2. 2
2
Introduction
Overhead costs have soared to 60
percent or more of total product
costs in heavily automated
manufacturing environments.
As overhead costs increase and
make up a larger portion of the total
costs of products, accuracy in
overhead application has become
much more important.
3. 3
3
Activity-Based Costing
In this chapter we introduce a
different approach to overhead
allocation using Activity-Based
Cost Drivers as opposed to
Volume-Based Cost Drivers
4. 4
4
Categories of Overhead
Costs
Unit-level costs are incurred each
time a unit is produced.
Examples:
Supplies for factory
Depreciation on factory machinery
Energy costs for factory machinery
Repairs and maintenance of factory
machinery
5. 5
5
Categories of Overhead
Costs
Batch-level costs are incurred
each time a batch of goods is
produced.
Examples:
Salaries related to purchasing and
receiving
Salaries related to moving material
Quality control costs
Depreciation of setup equipment
6. 6
6
Categories of Overhead
Costs
Product-level costs are incurred
as needed to support the
production of each different
type of product. Examples:
Salaries of engineers
Depreciation of engineering
equipment
Product development costs (testing)
Quality control costs
7. 7
7
Categories of Overhead
Costs
Facility-level costs simply sustain a
facility’s general manufacturing
process. Examples:
Depreciation or rent of a factory
building
Salary of a plant manager
Insurance, taxes, etc.
Training
8. 8
8
Activities and Cost Drivers:
Unit Level
Activity
•Machining
•Maintenance
of machines
Potential Cost Driver
•Machine hours,
labor hours or
number of units
produced
•Machine hours
9. 9
9
Activities and Cost Drivers:
Product Level
Activity
Product
Testing
Supervision
Potential Cost Driver
Number of change
orders, number of
tests, hours of testing
time
Number of supervision
hours
10. 10
10
Activities and Cost Drivers:
Batch Level
Activity
Purchasing
Receiving
Machine setups
Customer orders
Potential Cost Driver
Number of purchase
orders or number of
parts
Amount of material or
number of receipts
Number of setups
Number of orders,
11. 11
11
Activities and Cost Drivers:
Facility Level
Activity
Plant
Occupancy
Potential Cost Driver
Square footage,
number of employees,
labor hours, machine
hours
12. 12
12
Unit-level costs are incurred each time a
unit is produced. Batch-level costs are
incurred each time a batch of goods is
produced. Product-level costs are incurred
as needed to support the production of
each type of product. Facility-level costs
simply sustain a facility’s general
manufacturing process.
Unit-, Batch-, Product-, and
Facility-Level Costs
Key Concept
13. 13
13
The key feature of an Activity-Based
Costing system is allocating overhead costs
based on activities that drive costs rather
than on the volume or number of units
produced.
Activity-Based Costing
Key Concept
18. 18
18
Stage 2: Identification of
Cost Drivers & Allocation of
Costs
Activity
Inspections
Purchasing
Supervision
Delivery &
setup
Cost Driver
Number of
inspections
Number of purchase
orders
Hours of supervisor
time
Setup time (days)
25. 25
25
ABC Systems in Service
Industries
Although ABC was developed
for use primarily by
manufacturing companies, it
has gained widespread
acceptance in the service
sector.
26. 26
26
ABC Systems in Service
Industries
Problems
Type of work performed in service
industries tends to be non- repetitive
Activities differ for each customer
or service
Services have proportionately more
facility-level costs
27. 27
27
ABC Systems and
Nonmanufacturing Activities
ABC is used to determine the cost
of providing a selling or
administrative service.
Example: The U.S. Post Office used ABC to
help determine the costs and benefits of
allowing customers to pay using debit and
credit cards.
28. 28
28
Benefits of Activity-Based
Costing
Using ABC in the budgeting process
provides more accurate estimates
of resources
Provides more accurate cost
information for day-to-day decision
making
Costs that appeared to be indirect
using volume-based costing systems
are now traced to specific activities
using cost drivers
29. 29
29
Limitations of Activity-Based
Costing
High measurement costs
The higher the potential for cost
distortions, the more likely the
company will benefit from ABC
Distortions result from diverse
products
Diverse products: products that consume
resources in different proportions
30. 30
30
Backflush Costing
Companies using JIT generally have
little or no inventory or finished goods.
All manufacturing costs are flushed directly
into cost of goods sold
If the company has small amounts of
inventory on hand at the end of the period,
manufacturing costs are backflushed into
the appropriate materials inventory, WIP
inventory or finished goods inventory
