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    BA 116 / 1 Semester, AY 2013-2014 Activity-Based Costing (ABC) Systems: Handout #7

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    Becky Gonzaga
    This document discusses traditional costing models and activity-based costing (ABC) systems. [1] Traditional models use a single overhead pool and rate, which can result in inaccurate product costs when products use resources differently. [2] ABC systems address this by using multiple cost pools and rates assigned based on how activities consume resources. [3] ABC involves identifying activities, cost drivers, and cost pools to better allocate indirect costs and improve costing accuracy, especially for diverse products.

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    BA 116 / 1 Semester, AY 2013-2014 Activity-Based Costing (ABC) Systems: Handout #7

    Uploaded by

    Becky Gonzaga
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    This document discusses traditional costing models and activity-based costing (ABC) systems. [1] Traditional models use a single overhead pool and rate, which can result in inaccurate product costs when products use resources differently. [2] ABC systems address this by using multiple cost pools and rates assigned based on how activities consume resources. [3] ABC involves identifying activities, cost drivers, and cost pools to better allocate indirect costs and improve costing accuracy, especially for diverse products.

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    This document discusses traditional costing models and activity-based costing (ABC) systems. [1] Traditional models use a single overhead pool and rate, which can result in inaccurate product costs when products use resources differently. [2] ABC systems address this by using multiple cost pools and rates assigned based on how activities consume resources. [3] ABC involves identifying activities, cost drivers, and cost pools to better allocate indirect costs and improve costing accuracy, especially for diverse products.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    18 views2 pages

    BA 116 / 1 Semester, AY 2013-2014 Activity-Based Costing (ABC) Systems: Handout #7

    Uploaded by

    Becky Gonzaga
    This document discusses traditional costing models and activity-based costing (ABC) systems. [1] Traditional models use a single overhead pool and rate, which can result in inaccurate product costs when products use resources differently. [2] ABC systems address this by using multiple cost pools and rates assigned based on how activities consume resources. [3] ABC involves identifying activities, cost drivers, and cost pools to better allocate indirect costs and improve costing accuracy, especially for diverse products.

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    BA 116 / 1st Semester, AY 2013-2014

    Activity-Based Costing (ABC) Systems: Handout #7

    TRADITIONAL/FUNCTIONAL-BASED PRODUCT COSTING MODEL

    Direct Materials Direct Labor Overhead

    Plant/Departmental
    Cost Pool

    Products

    If the underlying structure of operations is such that different jobs or processes (cost objects) consume
    indirect costs in the same or in a similar way, the company can use the model above. This provides:
    a. A single cost pool and a single indirect-cost rate for allocation
    b. Uniform assignment of resources to cost objects
    This should provide accurate information because indirect-cost allocation matches indirect-cost
    consumption.

    However, if different jobs or processes (cost objects) consume indirect costs in a non-uniform way, the
    company should consider using an ABC System that provides:
    a. Multiple cost pools and multiple indirect-cost rates for allocation
    b. A better measure of how different jobs use organization resources
    In this case, the inadequacy of the plant-wide and departmental rate is due to:
    a. Non-unit-related overhead costs – overhead costs that are unrelated to the number of units
    produced. Examples are setup costs and administration costs.
    b. Product diversity – products consume overhead in different proportions.

    ABC MODEL
    In activity-based costing, a form of refining a costing system, the underlying structure of operations is
    looked at in greater detail for more understanding of how resources are used with the objective of
    achieving more accurate costing.

    Characteristics
    1. More indirect-cost pools than the traditional approach
    2. More cost drivers used as cost-allocation bases that are not output unit-level cost drivers (see
    activity levels below)
    3. More frequent use of nonfinancial variables as cost-allocation bases

    Activities associated with indirect costs examined are examined. Key or major activities are identified.
    In the context of cost accounting and ABC systems, an activity is an event, task, or unit of work with a
    specified purpose and will most likely entail an allocation of cost of resources.

    1
    Cost of Resources

    Cost assigned using


    Secondary
    driver tracing and
    Activity
    direct tracing

    Primary Activity
    Cost assigned using
    activity driver
    Products
    Six Steps of ABC
    1. Identify the products that are the chosen cost objects.
    2. Identify the direct costs of the products.
    3. Select the activities and cost-allocation bases to use for allocating indirect costs to the
    products.**
    4. Identify the indirect costs associated with each cost-allocation base.
    5. Computer the rate per unit of each cost-allocation base.
    6. Compute the indirect costs allocated to the products.

    ** IDENTIFICATION OF ACTIVITIES, COST-ALLOCATION BASES AND HOMOGENEOUS COST POOLS


     Activity Classification: The key to reducing the number of rates!
    Activity-Level Classification
    1. Unit-level activities – performed each time a unit is produced (grinding, polishing, assembly)
    2. Batch-level activities – performed each time a batch is produced (setup, inspection purchasing)
    3. Product-level activities – performed to enable the various product of the company to be
    produced (engineering changes, developing product-testing procedures)
    4. Facility-level activities – those that sustain a factory’s general manufacturing process (providing
    facilities, maintaining grounds, plant security)

    Caveat on use of ABC!


    A. Choice of level of detail. ABC is likely to provide benefits when there are:
    1. Significant or large amounts of indirect costs
    2. Products which make diverse demands on resources because of differences in volume, process
    steps, batch size, or complexity
    B. Necessary measurements are main costs and limitations of ABC.
    1. Many calculations required to determine costs of products and services
    a. Activity-cost rates need to be updated regularly
    b. Detailed system costly to operate and difficult to understand
    2. Allocation bases used for which data readily available rather than preferred allocation bases

    Sources:
    Horngren, Charles T., et.al, Cost Accounting: A Managerial Emphasis, 13th Ed, Pearson International
    Edition.
    Notes from S.S. Rico, UPCBA

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