Ch. 17 Activity-Base Costing (ABC)

Product-Level

Performed every time a company produces a new type of product. Ex. Pharmaceutical company can produce and sell a new type of medicine

Batch-Level

Performed every time a company produces another batch of products. Ex. Processing a new batch of ice cream

Unit- Level

Performed for each unit of production. Ex. Assembly of cell phones, amount assembly the company performs increases with each additional cell phone

Activity Cost Pool

Overhead cost attributed to a distinct type of activity (ordering materials or setting up machines). Traditional Cost Systems allocate these costs to departments.

Limitations of ABC

1. Can be expensive to use 2. Some arbitrary allocations continue

4 Steps to calculate unit cost under ABC

1. Identify the activities 2. Identify the cost driver 3. Compute the activity-based overhead rate 4. Assign overhead costs to products

Benefits to ABC

1. Leads to more cost pools 2. Leads to enhanced control over overhead costs 3. Leads to better management decisions

When to use ABC

1. Product lines differ greatly in volume 2. Product lines are numerous and diverse 3. OH constitutes a significant portion of total costs 4. Manu. process has changed significantly 5. Managers are ignoring data provided by the existing system

Activity-Based Overhead Rate

Estimated Overhead per Activity / Expected Use of Cost Drivers per Activity

Value-added Activities

A company's operations that increase the perceived worth of a product or service to customers. Ex. Performing surgery at a hospital or delivering packages by a freight company

Non-value-added Activities

Activities, if eliminated, would not hinder the company's operations. **Add cost to a product without increasing its perceived value** Ex. Eliminating the need to store inventory

To Assign Overhead Cost to each Product

Activity-Based Overhead Rate per Cost Driver X Number of cost drivers expected to be used per product

Cost Driver

Any factor of activity that has a direct cause-effect relationship with the resources consumed. Measures the number of individual activities undertaken to produce products **Products consume activity, and activities consume resources**

Activity- Based Costing (ABC)

Approach for allocating overhead costs. Segregates overhead into various cost pools in an effort to provide more accurate cost information

Facility-Level

Required to support an entire production process. Ex. Hospital building must be insured and heated no matter how many patients the hospital treats