1. Activity Based Costing (ABC)

2. Traditional Cost Accounting (TCA)
2 products: A & B
Product A:
1 hour of direct labor
Direct labor cost = $20/hr * 1 hr = $20
Demand: 100
Product B:
2 hours of direct labor
Direct labor cost = $20/hr * 2 hrs = $40
Demand: 950

3. TCA Total overhead: $100,000 Total direct labor: 2,000 hrs
Unit overhead: $100,000/2,000 hrs = $50/hr
Product A: 1 hr of direct labor
Product B: 2 hrs of direct labor
TCA overhead allocation:
Product A: $50/unit
Product B: $100/unit

4. When to use ABC Overhead is high
Products are diverse: complexity, volume, amount of direct labor
Cost of errors are high
Competition is stiff

5. ABC Basic Premise Cost objects consume activities
Activities consume resources
The consumption of resources is what drives costs

6. ABC Steps Identify activities Determine cost for each activity
Determine cost drivers
Collect activity data
Calculate product cost

7. ABC Illustration 1. Identify activities Set-up Machining Receiving
Packing
Engineering

8. ABC Illustration 2. Determine activity cost Set-up $10,000
Machining $40,000
Receiving $10,000
Packing $10,000
Engineering $30,000

9. ABC Illustration 3. Determine cost drivers Set-up Number of Setups
Machining Machining Hours
Receiving Number of Receipts
Packing Number of Deliveries
Engineering Engineering Hours

10. ABC Illustration 4. Activity Data Activity Cost A $ B Set-up $10,000 1
$2,500 3
$7,500
Machining
$40,000
100
$2,000
1900
$38,000
Receiving
Packing
Engineering
$30,000
500
$15,000
$100,000
$24,500
$75,500

11. ABC Illustration Overhead for product A: Overhead for product B:
5. Product cost calculation
Overhead for product A:
$24,500/100 = $245
Overhead for product B:
$75,500/950 = $79.47

12. Product Cost: TCA vs. ABC
Product A
TCA
ABC
Direct labor
$20.00
Overhead
$50.00
$245.00
$70.00
$265.00
Product B
$40.00
$100.00
$79.47
$140.00
$119.47