Activity-Based

Costing

Chapter
8

Learning Objectives
1. Understand the potential effects of using reported
product costs for decision making.
2. Explain how a two-stage product costing system
works.
3. Compare and contrast plantwide and department
allocation methods.
4. Explain how activity-based costing and a two-stage
product system are related.
5. Compute product costs using activity-based
costing.
6. Compare activity-based product costing to
traditional department product costing methods.
7. Demonstrate the flow of costs through accounts
using activity-based costing.
8. Apply activity-based costing to marketing and
administrative services.

8-2

Product Costs and Decision

1 Understand the potential effects
Making L.O.
of using reported product costs for
decision making.

Remember Sammys Skis and Boards?

Sammy is considering dropping

snowboards.

8-3

Sammys Skis and Boards

Sammys costs without
snowboards.

8-4

Sammys Skis and Boards

Look at overhead

Sammy allocates $18,000 overhead to the

Snowboards.
Only $5,400 of the overhead is avoided if Snowboards
are not produced.

8-5

8-6

Two-Stage
Allocation
L.O. 2. Explain how a two-stage product costing
system works.
Systems
Stage One Allocate overhead costs to
departments.

Allocate department
Stage Two overhead costs to the
products or services.

8-7

Two-Stage Cost Allocation

Continued
Cost Pool

Intermediat
e Cost Pools

Cost
Allocation
Rule

Overhead

Department
A

Direct Labor
Hours

Department B

Machine
Hours

Plantwide versus Department Allocation

Method

8-8

L.O. 3 Compare and contrast plantwide and department allocation

methods.

Plantwide Allocation Method

All overhead costs are recorded in one
cost pool and applied to products using
one overhead allocation rate.
One cost pool for the
factory
One
allocatio
n rate

Products

Factory
Overhea
d Costs

Department Allocation
Overhead costs traced to separate
departments and applied to products using
a department allocation rate.
One cost pool for each department

Assembly
Departmen
t Overhead
Costs

Each
departme
nt has an
allocation
rate

Products

Packaging
Departme
nt
Overhead
Costs

8-9

8-10

Cost Allocation: An Example

Production and Cost
Data
Port Arthur
Manufacturing
Facility
Third
Quarter

8-11

Cost Allocation: An
Production and Cost
Data
Manufacturing
Example Port ArthurFacility
Third
Quarter

8-12

Cost Allocation: An Example

Continued
Plantwide Cost
Allocation
Port Arthur
Manufacturing
Facility
Third
Quarter

Two-Stage Cost Allocation

Continued
Cost Pool

Overhead

Intermediat
e Cost Pools

Assembly

Packaging

Cost
Allocation
Rule

Machine
Hours

Direct
Labor Cost

8-13

8-14

Cost Allocation: An Example

Continued
Department Cost
Port Arthur Manufacturing
Allocation
Third
Facility
Quarter

Choice of Cost Allocation

Method

8-15

Which cost allocation method is appropriate?

Similar products
using same
Plantwide
resources
Allocation
Multiple products
using resources
differently

Department
Allocation

Activity-Based Costing
L.O. 4 Explain how activity-based costing
(ABC)
and a two-stage product system are

8-16

related.

Activity-Based Costing
Costing method that first assigns costs to
activities and then allocate them to
products based on the products
consumption of activities.
Stage One

Assign costs to activities

Stage Two

Allocate costs to products based

on the use of each activity

ABC Continued

Activities
consume
resources
Products
consume
activities

8-17

Developing Activity-Based
Costing
1. Identify the activities that consume
resources and assign costs to them.

2. Identify the cost driver(s) associated with

each activity.
3. Compute a cost rate per cost driver unit
or transaction.
4. Allocate costs to products by multiplying
the cost driver rate by the volume of cost
driver units consumed by the product.

8-18

8-19

Cost Drivers
Factors that cause or drive an activitys
costs.

