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Appendix C - Activity-Based Costing
APPENDIX C
ACTIVITY-BASED COSTING
Related Assignment Materials
Student Learning Objectives Discussion
Questions
Quick
Studies*
Exercises* Problems* Beyond the
Numbers
Conceptual objectives:
C1. Explain cost flows for activity
based costing
1,3,4
Analytical objectives:
A1. Identify and assess advantages and
disadvantages of activity-based
costing
7,10,11 C-1, C-7 C-2, C-3,
Procedural objectives:
P1. Assign overhead costs using the
plantwide overhead rate method
2 C-2 C-1, C-3 C-1, C-2
P2. Assign overhead costs using
activity-based costing
5,6,8,9 C-3, C-4,
C-5, C-6
C-2, C-3,
C-4, C-5
C-1, C-2,
*See additional information on next page that pertains to these quick studies, exercises and
problems.
C-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Appendix C - Activity-Based Costing
Additional Information on Related Assignment Material
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used
in practice, homework, or exam mode.
Corresponding problems in set B also relate to learning objectives identified in grid on previous page.
The Serial Problem for Success Systems continues throughout many chapters of the text and can be
completed with Sage 50 Software.
Chapter Revision
Revised discussion of advantages and disadvantages of ABC
C-2
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Appendix C - Activity-Based Costing
Chapter Outline
I. Overhead Cost Allocation Methods
A. Plantwide Overhead Rate Method
1. Uses one overhead rate to allocate overhead costs to products.
2. The target of the cost assignment, or cost object, is the unit of
product.
3. The rate is determined using volume related measure, such as
direct labor hours, machine hours, or direct labor cost dollars
4. Applying the Plantwide Overhead Rate Method:
a. Total budgeted overhead costs are combined into one cost
pool
b. The cost pool is divided by the selected allocation base
(direct labor hours, machine hours, direct labor cost dollars)
to arrive at a single plantwide overhead rate
c. The rate is then applied to assign costs to all products based
on the allocation base such as direct labor hours or machine
hours required to manufacture each product.
B. Activity-Based Costing
1. Attempts to better allocate costs to proper users of overhead
activities by focusing on activities.
2. Costs are traced to individual activities and then allocated to cost
objects
3. Exhibit C.4 shows the two stage activity-based cost allocation
method
4. First Stage
a. Identify activities involved in processing the product or
service and then form activity cost pools by combining
activities into homogenous groups called cost pools.
b. A homogenous cost pools consists of activities that belong
to the same process and/or are caused by the same cost
driver
c. A cost driver (activity cost driver) is a factor that causes the
cost of an activity to go up or go down.
d. An activity cost pool is a temporary account used to
accumulate the costs a company incurs to support an
identified set of activities. It is handled like a factory
overhead account.
5. Second stage
a. Compute predetermined overhead cost allocation rates for
each cost pool
b. Allocate costs to cost objects based on cost drivers
(allocation bases)
c. Cost objectsusers of the activity (such as jobs or products).
Notes
C-3
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McGraw-Hill Education.
Appendix C - Activity-Based Costing
C. Advantages and Disadvantages of Activity Based Costing
1. Traditional cost systems:
a. Capture overhead costs by individual department (or
function) in one or more overhead accounts.
b. Assign overhead costs using a single allocation base such as
direct labor or multiple allocation bases.
c. Allocation bases are often not closely related to the actual
way costs are incurred.
2. Activity-based cost systems:
a. Capture costs by individual activity. Activities and their
costs are accumulated into activity cost pools.
b. Select a cost driver (allocation base) for each activity pool;
use this cost driver to assign accumulated activity costs to
cost objects (such as jobs or products) benefiting from the
activity.
c. Generally ABC uses more allocation bases than a traditional
plantwide system
d. Especially effective when the same department or
departments produce many different kinds of products;
complex products are assigned greater portion of overhead.
e. Encourages managers to focus on activities as well as the
use of those activities.
f. Requires managers to look at each item and encourages
them to manage each cost to increase the benefit from each
dollar spent.
g. Encourages managers to cooperate because it shows how
their efforts are interrelated—results in activity-based
management.
h. ABC requires more effort to implement than a traditional
cost system. It doesn’t always conform to GAAP so it can’t
readily be used for external reporting.
i. The cost sometimes outweighs its value.
C-4
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McGraw-Hill Education.
Appendix C - Activity-Based Costing
DEMO PROBLEM
Plata Company manufacturers 2 printer models: Deluxe and Cheapie. A single
plantwide cost driver (150% of direct labor cost) is used to apply the $24,000 of
overhead costs to the products. The following information is available:
Deluxe Cheapie
quantity to be produced 100 1,000
Selling price per unit $ 300 $ 100
Direct Materials cost per unit 100 40
Direct Labor cost per unit 20 14
1. Using the plantwide overhead rate method, compute the cost per unit, the
gross profit per unit and gross profit rate per unit.
The company decided to apply the activity based costing (ABC) method to see if they
can get a be2er allocation of overhead costs. The following data was collected:
activity Name activity Cost Driver Deluxe Cheapie Total
Setups $ 4,000 Setup hours 600 200 800
Machining 20,000 Machine hours 2,000 3,000 5,000
Total overhead costs $ 24,000
2. Using the activity Based costing (ABC) method:
a. Compute the activity rate for each of the identified ac)vi)es
b. Compute the amount of overhead assigned to the Deluxe and Cheapie
printers
c. Compute the cost per unit, the gross profit per unit and gross profit rate
per unit.
C-5
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McGraw-Hill Education.
Appendix C - Activity-Based Costing
SOLUTION
1. Using the plantwide overhead rate method, compute the cost per unit, the gross
profit per unit and gross profit rate per unit.
Deluxe Cheapie
Sales per unit $ 300 $ 100
direct materials per unit $ 100 $ 40
direct labor per unit 20 14
overhead per unit (150% X DL cost) 30 21
cost per unit 150 75
gross profit ($) per unit $ 150 $ 25
Gross profit rate (%) (Gross Pro0t/Sales) 50.0% 25.0%
2. Using the activity Based costing (ABC) method:
a. Compute the activity rate for each of the identified ac)vi)es
Ac)vi)es activity Costs Driver quantity Rate __________
Setups $4,000 / 800 setup hours = $5 per setup hour
Machining $20,000 / 5,000 machine hours = $4 per machine hour
b. Compute the amount of overhead assigned to the Deluxe and Cheapie
printers
Ac)vi)es Deluxe
Rate x Act. activity Cost
Setups $5 per setup hr. x 600 setup hrs. $3,000
Machining $4 per machine hr. x 2,000 machine hrs. 8,000
Total costs allocated $11,000
Overhead Cost per Unit ($11,000 / 100 units) $110
Ac)vi)es Cheapie
Rate x Act. activity Cost
Setups $5 per setup hr. x 200 setup hrs. $ 1,000
Machining $4 per machine hr. x 3,000 machine hrs. 12,000
Total costs allocated $13,000
Overhead Cost per Unit ($13,000 / 1,000 units) $13
C-6
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McGraw-Hill Education.
Appendix C - Activity-Based Costing
c. Compute the Unit cost, the gross profit per unit and gross profit %
per unit
Deluxe Cheapie
Sales per unit $ 300 $ 100
direct materials per unit
$
100
$
40
direct labor per unit 20 14
overhead per unit (150% X DL cost) 110 13
cost per unit 230 67
gross profit ($) per unit $ 70 $ 33
Gross profit rate (%) (Gross Pro0t/Sales) 23.3% 33.0%
C-7
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McGraw-Hill Education.
