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Activity-based Costing (ABC),
Activity-based Management (ABM)
& Activity-based Budgeting (ABB)
Chapter 4
Traditional Costing Approach
Service Department
Cost Allocations
Operating Expense Allocations
•Traditional cost accounting systems
assign operating expenses to products
with a two-stage procedure:
1. Expenses are assigned to production
departments
2. Production department expenses are
assigned to the products
•Departmental structure influences the
first-stage allocation process
Effect Of Departmental Structure
•Departments that have direct responsibility
for converting raw materials into finished
products are called production
departments
•Service departments perform activities
that support production, such as:
•Machine setup
•Production engineering
•Production scheduling
–All service department costs are indirect support
activity costs because they do not arise from direct
production activities
•Machine maintenance
Two-Stage Cost Allocation
Conventional product costing systems assign
indirect costs to jobs or products in two stages
1. In the first stage:
–System identifies indirect costs with various
production and service departments
–Service department costs are then allocated to
production departments
2. The system assigns the accumulated indirect
costs for the production departments to
individual jobs or products based on
predetermined departmental cost driver rates
Two-Stage Cost Allocation(2 of 2)
Allocating Service Department
Costs To Production Departments
•There are three ways that companies
allocate service department costs to
production departments:
–Direct allocation
–Sequential allocation
–Reciprocal allocation
•The last two are used when service
departments consume services provided by
other departments
PATIENTAID EXAMPLE
Step 1 of Stage 1 cost allocations (given)
Direct Allocation Method
•The direct allocation method is a simple
method that allocates the service
department costs directly to the production
departments
–Allocations to production departments are
based on each production department’s
relative use of the applicable cost driver
–Possibility that some of the activities of a
service department may benefit other service
departments as well as production
departments is ignored
Allocation Bases Values
Allocation Ratios
300,000 / 1,200,000 = 0.250
Based on relative allocation basis value
Allocation of
Service Department Costs
