1. MANAGEMENT ACCOUNTING The Activity-Based Costing System based on John G. Burch, Cost and Management Accounting
Materials prepared by
Ph. D. Zofia Krokosz-Krynke
Faculty of Computer Science and Management

2. DEFINITIONS
Activity-based costing (ABC) - collection of financial and nonfinancial data about an entreprise’s activities
Activity analysis - proces of defining and describing activities and corresponding cost drivers
Activity-based management (ABM) - using ABC information to support cost management 2

3. COMPONENTS OF ABC SYSTEMS
Resource categories
First-stage resource drivers
Activities and activity cost pools
Second-stage activity drivers
Cost objects
Direct cost inputs 3

4. Activities and activity costs pools
Activity Analysis
Performance Information for Management
Cost objects
Direct cost inputs
Cost Management
Costing system
Resource categories
Resource drivers
Activity drivers 4

5. Resource categories Material handling & storage resources
Office space and furniture
Equipment (machines, transport, information technology)
Utilities
Salaries & benefits
Buildings
Accounting
Engineering
Insurance, licences, taxes 5

6. Cost objects Products Services Units Batches Contracts Cases Jobs
Projects
Customers
Customer groups
Distribution channels
Sales territories 6

7. Assignment of costs to cost objects
cost object = costs assigned from activity cost pools
cost object = direct materials + costs assigned from activity cost pools
cost object = direct materials + direct labor + costs assigned from activity cost pools
cost object = direct materials + direct labor + direct technology + costs assigned from activity cost pools 7

8. Direct cost inputs Direct materials Direct labor
Direct technology (or equipment) 8

9. Volume-Based Costing System
Overhead costs applied according to:
Direct labor hours (DLhr)
Direct labor dollars
Machine hours (Mhr)
Materials dollars 9

10. How the Costing System Influences Decision Making
a) overhead applied based on direct
b) overhead applied based on activity
cost element
product AX
product BX
direct materials
23,00
38,00
direct labor
7,00
total overhead at 500% of direct labor
35,00
setup driver
10,00
20,00
material handling driver
14,00
26,00
SAMC
65,00
80,00
54,00
91,00
current selling price
68,00
90,00
gross profit (loss) per unit
3,00
-1,00
Note: SAMC means standard absorptive manufacturing cost
Reduce selling price (to enable it to compete better)
Raise the price or … discontinue the product altogether 10

11. ABC is appropriate if: Competition is high.
Product mix is diverse in batch size, physical sizes, degree of complexity, and raw material characteristics.
Product life cycles are short (3 years or less)
Collection and manipulation of data are performed by an integrated computer-based information system (ICBIS). 11

12. Strategic goals of ABC systems
Appropriate pricing decisions based on good cost information.
Appropriate product mix decisions based on good profitability information.
Good cost management by focusing on activities and cost drivers. 12

13. ABC systems development life cycle
Phase one: Plan the system.
Phase two: Analyze and define resource categories.
Phase three: Analyze and define activities.
Phase four: Determine first-stage resource drivers and establish activity cost pools.
Phase five: Determine second-stage activity drivers and assign costs to cost objects. 13

14. Phase one: Plan the system
The ABC Systems Development Life Cycle
start here
Understanding purposes of ABC system:
costing of cost objects
providing information for daily operational management, continous improvement, and business reengineering
The system project team can include :
management accountant
engineering representative
production representative
marketing representative
logistics representative
financial accounting representative
Phase five:
Determine second-stage activity drivers and assign costs to cost objects
Phase one:
Plan the system
Phase four:
Determine first-stage resource drivers and establish activity cost pools
Phase two:
Analyse and define resource categories
Phase three:
Analyze and define activities 14

15. Phase two: Analyze and define resource categories - example.
service resources
salaries $
benefits
insurance
20 000
utilities
40 000
depreciation $
production resources
supervision $
90 000
60 000 $
total budgeted overhead resources $
Budgeted Costs of Service and Production Resources 15

