AE-CO1

Cost Accounting and

Control

Lyca Ashley T. Comia

Ronnel C. Frago
Magelle R. Manguera
Zane Dien R. Regal
Joanna Marie G. Urbano
 Chapter 9:
Activity-Based Costing
and Management
Cabrera, M.B, GA, BA Cost Accounting and Control (2021)

Flexible Learning Program - Mark Paul O. Altarejos

LEARNING OBJECTIVES:
After studying this chapter, you should be able to…
1. Define activity-based costing
2. State the advantages and limitations of activity-based costing.
3. Describe the steps in designing an activity based costing
system.
4. Enumerate examples of activity centers, cost drivers and
traceable costs.
5. Apply activity-based costing to a manufacturing company.
6. Apply activity-based costing to a merchandising company.
7. Discuss activity-based management.
8. Describe the opportunity cost concept.
Flexible Learning Program - Mark Paul O. Altarejos
 ACTIVITY-BASED COSTING
The most difficult task in accounting accurate unit cost lies
in determining the proper amount of overhead cost to assign to
each job, a unit of product or service activity.

Today, accountants recognize that manufacturing and

providing services are related activities . Thus, they direct
attention to the cost of these activities. The activity -based
management system links resource consumption to the
activities a company performs and costs the activities to
products or customers. Activity-based management uses
activity-based costing (also called transaction-based costing) to
measure and control these relationships.
Flexible Learning Program - Mark Paul O. Altarejos
ACTIVITY-BASED COSTING
Activity-based costing (ABC) has been developed in
response to the manager’s need for more accurate
product costs to make them more globally competitive.

ABC helps managers identify more clearly the costs

involved in manufacturing a product or providing a service
and thereby provides more accurate unit costs
information on which to base pricing and other decisions.

Flexible Learning Program - Mark Paul O. Altarejos

ACTIVITY-BASED COSTING
Activity-based costing (ABC) is a costing method that is
designed to provide managers with cost information for
strategic and other decision that potentially affect capacity and
therefore “fixed” costs. ABC is ordinary used as a supplement
to, rather than as a replacement for the company’s usual
costing system.
Most organizations that use activity-based costing have two
costing system- the official costing system that is used for
preparing external financial reports and the activity-based
costing system that is used for internal decision making and for
managing activities.

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ACTIVITY-BASED COSTING
Advantages and Limitations of ABC

Activity-based costing provides several benefits to the

manager, namely
1.More accurate product costs
2.Better data for decision making
3.Tighter cost control

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System
These are the steps or activities that required in designing an
ABC system.
Step 1. Process Value Analysis involves the following steps.
a) Analyze activities required to make the product or perform
the service.
b) Classify each activity as value-added or non-value-added.
c) Identify ways to either reduce or eliminate the
non-value-added activities.

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System
Step 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:
1. Unit-level activities
2. Batch-level activities
3. Product-level activities
4. Facility-level activities

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System
Step 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.

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System
Step 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:
1. The ease of obtaining data relating to the cost driver
2. The degree to which the cost driver measures actual
consumption by products of the activity involved

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System

Flexible Learning Program - Mark Paul O. Altarejos

Design of an Activity-Based
Costing System

Flexible Learning Program - Mark Paul O. Altarejos

Illustrative Problem 9.1
Manufacturing Applications of
Activity-based Costing
Luzon Company manufacturers 4, 000 units of Product A and
20, 000 units of Product B each year. The company currently
uses direct labor hours to assign overhead costs to products.
Product X requires 2.5 DLH and Product B requires 2.0 DLH to
produce.
Presently, Luzon Company uses a plantwide overhead
allocation rate. Using this method, the unit product cost is.

Flexible Learning Program - Mark Paul O. Altarejos

Manufacturing Applications of
Activity-based Costing

Flexible Learning Program - Mark Paul O. Altarejos

Manufacturing Applications of
Activity-based Costing
The following transaction data have been compiled by the
management of Luzon:

Flexible Learning Program - Mark Paul O. Altarejos

Manufacturing Applications of
Activity-based Costing

Flexible Learning Program - Mark Paul O. Altarejos

Manufacturing Applications of
Activity-based Costing

Flexible Learning Program - Mark Paul O. Altarejos

Manufacturing Applications of
Activity-based Costing

Flexible Learning Program - Mark Paul O. Altarejos

 Illustrative Problem 9.2 Activity-based
Costing Application to a Merchandising
Company
Essence, Inc., specializes in the distribution of soap products.
Essence buys from manufacturers and resells to each of three
different markets:
a. General supermarket chains
b. Drugstore chains
c. Small convenience stores

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Merchandising Company

Flexible Learning Program - Mark Paul O. Altarejos

 Illustrative Problem 9.3 Activity-based
Costing Application to a Trading Company

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Activity-based Costing Application
to a Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application to a
Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application to a
Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application to a
Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

Activity-based Costing Application
to a Trading Company

Flexible Learning Program - Mark Paul O. Altarejos

ACTIVITY-BASED MANAGEMENT
Activity-based management (ABM) is a management tool that
involves analyzing and costing activities with the goal of improving
efficiency and effectiveness. Basically, this management approach
aims to improve the value of products or services to customers
and increase the firm’s profit. ABM draws on ABC as its major
source of information and focuses on the efficiency and
effectiveness of key business processes and activities.

