Chapter 5 Lesson 1 Essay

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Learning Objectives page171
1. Explain activity-based costing and how it differs from traditional costing systems
2. Assign costs to cost pools using first-stage allocation and compute activity rates.
3. Assign costs to objects using a second-stage allocation
4. Use activity-based costing to compute product and customer margins
5. Compare product costs computed using traditional and activity based costing
6. Appendix 5A and 5B – review for knowledge level understanding Activity-Based Costing: A
Tool to Aid Decision Making
Chapter Five

© 2009 McGraw-Hill Ryerson Limited

© 2009 McGraw-Hill Ryerson Limited

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Activity Based Costing (ABC)

ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect fixed as well as variable costs.

ABC is a good supplement to our traditional cost system

Learning Objective 1

Explain activity-based costing and how it differs from a traditional costing system. I agree!

© 2009 McGraw-Hill Ryerson Limited

© 2009 McGraw-Hill Ryerson Limited

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Activity-Based Costing at Classic Brass
Direct
Materials

Direct
Labour

Shipping
Costs

Activity-Based Costing – Final Outcome
Direct
Materials

Overhead Costs

Direct
Labour

Shipping
Costs

Overhead Costs

First-Stage Allocation

Traced Traced Traced

Customer
Orders

Product
Design

Order
Size

Customer
Relations

Other

Second-Stage Allocations
$/Order

Cost Objects:

$/MH

$/Customer

Cost Objects:

Products, Customer Orders, Customers
© 2009 McGraw-Hill Ryerson Limited

$/Design

Products, Customer Orders, Customers
LO 2

© 2009 McGraw-Hill Ryerson Limited

Unallocated

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Traditional vs ABC

How Costs are Treated Under
Activity–Based Costing

• What are four ways ABC differs from Traditional costing methods?

ABC differs from traditional cost accounting in four ways.

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1. ABC assigns both manufacturing and nonmanufacturing costs to products. What nonmanufacturing costs would you consider part of the product cost?
2. ABC does not assign all manufacturing costs to products. Why?
3. ABC uses more cost pools. How is overhead assigned in a traditional system?
4. ABC bases level of activity on capacity. What does this mean if ‘we’ don’t reach capacity?
© 2009 McGraw-Hill Ryerson Limited

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ABC product costing

How Costs are Treated Under
Activity–Based Costing

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Level of complexity

ABC differs from traditional cost accounting in four ways.

Nonmanufacturing costs Some

All

Traditional product costing

 ABC assigns both types of costs to products.

ABC differs from traditional cost accounting in four ways.

Traditional product costing

Nonmanufacturing costs © 2009 McGraw-Hill Ryerson Limited

How Costs are Treated Under
Activity–Based Costing

Manufacturing costs Manufacturing costs ABC product costing

Activity–Based
Costing
Departmental
Overhead
Rates
Plantwide
Overhead
Rate

Number of cost pools
ABC uses more cost pools.

 ABC does not assign all manufacturing costs to products.
© 2009 McGraw-Hill Ryerson Limited

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© 2009 McGraw-Hill Ryerson Limited

How Costs are Treated Under
Activity–Based Costing

How Costs are Treated Under
Activity–Based Costing

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Activity

An event that causes the consumption of overhead resources. Activity
Cost Pool

A “cost bucket” in which costs related to a particular activity measure are accumulated. ABC differs from traditional cost accounting in four ways.

Traditional Costing

ABC

The predetermined overhead rate is based on budgeted activity.
This results in applying all overhead costs including unused, or idle capacity costs to products. Products are charged for the costs of capacity they use – not for the costs of capacity they don’t use.
Unused capacity costs are treated as period expenses. $$
$
$
$

$

 ABC bases level of activity on capacity.
© 2009 McGraw-Hill Ryerson Limited

© 2009 McGraw-Hill Ryerson Limited

Example: think of a product?
What

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