ACTIVITY-BASED COSTING

What is Activity-Based Costing?

Recognizes several levels of costs
Accumulates costs into related cost pools
Uses multiple cost drivers to assign costs

When to use Activity-Based Costing?

Product Variety and Process Complexity
Wide variety of products or services
Lack of Commonality in Overhead Costs
High overhead costs are not proportional to
the unit volume of individual products
Problems with Current Cost Allocations
Significant changes in the processes with no
change in cost allocations
Changes in Business Environment
Increase in competition
Change in management strategy

How to use Activity-Based Costing?

Collect costs in general ledger and subsidiary
accounts
Identify activity centers
Considerations on choosing activity centers:
Geographical proximity of equipment
Centers of managerial responsibility
Magnitude of product costs
Manageable number of activity centers
Accumulate costs into activity center cost pools
identify cost drivers
Cost Driver
Used to assign costs to cost pools
Costs in each cost pool are:
Assumptions
Driven by homogenous activities
Strictly proportional to the activity
Allocate costs to products and services
Activity Driver
Used to assign costs to cost objects

Traditional vs. Activity-Based Costing:

When ABC is implemented, costs are:
Reduced for high-volume, standard products
Increased for low-volume, complex products
Product variety number of different types of
products
Product complexity number of processes
through which a product flows

Criticisms of Activity-Based Costing:

Significant amount of time and cost to implement

Must overcome barriers to change

Does not conform to GAAP
TRUE OR FALSE:
____ 01. Activity-based costing is appropriate for a
company manufacturing a single product.
____ 02. Activity-based costing is appropriate for a
company with low overhead costs that are
proportional to the unit volumes of products.
____ 03. There is a direct relationship between the
complexity of a production process and
overhead costs.
____ 04. Activity-based costing conforms to GAAP
with regard to which costs should be
expensed.
____ 05. An activity-based costing system should be
evaluated with regard to the benefits it can
provide an organization versus the costs of
implementing it.
____ 06. Today, traditional accounting methods are
still appropriate for financial reporting.
____ 07. In activity-based costing, the final cost
allocations assign costs to activities.
____ 08. In allocating fixed costs to products in
activity-based costing, a cost driver that is
not volume-related should be used.
____ 09. Costs within an ABC cost pool tend to be
more homogeneous than the costs within a
traditional system's cost pool
____ 10. Compared to an ABC system, a traditional
costing system reports a higher unit cost for
high-volume products and a lower unit cost
for low-volume products
MULTIPLE CHOICE:
____ 1.) Relative to traditional costing, activity-based
costing differs in the way costs are
a. Processed
c. Incurred
b. Allocated
d. Recognized
____ 2.) In activity-based costing, cost reduction
efforts are directed at specific
a. cost categories
c. processes
b. cost pools
d. cost drivers
____ 3.) When a company is labor-intensive, the cost
driver that is probably least significant is
a. Direct labor hours c. Machine hours
b. Direct labor costs d. Material Costs
____ 4.) In activity-based costing, the final cost
allocations assign costs to
a. departments
c. products
b. processes
d. activities
____ 5.) In activity-based costing, the preliminary cost
allocations assign costs to
a. departments
c. products

b.

processes

d.

activities

Overhead cost per unit of Roll: _____ 5.32

PROBLEMS:
SPECTER & ROSS, Attorneys at Law, provide a variety
of legal services. The law firm uses an activity-based
costing system and has developed the following activity
pool cost rates:

OBELISK Manufacturing manufactures several different

products and uses an activity-based costing system.
Information from its system for the year for all products
follows:

Activity Cost Pool

Legal Research
Court Filing Cost
Document Filing

Cost Pool
Assembly
Processing
Inspection

$45
$325
$20

Activity Rate
per hour of paralegal time
per case filed
per document

Cost and activity data related to two clients is as follows:

Number of paralegal hours
Number of cases filed
Number of documents

Marco
38
4
18

Tarma
79
1
40

The amount of overhead that would be allocated to

Marco would be: ______ 3,370
The amount of overhead that would be allocated to
Tarma would be: ______ 4,680

OSIRIS Corporation, manufacturer of variety of products,

uses an activity-based costing system. Information from
its system for the year for all products follows:
Cost Pool
Assembly
Inspection
Packaging

Total Cost
$528,000
$296,625
$45,500

Total Activity
32,000 Machine hours
8,750 Inspection Hours
2,500 Orders

OSIRIS makes 750 of its product Kuriboh a year, which

requires a total of 55 machine hours, 20 inspection hours,
and 18 orders. Kuriboh requires $77.00 in direct materials
per unit and $65.00 in direct labor per unit. Kuriboh sells
for $195 per unit.

Activity Cost Pool Rates:

Assembly: _____ 16.50
Inspection: _____ 33.90
Packaging: _____ 18.20
Total overhead allocated to Kuriboh: _____ 1,913.10
Total product margin of Kuriboh: _____ 37,836.90

BOWLES Inc. uses ABC and produces two products: Pick

and Roll. The expected annual production of Pick and
Roll is 1,500 and 2,200 units respectively. Other relevant
data are as follows:
Activity Cost Pool
Assembling
Testing
Packing

Estimated Cost
$5,548
$25,715
$2,401

Expected Activity
Pick
Roll
630
130
1,200
650
70
175

Total Cost
$153,000
$94,500
$15,600

Total Activity
12,750 Machine hours
5,250 Orders
1,560 Inspection Hours

The annual production and sales of one of its products,

the Sizzler, are 1,500 units. The following data relate to
the current production and sales of Sizzlers
Annual machine hours
Annual number of orders
Annual number of inspections
Direct materials cost per unit
Direct labor cost per unit

700
200
375
$120.00
$72.00

Activity Cost Pool Rates:

Assembly: _____ 12
Processing: _____ 18
Inspection: _____ 10
Average cost of one Sizzler: _____ 202.50

GLOBALPORT Company, which uses an activity-based

costing system, produces travel trailers and boat trailers.
The company allocates batch setup costs to the two
products based on direct labor hours using the following
budgeted data:
Units to be produced
Number of setups
Direct labor hours per unit
Setup Costs = $158,400

Travel
2,250
340
40

Boat
2,900
560
60

Setup costs allocated to Boat trailers: _____ 104,400

Smithson Company produces two products (A and B).

Direct material and labor costs for Product A total $35
(which reflects 4 direct labor hours); direct material and
labor costs for Product B total $22 (which reflects 1.5
direct labor hours). Three overhead functions are needed
for each product. Product A uses 2 hours of Function 1 at
$10 per hour, 1 hour of Function 2 at $7 per hour, and 6
hours of Function 3 at $18 per hour. Product B uses 1, 8,
and 1 hours of Functions 1, 2, and 3, respectively.
Smithson produces 800 units of A and 8,000 units of B
each period. Total overhead is assigned to A and B on the
basis of overhead activity hours used.

Unit product cost of Product B: _____ 111.44