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Chapter 7 Activity-Based Costing

Activity-Based Costing (ABC) costing method designed to provide managers with cost information for
strategic and other decisions that potentially affect capacity. ABC costing is meant to supplement a
companys current costing system, not replace it.

ABC differs from absorption costing in 3 ways:


1. Nonmanufacturing and manufacturing costs may be assigned to products but only on a cause-
and-effect basis.
a. Direct nonmanufacturing costs are traced to products
i. Examples: sales commissions, shipping, warranty repairs
b. Manufacturing costs, or organization-sustaining costs, are not assigned to products, but
treated like period costs instead
i. Examples: factory security guard wages, pant controllers salary
2. Some manufacturing costs may be excluded from product costs.
3. Many overhead cost pools are used, each of which is allocated to products and other cost
objects using its own unique measure of activity.
Activity an event that causes the consumption of overhead resources
Activity cost pool a bucket in which costs are accumulated that relate to a single activity measure
Activity measure an allocation base or cost driver in ABC costing
- The activity measure should drive the cost being allocated
- 2 types of 2 most common activity measures:
o Transaction drivers simple counts of the number of times an activity occurs
o Duration drivers measure the amount of time required to perform an activity

ABC 5 levels of activity:


1. Unit-level activities performed each time a unit is produced, is proportional to the number of
units being produced (electricity)
2. Batch-level activities performed each time a batch is handled or processed, regardless of how
many units are in the batch (placing purchase orders, setting up equipment, arranging
shipments to customers)
3. Product-level activities relate to specific products and typically must be carried out regardless
of how many batches are run or units of product are produced or sold (product design,
advertising, product manager and staff)
4. Customer-level activities related to specific customers (sales calls, catalog mailings, general
technical support)
5. Organization-sustaining activities carried out regardless of which customers are service or
what products are made, or how many batches are run or how many units are made (heating
the factory, cleaning executive offices)

Steps for Implementing ABC:


1. Define activities, activity cost pools, and activity measures.
a. All companies will have different cost pools, below is textbook example for Classic Brass

2. Assign overhead costs to activity cost pools


3. Calculate activity rates.

4. Assign overhead costs to cost objects using the activity rates and activity measures.
5. Prepare management reports.
Absorption verses ABC

- ABC is not GAAP compliant


o Product costs must include all the manufacturing costs, but ABC excludes some
manufacturing and adds some nonmanufacturing costs.
- Auditors not comfortable with how cost allocations are based, data can be manipulated by
managers
- ABC requires extensive resources, more costly to maintain (needs constant updating)

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