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StratCost Chapter 5

Activity-based costing (ABC) is a costing method that focuses on activities and traces overhead costs to products and services based on cost drivers like labor hours. It has advantages over traditional costing like more accurate product costing. ABC involves identifying activities, cost pools, and cost drivers. It may be time-consuming to implement and data is not always readily available. Activity-based management uses ABC to eliminate non-value added activities and increase profitability. The document provides an illustration of computing product costs under traditional and ABC costing.

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111 views2 pages

StratCost Chapter 5

Activity-based costing (ABC) is a costing method that focuses on activities and traces overhead costs to products and services based on cost drivers like labor hours. It has advantages over traditional costing like more accurate product costing. ABC involves identifying activities, cost pools, and cost drivers. It may be time-consuming to implement and data is not always readily available. Activity-based management uses ABC to eliminate non-value added activities and increase profitability. The document provides an illustration of computing product costs under traditional and ABC costing.

Uploaded by

Elle
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 5 (ACTIVITY BASED COSTING AND SERVICE COST)


▲ Activity-based costing – a cost allocation system that focuses on
activities performed to manufacture a product or service
- It’s purpose is to trace costs to product/services instead of arbitrarily
allocating costs

• Major Components of ABC and their Relationship


■ Activity center/Activity cost pool – a segment of the organization for
which management wants the cost of a set activities to be reported
separately
■ Cost driver – a mechanism used to link a given activity's pool of costs
■ Cost function – created from the activity's cost and the planned cost
driver activity level

• Advantages of ABC
- Provides realistic cause of manufacturing for specific products
- Allocates manufacturing overhead more accurately to products and
processes that use the activity
- Identifies and efficient processes and targets for improvement determines
product profit margins more precisely
- Discovers which processes have unnecessary and wasted cost
- Offers better understanding and justification of costs in manufacturing In this problem, assume that:
overhead - Produced and sold 2,500 units each of all products
- No beginning and ending WIP and FG
• Limitations of ABC Requirement:
- Collection and preparation of data is time consuming 1. Compute for the product cost under traditional costing
- Costs more to accumulate and analyze information 2. Compute for the product cost under ABC
- Source data isn't always readily available from normal accounting reports
- Reports don't always conform to GAAP and can't be used for external 1.
reporting
- Data produced may conflict with managerial performance standards
previously established from traditional costing methods
- May not be as useful for companies were overhead is small in proportion
to total operating cost

▲ Activity based management – focused on the analysis of the entity's 2.


activities that affects the production greatly
- Eliminates activities that are non-value added costs
It recognizes value added activities which increase the worth of a product
or service
• Non-value added activities – activities that can be eliminated without
deterioration of product quality value through reduced production time
and, thus, increases profitability

▲ Steps in Developing ABC Costing System


• Calculate for the overhead rates per activity based on cost drivers
• Allocate overhead based on activity using the rates calculated
• Compute for the total manufacturing costs for each product

ILLUSTRATION

Pagatpat, Aischelle Mhae R.


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Pagatpat, Aischelle Mhae R.

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