7-1

Activity-Based Costing: A Tool

to Aid Decision Making
 7-2

ActivityBased Costing (ABC)

ABC is a
ABC is designed to good supplement
provide managers with to our traditional
cost information for cost system
I agree!
strategic and other
decisions that potentially
affect capacity, and
therefore, affect fixed
as well as variable costs.
 7-3

How Costs are Treated Under

ActivityBased Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.

Manufacturing Nonmanufacturing
costs costs

Traditional ABC
product costing product costing

ABC assigns both types of costs to products.

 7-4

How Costs are Treated Under

ActivityBased Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.

Manufacturing Nonmanufacturing
costs costs

Some
Mo
st,
All

not but
all
Traditional ABC
product costing product costing

ABC does not assign all manufacturing costs to products.

 7-5

How Costs are Treated Under

ActivityBased Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Level of complexity

ActivityBased
ActivityBased
Costing
Costing

Departmental
Departmental
Overhead
Overhead
Rates
Rates
Plantwide
Plantwide
Overhead
Overhead
Rate
Rate

Number of cost pools

ABC uses more cost pools.
 7-6

How Costs are Treated Under

ActivityBased Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.

Each
Each ABC
ABC cost
cost pool
pool has
has its
its
own
own unique
unique measure
measure of
of activity.
activity.

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 toto allocate
allocate
all
all overhead
overhead costs
costs to
to products.
products.

ABC uses more cost pools.

 7-7

How Costs are Treated Under

ActivityBased 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.
$$
$
$ $
$
 7-8

How Costs are Treated Under

ActivityBased 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.
 7-9

How Costs are Treated Under

ActivityBased 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.
 7-10

How Costs are Treated Under

ActivityBased 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.
 7-11

How Costs are Treated Under

ActivityBased 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
 7-12

Characteristics of Successful ABC

Implementations

Strong
Strong top
top
management support
Link
Link to
to evaluations
and rewards

Cross-functional
involvement
 7-13

Targeting Process Improvement

Activity-based management is
used in conjunction with ABC to
identify areas that would benefit
from process improvements.

While the theory of constraints

approach discussed in Chapter 1
is a powerful tool for targeting
improvement efforts, activity rates
can also provide valuable clues on
where to focus improvement efforts.

Benchmarking
Benchmarking can
can be
be used
used to
to compare
compare activity
activity cost
cost
information
information with
with world-class
world-class standards
standards of
of performance
performance
achieved
achieved by
by other
other organizations.
organizations.
 7-14

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 companys
companys
accounting
accounting system.
system.
3.
3. ABC
ABC does
does not
not conform
conform to
to GAAP.
GAAP.
4.
4. Auditors
Auditors may
may be
be suspect
suspect ofof the
the subjective
subjective allocation
allocation
process
process based
based on
on interviews
interviews with
with employees.
employees.
 7-15

ABC Limitations
Substantial resources Resistance to
required to implement unfamiliar numbers
and maintain. and reports.

Desire to fully Potential

allocate all costs misinterpretation of
to products. unfamiliar numbers.

Does not conform to

GAAP. Two costing
systems may be needed.
 7-16

Appendix 7A: ABC Action Analysis

Conventional ABC analysis does not
identify potentially relevant costs. An
action analysis report helps because it:
Shows what costs have been
assigned to a cost object.
Indicates how difficult it would be to
adjust those costs in response to
changes in the level of activity.
 7-17

Appendix 7B

A modified
modified form
form of activity-based
costing
costing can
can bebe used
used to develop product
product
costs for
for external financial reports.
reports.

ABC
ABC product
product costs:
costs:
Include
Include organization-sustaining
organization-sustaining costs
costs
and
and unused
unused capacity
capacity costs.
costs.
Exclude
Exclude nonmanufacturing
nonmanufacturing costs
costs even
even
ifif they
they are
are caused
caused by
by the
the products.
products.
 7-18

End of Chapter 07