Number of setups
b) Machine hours
c) Number of workers
d) Number of units

2. Which of the following measures is appropriate as a cost driver for

personnel administration costs?
a) Direct labor hours
b) Machine hours
c) Number of employees
d) Square feet of area
 MULTIPLE CHOICE

3. Which of the following is not a cost driver?

a) Materials handling
b) Computer time
c) Purchase orders
d) Number of items sold

4. Which of the following factors would suggest a switch to activity-

based costing?
a) Product lines similar in volume and manufacturing complexity
b) Overhead costs constitute a significant portion of total costs.
c) The manufacturing process has been stable
d) Production managers use data provided by the existing system
Woody Company has established the following support cost pools and cost drivers for October 2021:

COST POOL SUPPORT COSTS COST DRIVER LEVELS

Purchase orders P50,000 100 orders
Machine set ups 120,000 200 set ups
Electricity 30,000 100,000 khw

The following information pertains to the actual consumption of activity resources for two
representative jobs completed during October:
Job #1 Job # 2
Number of units produced 2,000 4,000
Number of purchased orders 20 30
Number of setups 40 40
Number of kilowatt hours 1,000 2,000

Determine the following:

a) The cost driver rate per purchase order.
b) The cost driver rate per machine setups
c) The total support cost assigned to Job # 1
 a) The cost driver rate per purchase order.
P50,000 / 100 orders = P500 per order

b) The cost driver rate per machine setup

P120,000 / 200 set ups = P600 per order

c) The total support cost assigned to Job# 1

Purchase order= P500 x 20 orders P10,000
Setups = P600 x 40 setups 24,000
Electricity = P30,000/100,000 x 1,000 300
Total support cost P34,300
d) The total support per unit produced for Job# 2
Purchase order= P500 x 30 orders P15,000
Setups = P600 x 40 setups 24,000
Electricity = P30,000/100,000 x 2,000 600
Total support cost P39,600
Divided by units produced 4,000
The Provincial Plant of the X Company manufactures cash registers. It plans to implement an ABC system. The controller has prepared the
following estimates regarding cost pools and activity levels for the next year:
COST POOLS ACTIVITY COSTS ACTIVITY DRIVER LEVELS
Electricity P200,000 40,000 kwh
Machine setups 600,000 1,500 setup hours
Material moves 160,000 40,000 moves
Quality inspection 240,000 30,000 inspections
Totals P1,200,000

The plant’s present cost accounting system allocates manufacturing support costs to job using a plant-wide cost driver rate based on machine
hours. The total machine hours for the coming year are estimated to be 100,000 hours.
The company has received a request for a bid to deliver 2,000 units of the cash register model K1. The following estimates pertain to the
production of 2,000 units of K1:

Direct materials P60,000 Required:

Direct labor (P10 per hour) P30,000 1. What is the estimated manufacturing costs per
unit of K1 under the present accounting
Machine hours 2,000 system?
Set up hours 50 2. What is the estimated manufacturing costs per
unit of K1 if the activity based costing system is
Electricity (kwh) 2,000 implemented?
Number of quality inspections 500
Number of material moves 200
No. 01 Traditional Costing System
Direct Materials P60,000
Direct Labors 30,000
Overhead
P1,200,000 / 100,000 hrs x 2,000 24,000
Total Manufacturing costs P114,000
Units Produced ÷2,000
Manufacturing Costs per unit P57.00

Direct Materials P60,000

Direct Labors 30,000
Overhead- Electricity P200,000/40,000kwh x 2,000 10,000
Machine Set ups P600,000/1,500 set ups x 50 20,000
Material moves P160,000/40,000 moves x 200 800
Inspection P240,000/ 30,000 inspections x 500 4,000

Total Manufacturing costs P124,800

Units Produced ÷2,000
Manufacturing Costs per unit P62.40