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I. Appendix 3A: Activity-Based Absorption Costing (Slide
1 is the title slide)
Learning Objective 8: Use activity-based absorption
costing to compute unit product costs.
A. Key definitions/concepts
i. Activity-based absorption costing assigns all
manufacturing overhead costs to products
using activity cost pools instead of plantwide
or departmental cost pools.
1. An activity is an event that causes the
consumption of overhead resources.
2. An activity cost pool is a “bucket” in which
costs are accumulated that relate to a single
activity.
3. An activity measure is an allocation that is
used as the denominator for an activity cost
pool.
4. An activity rate is used to assign costs from
an activity cost pool to products.
ii. Activity-based absorption costing differs from
traditional absorption costing in two ways:
1. The activity based approach uses more cost
pools than a traditional approach.
2. The activity-based approach includes some
batch-level and product-level activities and
activity measures that do not relate to the
volume of units produced, whereas the
traditional approach relies exclusively on
volume-related overhead allocation.
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B. Simmons Industries – a traditional approach
i. Assume the following information for the
company as a whole and for its only two
products—deluxe and standard hedge
trimmers.
ii. If we assume that Simmons’ traditional cost
system relies on one predetermined plantwide
overhead rate with direct labor-hours as the
allocation base, then its plantwide overhead
rate ($4.50 per direct labor-hour) would be
computed as shown.
iii. Simmons’ traditional cost system would report
unit product costs as shown. Notice:
1. The deluxe product line is assigned $9.00 of
overhead cost per unit (2.0 DLH × $4.50 per
hour).
2. The standard product line is assigned $4.50
of overhead cost per unit (1.0 DLH × $4.50
per hour).
C. Simmons Industries – activity-based absorption
costing
i. Assume that Simmons assigned its $1,800,000
of manufacturing overhead costs to three
activities with expected activity levels as
shown.
ii. The activity rates for each of the three
activities would be computed as shown.
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iii. The overhead cost assignments to the deluxe
and standard product lines are computed as
shown. Notice:
1. All manufacturing overhead has been
assigned to products ($1,130,000 +
$670,000 = $1,800,000).
iv. The activity-based unit product costs for both
product lines are computed as shown. Notice:
1. The manufacturing overhead per unit for
both products is computed by taking the
total overhead assigned to that product and
dividing it by the number of units produced.
D. Simmons Industries – comparing the two approaches
i. The difference in unit product costs between
the two methods is as shown. Notice, the
activity-based unit product cost for the deluxe
(standard) product line is higher (lower) than
what was computed using the traditional cost
system. This is because:
1. The activity-based approach contains two
non-volume-related cost pools—“setting
up machines” which is a batch-level activity
and “parts administration” which is a
product-level activity.
2. The activity-based approach assigned these
costs to products in a way that shifted costs
from the high volume product (standard)
to the low volume product (deluxe).
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