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Activity Based Costing
Activity Based Costing
COSTING
MARIA CRISTINA P. OBESO, CPA, MBA
COSTING PRODUCTS
• Direct materials and direct labor costs are easy to
trace
• Overhead cannot be traced easily and must be
assigned with estimates
TRADITIONAL COSTING METHODS
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
Unit-Level Activities
Activities performed for each unit of production
Ex. Drilling, cutting, milling, assembling, painting, sanding
FOUR LEVELS OF ACTIVITIES
Batch-level Activities
Activities performed for each batch of products.
Ex. Equipment setups, purchase ordering, inspection,
material handling
FOUR LEVELS OF ACTIVITIES
Product-Level Activities
Activities performed for and identifiable with an entire
product line.
Ex. Product design, engineering changes, inventory
management
FOUR LEVELS OF ACTIVITIES
Facility-Level Activities
Activities required to support or sustain an entire
production process and not dependent on number of
products, batches, or units produced
Ex. Plant management, personnel administration, training,
security
This hierarchy provides managers and accountants a
structured way of thinking about relationships between
activities and the resources they consume. In contrast,
traditional volume-based costing recognizes only unit-level
costs. Failure to recognize this hierarchy of activities is one
of the reasons that volume-based cost allocation causes
distortions in product costing.
As indicated earlier, allocating all overhead costs by unit-based cost drivers can
send false signals to managers; Dividing batch, product, or facility level costs by the
number of units produced gives the mistaken impression that these costs vary with
the number of units. The resources consumed by batch, product and facility level
supporting activities do not vary at the unit level, not can they be controlled at
the unit level. The number of activities performed at the batch level goes up as the
number of batches rises- not as the number of units within the batches changes.
Similarly, the number of product-level activities performed depends on the number
of different products- not on how many units or batches are produced.
Furthermore, facility-sustaining activity costs are not dependent upon the number
of products, batches, or units produced. Batch, product and facility level costs can
be controlled only by modifying each batch, product and facility level activities.
ACTIVITY CENTERS, COST DRIVERS,
AND TRACEABLE COSTS
I. Unit-Level Activities
Activity Centers Cost Drivers Traceable Costs
Machine-related activities, Machine-hours Power costs
Such as milling, cutting, Maintenance costs
and maintenance. Labor costs
Labor-related activities, Labor-hours Factory supplies
including fringe benefits Number of units of output Depreciation of general-
use machines and
equipment
Depreciation of
maintenance equipment
ACTIVITY CENTERS, COST DRIVERS,
AND TRACEABLE COSTS
II. Batch-Level Activities
Activity Centers Cost Drivers Traceable Costs
Purchase order processing Number of orders Clerical costs
Production order processed Supplies consumed
processing Labor setup costs
Material handling Number of material Labor cost to handle
receipts material
Pounds of material Depreciation of office,
handled setup, and material-
Equipment setups Number of setups handling equipment
Hours of setup time Quality control costs
Quality inspection Number of inspections
Hours of inspection time
ACTIVITY CENTERS, COST DRIVERS,
AND TRACEABLE COSTS
III. Product-Level Activities
Activity Centers Cost Drivers Traceable Costs
Product testing Number of tests Testing facility costs
Hours of testing time Parts administration costs
Parts inventory Number of part types Parts carrying costs
management Product engineering costs
Product design Hours of design time Design costs
Number of engineering
change orders
ACTIVITY CENTERS, COST DRIVERS,
AND TRACEABLE COSTS
IV. Facility-Level Activities
Activity Centers Cost Drivers Traceable Costs
General factory Machine-hours Plant management
Plant occupancy Labor-hours salaries
Personnel administration Number of employees Plant depreciation
and training* (head count) Property taxes &
Hours of training time insurance
Personnel administration
costs
Employee training costs
Employee training costs
Work recreational
facilities
*The costs of some of these activities may be traceable in part to the facility level and in part to other activity centers at
the unit level, product level, and batch level. Personnel administration and training may be such an activity.
PROBLEM
Gonzales Company uses activity-based costing to compute
unit product costs for external financial reports. The
company manufactures two products, the Megastar and the
Superstar. During the coming year the company expects to
produce 20,000 units of the megastar and 5,000 units of the
superstar. Listed below are other selected data relating to
the coming year.
BASIC DATA
Expected Activity
Activity Center Estimated
(and Cost Driver) Overhead Costs Total Megastar Superstar
Labor related P 80,000 10,000 8,000 2,000
(direct labor-
hours)
Machine setups 420,000 1,400 500 900
(number of
setups)
Product testing 600,000 8,000 6,400 1,600
(number of tests)
General factory 900,000 45,000 30,000 15,000
(machine hours)
Required:
1. Compute the overhead rates by activity center.
2. Determine the overhead cost per unit for each product.
SUGGESTED ANSWERS
1. Overhead rates by activity center.