Flexible Learning Program - Mark Paul O. Altarejos

ACTIVITY-BASED MANAGEMENT
ABM is closely related to ABC, but the two schemes differ in their
primary goals. To clarify the difference, consider activities
involved in setting up machinery for a production user. ABC seeks
to measure the cost of setups and then assign a cost to products
based on how many setups each product requires. ABM focus on
ways to improve the setup process and ways to eliminate the
demand for set-up activity ( thus reducing setup cost). In other
words, one needs to know the costs of activities before one can
do a good job of managing them.

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ACTIVITY-BASED MANAGEMENT

There are basically two categories of ABM

applications, namely
a. Operational ABM, and
b. Strategic ABM

Flexible Learning Program - Mark Paul O. Altarejos

ACTIVITY-BASED MANAGEMENT
Operational ABM enhances operation efficiency and
asset utilization and lowers cost. It focuses on doing
things right and performing activities more
efficiently.Among the management techniques that are
applied in operational ABM are activity management,
busines process reengineering, total quality
management and performance management.

Flexible Learning Program - Mark Paul O. Altarejos

ACTIVITY-BASED MANAGEMENT

Strategic ABM, on the other hand, attempts to alter the

demand for activities and increase profitability at the
current or improves activity efficiency. It focuses on
choosing the activities for the operations. Strategic ABM
applications use management techniques such as
process design, product-line and customer mix, supplier
relationships; customer relationship (delivery, pricing
order size, packaging, etc.) market segmentation and
distribution channel.
Flexible Learning Program - Mark Paul O. Altarejos
 ACTIVITY-BASED MANAGEMENT
Frequently, ABM uses cost-driver analysis, activity analysis
and performance measurement, to improve operations. A
brief explanation of these techniques follows:
Cost-Driver Analysis
This technique examines, quantifies and explains the effects of the
cost driver on the cost of an activity. Its purpose is to search for the
root cause of activity costs. Among the tools used in cost driver
analysis include benchmarking, cause-and effect diagrams, and
Pareto analysis. Benchmarking involves the search for the best
practices anywhere to identify ways to improve the operation for a
task, activity or process.
Flexible Learning Program - Mark Paul O. Altarejos
ACTIVITY-BASED MANAGEMENT
A Pareto analysis is a histogram of the cost drivers that
contribute to the total cost. Most analyses under this
technique show that 20 percent of the cost drivers are
responsible for 80 percent of the total cost incurred.
Activity analysis
To be competitive a firm must assess each of its activities
based on its need by the product or customer, its
efficiency,and its value content.
Flexible Learning Program - Mark Paul O. Altarejos
 ACTIVITY-BASED MANAGEMENT
Activity analysis identifies and describes the activities in an
organization. Through interviews, questionnaires, observation
and a review of documentation, an activity analysis collects
information.
A firm performs an activity because it is:
• Required to meet the specification of the product or
service or satisfy customer demand:
• Required to sustain the organization; or
• Deemed beneficial to the firm.
Flexible Learning Program - Mark Paul O. Altarejos
ACTIVITY-BASED MANAGEMENT
Performance measurement
This involves the identification of the work performed and
the results achieved by an activity process, or
organizational unit. Performance measures include both
financial and nonfinancial. Examples of financial
performance measures are the cost per unit of output,
return on sales, and cost of every department’s
high-value-added and low-valued-added activities.

Flexible Learning Program - Mark Paul O. Altarejos

Opportunity Costing Concepts
One significant factor that managers should include in
their decision process information is the capacity usage of
the plant and the other resources of the entity. Capacity
usage information is a critical signal of the potential
relevance of opportunity costs.
Managers can never be sure whether their decisions were
wise or unwise because
1. unexpected events can influence subsequent results and
2. what would have happened had the decision been
different can never be unknown.

Flexible Learning Program - Mark Paul O. Altarejos

Opportunity Costing Concepts
The basic approach to decision making is to compare decision
alternatives in terms of costs and revenues that are incremental.
Costs that can be avoided by taking particular course of action.
Cost that are sunk are never incremental costs because they do
not differ among the decision alternatives. Opportunity costs
represent the benefit foregone by selecting a particular decision
alternative over another. By their nature, they are always
incremental costs and they must be considered when making a
decision. An opportunity cost is the benefit lost by taking one
action as opposed to another. The “other” action is the best
alternative available other than the one being contemplated.

Flexible Learning Program - Mark Paul O. Altarejos

Illustrative Problem 9.4
Opportunity Costs

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Flexible Learning Program - Mark Paul O. Altarejos
Flexible Learning Program - Mark Paul O. Altarejos
Flexible Learning Program - Mark Paul O. Altarejos
Flexible Learning Program - Mark Paul O. Altarejos
Flexible Learning Program - Mark Paul O. Altarejos
Flexible Learning Program - Mark Paul O. Altarejos