Activity-Based Costing
Chapter 4
Activity-Based Costing
4-1
4-2
Traditional Costing and Activity-Based Costing
Traditional Costing Systems
Allocates overhead using a single predetermined rate.
►
Job order costing: direct labor cost may be the relevant activity base.
►
Process costing: machine hours may be the relevant activity base.
Assumption was satisfactory when direct labor was a major portion of total manufacturing costs.
►
Wide acceptance of a high correlation between direct labor and overhead costs.
4-3
LO1 Recognize the difference between traditional costing and activity-based costing.
Traditional Costing and Activity-Based Costing
The Need for a New Approach
Tremendous change in manufacturing and service industries.
Decrease in amount of direct labor usage.
Significant increase in total overhead costs.
Inappropriate to use plant-wide predetermined overhead rates when a lack of correlation exists.
Complex manufacturing processes may require multiple allocation bases; this approach is called
Activity-Based Costing (ABC).
4-4
Illustration 4-1
Traditional one-stage costing system
Traditional Costing and Activity-Based Costing
Activity-Based Costing
Allocates overhead to multiple activity cost pools and
Assigns the activity cost pools to products or services by means of cost drivers.
4-5
Traditional Costing and Activity-Based Costing
Activity-Based Costing
Activity: any event, action, transaction, or work sequence that causes a cost to be incurred in producing a product or providing a service.
Activity Cost Pool: a distinct type of activity. For example: ordering materials or setting up machines.
Cost Drivers: any factors or activities that have a direct cause-effect relationship with the resources consumed.
4-6
LO1 Recognize the difference between traditional costing and activity-based costing.
Traditional
Activity-Based Costing
4-1
4-2
Traditional Costing and Activity-Based Costing
Traditional Costing Systems
Allocates overhead using a single predetermined rate.
►
Job order costing: direct labor cost may be the relevant activity base.
►
Process costing: machine hours may be the relevant activity base.
Assumption was satisfactory when direct labor was a major portion of total manufacturing costs.
►
Wide acceptance of a high correlation between direct labor and overhead costs.
4-3
LO1 Recognize the difference between traditional costing and activity-based costing.
Traditional Costing and Activity-Based Costing
The Need for a New Approach
Tremendous change in manufacturing and service industries.
Decrease in amount of direct labor usage.
Significant increase in total overhead costs.
Inappropriate to use plant-wide predetermined overhead rates when a lack of correlation exists.
Complex manufacturing processes may require multiple allocation bases; this approach is called
Activity-Based Costing (ABC).
4-4
Illustration 4-1
Traditional one-stage costing system
Traditional Costing and Activity-Based Costing
Activity-Based Costing
Allocates overhead to multiple activity cost pools and
Assigns the activity cost pools to products or services by means of cost drivers.
4-5
Traditional Costing and Activity-Based Costing
Activity-Based Costing
Activity: any event, action, transaction, or work sequence that causes a cost to be incurred in producing a product or providing a service.
Activity Cost Pool: a distinct type of activity. For example: ordering materials or setting up machines.
Cost Drivers: any factors or activities that have a direct cause-effect relationship with the resources consumed.
4-6
LO1 Recognize the difference between traditional costing and activity-based costing.
Traditional