ACTIVITY-BASED

COSTING
ATTY. MANGIE A. PATANGAN, CPA, MBA
Instructor
Strategic Cost Management (SCM 32)
Lesson Objectives:
As a result of completing this learning module, students will be able to:
 Define, state the advantages and limitations of activity based costing;
 Describe the steps in designing an activity-based costing system; and
 Apply activity-based costing to manufacturing and merchandising
company.
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 ACTIVITY-BASED COSTING (ABC) – is a costing method that
uses several activities to allocate indirect costs (e.g., overhead) to
products.

 Activity-based costing vs. Traditional costing - Under the traditional

costing, a single cost driver (e.g., hours) is used to estimate and
allocate overhead cost assigned to products. On the other hand, ABC
identifies multiple cost drivers that cause the incurrence of overhead
costs and assign overhead cost to individual products on the basis of
these identified activities or cost drivers.
Steps in
Process
Implementing ABCValue
01
Analysis
• Identifying value adding or non value adding activities.

• A value adding activity is a non-eliminable activity that

incurs costs but increases the worth of the product to the
customer (e.g., engineering designs modification).

• A non-value adding activity does not make the product

more valuable to the end-consumers.
1.Developing computer coding for a new
spreadsheet package
2. Painting the office of a maintenance
supervisor at a plant that produces
cereal
3. Examining a new patient
4. The 90 minutes that a Boeing 757 sits
idle on the ground between flights
5. Moving cases of paper from one location
to another in the same warehouse
6. Attaching a watch band to the watch’s
face
7. Reprocessing mail that had been sorted
incorrectly on a malfunctioning sorting
machine.
8. Correcting errors made by company
personnel in customer accounts
9. Upgrading the quality of bedding used
at hotels in very competitive
marketplaces
11. Installing a new air-conditioning system in the
executive offices.
12. Replacing a defective wheel with a new wheel.
13. Designing and printing an owner's instruction
manual for a new model.
14. Moving completed mowers to the finished-
goods warehouse.
15. Attaching the handle to the mower's body. The
process took longer than normal because of a
worker slowdown caused by disgruntled
employees.
Steps in
Implementing
Identify cost ABC
drivers (activities), cost pools,
02 and activity centers
 A cost driver is the particular activity that causes the incurrence of certain
costs.
 A cost pool is a group of similar costs usually increased or decreased by a
common cost driver.
 An activity center is a unit of organization that performs a set of tasks. It
is part of the production process for which management wants to separate
reporting of the cost of the activity involved.
Steps in
Implementing
Identify cost ABC
drivers (activities) cost pools and
02 activity centers
 Level of activity centers can be classified into four general categories.
a. Unit-level activities – performed each time a unit is produced.
b. Batch-level activities – performed each time a batch of goods is handled
or processed.
c. Product-level activities – performed to support production of specific
product type.
d. Facility-level activities – performed to sustain a facility’s manufacturing
process.
1. Equipment set-ups
2. Machine Hours
3. Plant Supervision and
Landscaping
4. Indirect materials
5. Prime Cost
6. Safety Costs at Winery
7. Packaging and Shipment
8. Truckload shipping costs
9. Advertising
10.Building Maintenance Costs
Steps in
Calculate
Implementing ABCActivity
03
Rates
• Activity rate=
Activity cost pool/ Activity cost driver
Calculate predetermined OH rates for each
activity
• Predetermined OH rate=
Estimated OH Costs/ Estimated Activity Level
Steps in
Implementing ABC
04 Assign costs to the products
using activity rates
• Overhead cost may be assigned to
products using the activity rates or
consumption ratios.
ADVANTAGES and LIMITATIONS
• ABC provides several benefits to manager,
namely: more accurate product costs; better
data for decision making; and tighter cost
control. ABC has also limitations, the chief of
which is the difficulty and high costs involved
with gathering data relating to activity centers
and cost drivers.
 Activity Based
ABMManagement
is management tool that involves
analyzing and costing activities with the goal
of improving efficiency and effectiveness
(e.g., eliminating waste and non-value adding
activities; reducing delays and defects.)
 Two Categories of ABM
1. OperationalApplication
ABM – enhances operation efficiency
and asset utilization and lowers cost. It focuses on
doing things right and performing activities more
efficiently.
2. Strategic ABM – attempts to alter the demand for
activities and increase profitability at the current or
improved activity efficiency. It focuses on choosing
the activities for the operations.
Frequently, ABM uses cost-driver analysis, activity analysis and
performance measurement, to improve operations.

 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 root cause of activity costs.
 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. 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.
Activity analysis identifies and describes the activities in an
organization. Through interviews, questionnaires, observation,
and a review of documentation, an activity analysis collects
information.
 Performance measurement – this involves the identification of the
work performed and the results achieved by an activity process, or
organizational unit. It include both financial and nonfinancial.
Examples of financial performance measures are cost per unit of
output, return on sales, and cost of every department’s high-value-
added and low-value-added activities. Nonfinancial performance
measures evaluate operating characteristics of manufacturing process
and measure of or feedbacks from customers or personnel. Examples
of nonfinancial performance measures are the: number of customer
complaints; customer satisfaction; number of defective parts or
output; number of output unit; cycle-time, on-time delivery rate;
number of employee suggestions; and scores on employee morale.
“And when you want something, all the
universe conspires in helping you
achieve it.

—Paulo Coelho, The

Alchemist