Scribd
Upload
62 views

Activity-Based Costing (ABC) Notes

Activity-Based Costing (ABC) System assumes that the activities are the one responsible for the incurrence of costs and those products creates the demand for activities.

Uploaded by

fernandezkristine135
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
62 views

Activity-Based Costing (ABC) Notes

Activity-Based Costing (ABC) System assumes that the activities are the one responsible for the incurrence of costs and those products creates the demand for activities.

Uploaded by

fernandezkristine135
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 2

`AE103: ACTIVITY-BASED COSTING SYSTEM

Activity-Based Costing (ABC)


- When there are many products, machines, and processes in production, ABC system helps the management to determine the true
cost and true profitability of individual products and services; It also helps in making better decisions.
- Defined as a method of assigning costs to products or services based on the activities and collects costs based on the underlying
nature and extent of those activities rather than by department or by function for the purpose of determining the product cost.
- ABC assumes that the activities are the one responsible for the incurrence of costs and those products creates the demand for
activities.
- It recognizes the relationship between the costs, activities, and products; Through this relationship, it assigns the costs to products
based on individual product’s use of each activity and with that, costs are assigned accurately compared to traditional methods.

Objective of ABC: To allocate OH cost to multiple activity-cost pools and assigns the activity cost pools to products/services by
means of cost drivers.

Advantages of ABC
 Fair allocation of MOH costs
 Recognizes that MOH costs are not all related to production and sales volume.
 Product costs are more accurately and reliably estimated as it focuses on the cause and effect of the relationship of costs and
activities in producing the products.
 Selling prices are reliably determined because costs are accurately allocated to individual products.
 Sufficient and more accurate information of costs can be obtained which helps identify inefficient and unprofitable
products/services that cut into the profitability of highly profitable products.
 MOH costs can be easily controlled by managing the cost drivers.

Disadvantages of ABC
 Difficult to apply as it is not easy to identify the overall activities that drive the costs.
 It is not easy to select the most suitable cost driver.
 Not suitable for small manufacturing companies.
 Too costly and time consuming because data concerning different activities must be collected, checked, and entered into the
system.
 Has limited benefit if the FOH costs are primarily volume related or if the FOH cost is too small in proportion to the total MOH
costs.
 It does not conform with the GAAP, and the company needs to maintain two cost systems and accounting books, one for internal
use and one for external use for filing and for compliance.
 It is impossible to allocate all FOH costs to specific activities.

Terminologies used in ABC:


(1) Activity – event, action, transaction, or work sequence that incurs costs when producing a product.
(2) Activity Cost Pool – set of costs attributed to a distinct type of activity.
(3) Cost Drivers – any factors/activities that have direct cause and effect relationship with the resources consumed.
(4) Cost Objects – responsibility centers, product/services to which costs are assigned.
(5) Activity Rate – budgeted activity cost divided by total activity base usage.

Examples of Activities and its Activity Cost Driver


ACTIVITY ACTIVITY COST DRIVER
Purchasing Number of Purchase Orders
Receiving Number of Purchase orders, amount of materials
Materials Handling Number of Materials Requisitions
Setup of Machine Number of Machine Setups
Inspection Number of Inspections
Engineering Number of Engineering Change Orders
Personnel Processing Number of Employees Hires or Laid off
Supervisors Number of Direct Labor Hours
Repair, Maintenance Repair Hours
Testing Number of Test
Product Testing Number of Change Orders, Number of Tests, Testing Hours
Customer’s Orders Number of Orders, Number of Customers
Plant Occupancy Square Footage, # of Employees, Labor Hours, Machine Hours
Cost Hierarchy
- Framework used to classify activities based on how easily they can be traced to a product. The total cost is broken down into
different cost levels in the hierarchy, and a separate cost driver is determined for each level of costs.

(1) Unit-Level Activities – activities performed every time a service is performed, or product is made. If a unit is not produced, then
this activity would not occur. The cost of activity increases/decreases proportionately with the unit volume.
- Examples: Assembly, Painting, Machining

(2) Batch-Level Activities – are activities which occur every time a group of units is produced, or a series of steps is performed.
- Examples: Scheduling, Moving products from one department to another, Quality control, Quality Inspection

(3) Product-Line Activities – are activities that occur to support an entire product line but not always performed every time a new
unit/batch of products is produced.
- Examples: Designing, Advertising & Promotion, Costing/Pricing

(4) Facility-Level Activities – are activities that are carried out at the plant level, it is independent of the number of units produced. It
is also known as “Company Sustaining Activities.”
- Examples: Insurance, Utilities, Rental, Taxes, Security, Building Depreciation, Accounting, Support and Plant
Supervisor’s Salary, Landscaping and Maintenance of the Facility

You might also like