Identified activity

Identified cost driver

Preparing cafeteria food

Number of students in the

dorm

Taking customer orders

Number of orders

Setting up equipment

Number of set-ups

Purchasing materials

Number of purchase orders

Cost Allocation
Pools
Plantwid
e

One pool

Departmen
t

As many pools
as
departments

ABC

As many pools
as activities and
cost drivers
identified

8-20

8-21

Cost Allocation Pools:

ABC
Cost Flow Diagram: Activity-Based Costing
System

Overhead

Assign costs to
activities

Set-up
Allocate
costs to
products
based on
the use of
each
activity

Setup
hours

Handle
Material

Machine

Production
runs

Products

Machine
hours

Pack &
Ship
Shipments

Cost Hierarchy
Classification of cost drivers into general
levels of activity; volume, batch, product
and so on.

8-22

Cost Hierarchy
Classification of cost drivers into general
levels of activity; volume, batch, product
and so on.

8-23

Cost Hierarchy
Classification of cost drivers into general
levels of activity; volume, batch, product
and so on.

8-24

Cost Hierarchy
Classification of cost drivers into general
levels of activity; volume, batch, product
and so on.

8-25

Cost Hierarchy
Classification of cost drivers into general
levels of activity; volume, batch, product
and so on.

8-26

ABC Example
L.O. 5 Compute product costs using activity-based
costing.
Production and Cost
Data
Port Arthur
Manufacturing
Facility
Third
Quarter

8-27

ABC Example Continued

Step 1 Identify the activities

8-28

ABC Example Continued

Identify the cost drivers and the
Step 2 expected volume of each cost driver.

8-29

ABC Example Continued

Step 3 Compute the Cost Driver Rates
Overhead Cost
Port Arthur
Data Manufacturing
Facility Third
Quarter

8-30

ABC Example Continued

Step
4

Allocate costs to products

8-31

ABC Example Continued

8-32

8-33

Cost Flow Diagram

Direct costs

Cost Flow
Activity-Based
Diagram Costing System
Port Arthur Manufacturing
Facility

Overhead costs

Assembl
y

Assemble

Handle
Material

J3MP

Packaging

Setup

Inspect
& Pack

J5MP

Ship

Product Cost Methods: A

L.O. 6 Compare activity-based product costing to
Comparison
traditional department product costing methods.
Comparison of Reported Unit Product Costs

8-34

Overhead Costs using

L.O. 7 Demonstrate the flow of costs through
ABC accounts using activity-based costing.
Lets see ABC cost flow for the
Assembly Department
Its T Account
time

8-35

8-36

Direct Material Costs

Assembly WIP
DM

Material
Inventory 1,500,00

J3MP

1,500,00

0
2,400,00
0

Assembly WIP
DM

2,400,00

J5MP

8-37

Direct Labor Costs

Assembly WIP

J3MP

1,500,00
0
DL 750,000
DM

Wages Payable
750,000
600,000

Assembly WIP
2,400,00
0
DL 600,000
DM

J5MP

8-38

Overhead Costs
Assembling
180,00
0
900,00
0

Setting up
Machines
36,000
360,00
0

Assembly WIP
1,500,00
0
DL 750,000
OH 240,000

DM

Assembly WIP
2,400,00
0
DL 600,000

DM

Handling Material
24,000
120,00
0

J3MP

OH

1,380,00
0

J5MP

Transfer from Assembly to

Packaging
Assembly WIP
1,500,00
0
DL 750,000
OH 240,000

DM

2,490,00
0

Assembly WIP
2,400,00
0
DL 600,000

DM

1,380,00
0

OH

J3MP

J5MP

4,380,00
0

Packaging WIP

8-39

J3MP

2,490,00
0

Packaging WIP
4,380,00
0

J5MP

ABC in Administration
L.O. 8 Apply activity-based costing to marketing and
administrative services.

The same four-step

process
1. Identify the activities that consume resources.
2. Identify the cost driver associated with each
activity.
3. Compute a cost rate per cost driver for each
unit or transaction.
4. Allocate costs to the marketing or
administration activity by multiplying the cost
driver rate by the volume of cost driver units
consumed by that activity.

8-40

Chapter 8

8-41