1. Activity Based Costing
EMBA Session
November 17, 2016
Activity Based Costing

2. Overview of Lecture Review of cost behaviors
Rationale for ABC approach
Factors supporting an ABC system
Cost flows
Steps in implementation
Examples
Level of acceptance of ABC costing

3. Types of Costs
Fixed costs
Variable costs
Mixed costs

4. Relating Costs to Objectives
Traceable costs
Direct labor
Direct material
Allocated costs
Fixed overhead
Variable overhead

5. Traditional Allocation Method
Purchasing
Product A
Warehousing
Engineering
Direct Labor Hours
Product B
Maintenance

6. Rational for ABC Approach
Single allocation rate not sufficient
Currently many firms must target price their products
ABC assists in target pricing
Advent of high speed computing power made ABC feasible

7. Environmental Factors Supporting ABC Approach
High levels of competition
Very diverse product mix
Low cost of measurement for additional data required

8. ABC Cost Flow Schematic
Purchasing
Purchase Orders
Warehouse
Product A
Number of Receipts
Product B
Engineering
Maintenance
Number of Hours
Number of Hours

9. Implementation Steps Identify the cost objectives
Identify the direct costs of the products
Identify the overhead cost pools
Select the appropriate drivers
Test the assumptions
Install

10. Example of Product Costing
Raw Materials Department
$1,000,000
Raw Material
$150,000
15,000 Receipts
Purchased Parts
$600,000
1,000 Receipts
Material Movements
250,000
250 Setups
Product A
Product B
Product C
Product D

11. Allocation Using Single Driver
$1,000,000  16,000 Receipts = $62.50 per receipt
No. of
Product Receipts Rate Allocated Cost
A 4,040 $ $252,500
B 6,200 $ ,500
C 2,000 $ ,000
D 3,750 $ ,000
16,000 $1,000,000

12. Calculation of Multiple Rates
No. of Per
Cost Pool Pool Dollars Drivers Driver Driver
Raw Material $ 150,000 15,000 $10 Per Receipt
Purchased Parts 600,000 1,000 $600 Per Receipt
Material Handling , $1,000 Per Setup
$1,000,000

13. Use of Activities by Products

14. Allocation to Products

15. Comparison of Two Methods
Product Traditional ABC Method Variance
A $ 252,500 $ 114,000 $ 138,500 Over
B 387, , ,500 Over
C 125, , ,000 Under
D , , ,000 Under
Totals $1,000,000 $1,000,000 $

16. Retail Example of ABC Costing

17. Traditional Allocation

18. Identify Cost Pools and Drivers
No. of Cost per
Activity Driver Cost Pool Drivers Driver
Ordering # of P.O. $5, $100
Delivery # of Del. $8, $ 80
Stocking # of L.H. $5, $ 20
Cust. Sup. # of Items $10,240 51,
Bottle Return $400
Total $30,000

19. New Cost Drivers

20. Results Applying ABC

21. Acceptance of ABC Costing
Approximately 60% of manufacturing firms in the US have tried ABC
10%-20% finally kept it in place
Reasons for rejection:
Cost of gathering information
Complexity outweighs usefulness
Disagreement on proper drivers

22. Copyright by Frank Ilett, 2016