16. Phase three: Analyze and define activities
activity flow diagram
fishbone diagram
aggregation and decomposition processes 16

17. Design of Activities Using The Activity Flow Diagram (flow diagram models the purchasing, inspecting, receiving, accounting, machining, and setting up activities at a firm)
Vendor
Invoice
Payment
Purchase order copy
Purchase order
Receiving report
Purchase materials activity
Account for materials activity
Vendor
Source or destination
Notify
Bill of lading and materials
Purchase request
Inspection report and materials
Receiving report and materials
Inspect materials activity
Store materials activity
Receive materials activity
Materials
Machine materials activity
Products
Finished goods
Activity that transforms inputs to outputs
Materials requisition
Setup requisition
Setup completed
Input and output flows
Shop floor
Setup machine activity 17

18. Phase four: Determine first-stage resource drivers and establish activity cost pools
Amount Assigned to Activity Cost Pools
store materials
CF x $6 $
purchase materials
$ x 10/30
receive materials
$ x 9/30
inspect materials
$ x 5/30
account for materials
$ x 6/30
machine materials
$ x 0,90
setup machine
$ x 0,10
total budgeted costs assigned to activity cost pools $
service
production 18

19. Phase five: Determine second-stage activity drivers and assign costs to cost objects.
Activity-Based Costing Model Showing Activity Cost Pools
Service resources $
Production resources $
First-stage resource drivers 9
employees
cubic feet 10
employees
90%
10% 5
employees 6
employees
Purchase materials $
Receive materials $
Inspect materials $
Store materials $
Account
for materials $
Machine materials $
Setup machine $
Number of receiving reports
Number of purchase orders
Number of inspections
Number of parts stored
Number of payments
Number of machine hours
Number of setups
Products A and B
Second-stage activity drivers
Direct materials
Direct labor 19

20. Phase five: Determine second-stage activity drivers and assign costs to cost objects.
Activity-Based Costing Model Showing
Activity Cost Pools Included in Activity Centers
Service resources $
Production resources $
First-stage resouce drivers 9
employees
cubic feet 10
employees 5
employees 6
employees
90%
10%
Materials handling
Accounting
Production
Purchase materials $
Receive materials $
Inspect materials $
Store materials $
Account
for materials $
Machine materials $
Setup machine $
Number of receiving reports
Number of purchase orders
Number of inspectio ns
Number of parts stored
Number of payments
Number of machine hours
Number of setups
Products A and B
Second-stage activity drivers
Direct materials
Direct labor 20

21. Costing Cost Objects
The project team created an activity cost pool for each activity and selected an activity drivers for each activity cost pool. The activity driver is used to apply the costs of the activity cost pool to each product according to the amount of activity costs consumed. The costs consumed are assigned to the costs object through a bill of activities.
The cost per unit for direct materials is determined from the bill of materials. The amount of direct materials used comes from materials requisitions.
Calculate the cost per unit of products A and B under four different costing systems:
Activity-based costing
Activity-based costing system using three direct cost elements:direct materials, direct labor, and direct technology
Traditional volume-based costing system using a plantwide predetermined overhead rate (POR) based on direct labor hours
Treaditional volume-based costing system using two predetermined overhead rates (PORs) based on materials dollars and machine hours. 21

22. Bill of Activities for Product-Driven Activities
Bill of Activities , Products A and B
For the Period Ended December 31, 200X
Product A
Product B
50 000
units
Activity Cost Pool
Second-Stage Activity
Driver Rate
Activity Driver Quantity
Activity Cost
Unit Cost
Purchase Materials
$60
per purchase order
4 000 $
$4,80
1 000
$60 000
$0,60
Receive materials
$90
per receipt
2 500
4,50
500
45 000
0,45
Inspect materials
$50
per inspection
2,50
25 000
0,25
Store materials
$20
per part stored
20 000
8,00
10 000
2,00
Account for materials
$72
per payment
1 500
2,16
72 000
0,72
Machine materials
$996
per machine hour
19,92
2 000
Setup machine
$3 320
per setup 90
5,98 10
33 200
0,33
Total activity costs assigned to products $ $
Activity costs per unit
47,86
24,27
Direct material costs per unit
60,00
50,00
Direct labor costs per unit
24,00
Total costs per unit
$131,86
$98,27 22

