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Overview of Activity-Based Costing (ABC) and Its Implications on Cost Structures

This chapter delves into Activity-Based Costing (ABC), a cost accounting system that allocates costs based on specific activities involved in producing products or providing services. It explores different types of costs, such as direct and indirect costs, and common pitfalls like undercosting and product cross-subsidization. It highlights the benefits of using ABC, including improved accuracy in product costing and a focus on activity control. Additionally, it discusses various overhead allocation methods and the implications of setting predetermined overhead rates.

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Overview of Activity-Based Costing (ABC) and Its Implications on Cost Structures

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  1. ACTG 4310 Chapter 9 Activity-Based Costing (ABC)

  2. Overview of Costs • Direct costs • Indirect costs • Undercosting/overcosting products • Product-cost cross subsidization • Trends - more direct costs, multiple indirect cost pools, assigning manufacturing and marketing/admin. costs to products • Eliminating a Product • The Death Spiral

  3. Setting Predetermined Overhead Rates • Estimated OverheadPlantwide • Estimated Activity = OH Rate • Benefits and costs of a plantwide rate - one rate for entire plant • Two stage cost allocation: • Departmental rates - different rates for each department • Est.Dept. 1 OHEst. Dept. 2 OH • Est. Machine hrs Est. DLH. • = Dept. 1 OH rate = Dept. 2 OH rate • Benefits and costs of different departmental OH rates

  4. Activity Based Costing (ABC) • Cost accounting system that focuses on the collecting and attaching costs to products and services based on the activities conducted to produce, perform, distribute, or support those products or services • Uses same procedure as traditional OH application • More OH rates • OH rates based on activities

  5. When to use ABC • More than one product • Different complexities in products • A high OH item is caused by a low volume product • Costs of products don’t make sense • Increased competition

  6. Benefits/Criticisms of ABC • Benefits • More accurate product costing • More direct costs • Focus switches to control over activities • Criticisms • More complex • Time consuming to set up • More detailed accounting

  7. ABC - Procedure • 1) Identify activities that consume resources and assign costs to them. • 2) Choose a cost driver for each cost pool. • Output unit-level costs • Batch-level costs • Product-sustaining costs • Facility-sustaining costs

  8. ABC - Procedure • 3) Compute the cost rate per activity. • 4) Assign costs to products based on how many activities each product uses, along with direct costs. • 5) Compute total and unit costs.

  9. Cost Driver Analysis • Traditional Measures • Direct labor hours • Direct labor cost • Machine hours • New Measures • # of engineering orders • # of purchase orders • Computer time • Machine hours

  10. Activity Bases • Service companies • Banks • CPA firms • Advertising firms • Marketing and administrative costs allocated

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