Management, decision-making and control

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Management, decision-making
and control

Topic:
Activity-based costing

Concept:
Context and Theory
 • Define all the relevant ABC terms, for
example, cost drivers, activities
• Compareand contrast an ABC system with
traditional cost allocation system;
• Explain the concept of an activity based
costing (ABC) system
Learning • Identify and explain each of the four stages
involved in designing ABC systems;
Outcomes • Calculate product cost by means of an
ABC system; and
• Analyse an ABC system and apply it to
manufacturing and service organisation.
• Discuss the appropriateness of cost
allocation for decision-making
 Introduction

• Costing systems can vary in terms of which costs are assigned to

cost objects and their level of sophistication.
• Typically, cost systems are classified as follows:
1. direct costing systems;
2. traditional absorption costing systems;
3. activity-based costing systems.
How do we allocate fixed manufacturing
overheads?
Production units/
Machine hours/
Labour hours/
% of production costs

POR* x actual activity

Allocated FMOH**
Budgeted fixed cost
Budgeted activity

*POR = predetermined overhead rate

**FMOH = Fixed manufacturing overheads
• What is included in fixed manufacturing
overheads?
• Can these costs be grouped in terms of
their nature?
• Is it correct to use the same
denominator across the costs when
allocating fixed costs to products?
• Do you think that products utilize the
fixed costs at the same rate?

ABC attempts to resolve some of these questions

 • ABC is a system of allocating production
overheads to products manufactured in a
manner that is more equitable than the
traditional method of using a single
allocation base such as labour hours for all
fixed overheads.
Background
• ABC recognises that low-volume products
require a higher proportion of
manufacturing support costs such as
machine-set costs, inspection, packaging,
ordering, selling, etc than high volume
products
 Overhead allocation

• Fixed manufacturing overheads = R3 650 000.

• Entity uses DLH to allocate overheads to products.
• What is included in the FMO balance?
Is there a relationship
• Depreciation between labour hours and
• Rent these overheads?
• Water and electricity
• Supervisor salary
• Maintenance costs
 Activity-based costing

DEFINITION: A system of cost allocation that

aims to use mainly cause-and-
effect cost allocations by assigning
costs to activities.
DESIGN:
1. Identify the major activities that takes
place in an organisation
2. Assign costs to cost pools for each
activity
3. Determine the cost driver for each
major activity
4. Assign the cost of activities to products
according to products demand for
activities
 Hope this was useful.
We recommend that you watch the concept videos a
few times until you are comfortable with the
concept.

Do the practice questions on eFundi on your own

before you look the memo.

Remember to consult with your lecturers or the

academic trainees!

All the best with your studies 

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