23. Bill Of Materials (BOM)
Direct cost inputs
Bill Of Materials (BOM)
Product A
Total cost = $60 per unit A1
2 parts x $15 = $30 A2
4 parts x $5 = $20 A3
1 part x $10 = $10
A1.1
3 components x $3 = $9
A1.2
2 components x $3 = $6
A3.1
1 component x $5 = $5
A3.2
1component x $3 = $3
A3.3
1 component x $2 = $2
Product B
Total cost = $ 50 per unit B1
1 part x $30 = $30 B2
1 part x $20 = $20 23

24. Activity-based costing
Product A
Product B
Direct materials
60,00
50,00
Direct labor ($12 x 2 DLhr)
24,00
Activity costs
47,86
24,27
Total costs per unit
$131,86
$98,27
Activity-based costing with direct technology as a cost element
Product A
Product B
Direct materials
60,00
50,00
Direct labor ($12 x 2 DLhr)
24,00
Direct technology
19,92
Activity costs
27,94
4,35
Total costs per unit
$131,86
$98,27
Machine (Direct technology):
A: $ x 1/3 = $ / units = $19,92 per unit
B: $ x 2/3 = $ / units = $19,92 per unit
Activities without the machine materials activity
Product A Product B
Purchase Materials
Receive materials
Inspect materials
Store materials
Account for materials
Setup machine
Total activity costs
A: $ / units = $27,94 per unit
B: $ / units = $4,35 per unit 24

25. Traditional volume-based costing using a plantwide predetermined overhead rate based on direct labor hours
Product A
Product B
Direct materials
60,00
50,00
Direct labor ($12 x 2 DLhr)
24,00
A: Overhead ($80,33 x DLhr)/ units
32,13
B: Overhead ($80,33 x DLhr)/ units
Total costs per unit
$116,13
$106,13
Calculation of plantwide predetermined overhead rate based on direct labor hours :
A: Direct labor budgeted
B: Direct labor budgeted
Total direct labor hours budgeted
Total resouces :
Service resources $
Production resources
Total resources budgeted $
$ / DLhr = $ 80,33 per DLhr 25

26. Traditional volume-based costing using two predetermined overhead rates based on direct materials dollars and machine hours
Product A
Product B
Direct materials
60,00
50,00
Direct labor ($12 x 2 DLhr)
24,00
A: OH based on materials dollars ($ / units)
11,25
B: OH based on materials dollars ($ / units)
9,38
A: OH based on machine hours ($ / units)
22,13
B: OH based on machine hours ($ / units)
Total costs per unit
$117,38
$105,51
Predetermined overhead rate based on direct materials dollars :
Service resouces:
A: ($60 x units) = $ (3/8)
B: ($50 x units) = (5/8)
Total direct materials = $ (8/8)
A: $ x 3/8 = $ / units = $ 11,25 per unit
B: $ x 5/8 = $ / units = $ 9,38 per unit
Predetermined overhead rate based on machine hours :
Production resources:
A: Machine hours budgeted (1/3)
B: Machine hours budgeted (2/3)
Total machine hours budgeted (3/3)
A: $ x 1/3 = $ / units = $ 22,13 per unit
B: $ x 2/3 = $ / units = $ 22,13 per unit 26

27. 4 (traditional DM$ and Mhrs)
Results comparison
Method
Product A
Product B
1(ABC – 2 direct)
$ 131,86
$ 98,27
2 (ABC – 3 direct)
3 (traditional DLhrs)
$ 116,13
$ 106,13
4 (traditional DM$ and Mhrs)
$ 117,38
$ 105,51 27

28. the end
the end