6.3 Calculate Activity-Based Product Costs
4 min read•june 18, 2024
(ABC) revolutionizes by linking costs to specific activities. Unlike traditional methods, ABC provides a more accurate picture of product costs by recognizing that different products consume varying amounts of overhead resources.
ABC involves identifying , assigning costs to those activities, and then allocating them to products based on consumption. This method helps managers make better decisions on pricing, product mix, and cost reduction by providing more precise cost information.
Activity-Based Costing (ABC)
Principles of activity-based costing
Top images from around the web for Principles of activity-based costing
Accounting Information | Boundless Business View original
Is this image relevant?
Kostenoptimalisatie en architectuur? – Organisatieontwerp.nl View original
Is this image relevant?
Costeo Basado en Actividades - ABC View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
Kostenoptimalisatie en architectuur? – Organisatieontwerp.nl View original
Is this image relevant?
1 of 3
Top images from around the web for Principles of activity-based costing
Accounting Information | Boundless Business View original
Is this image relevant?
Kostenoptimalisatie en architectuur? – Organisatieontwerp.nl View original
Is this image relevant?
Costeo Basado en Actividades - ABC View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
Kostenoptimalisatie en architectuur? – Organisatieontwerp.nl View original
Is this image relevant?
1 of 3
- ABC assigns to products based on the activities that drive those costs
- Identifies resource-consuming activities and assigns costs to those activities
- Allocates activity costs to products based on each product's consumption of those activities (, )
- methods allocate overhead costs based on a single cost driver (, )
- May lead to inaccurate product costs when overhead costs are not proportional to the chosen cost driver
- ABC recognizes that different products consume different amounts of overhead resources
- Provides a more accurate representation of the true cost of producing each product (customized vs. standard)
- Steps in ABC:
- Identify activities that consume resources (machine setups, )
- Assign costs to activities based on
- Identify for each activity (number of setups, number of inspections)
- Calculate based on the total cost of each activity and the total quantity of the cost driver
- Assign activity costs to products based on each product's consumption of the cost driver
- is crucial for identifying and understanding the activities that drive costs in an organization
Calculation of overhead rates
- In ABC, overhead costs are grouped into based on the activities that drive those costs
- Each cost pool is associated with a specific activity cost driver (machine hours, number of purchase orders)
- are calculated for each cost pool using the estimated total cost of the activity and the estimated total quantity of the cost driver
- Predetermined overhead rate =
- Example cost pools and :
- (cost pool) driven by the number of setups (cost driver)
- (cost pool) driven by the number of material moves (cost driver)
- (cost pool) driven by the number of inspections (cost driver)
- Calculating predetermined :
- Machine setup cost pool: 100 per setup
- Material handling cost pool: 20 per move
- Quality inspection cost pool: 20 per inspection
- Overhead allocation is a key component of ABC, ensuring costs are distributed accurately to products based on their resource consumption
Application of ABC vs traditional methods
- Once predetermined overhead rates are calculated for each cost pool, they are applied to products based on each product's consumption of the activity cost driver
- The overhead cost assigned to a product for a specific activity is calculated by multiplying the predetermined overhead rate by the quantity of the cost driver consumed by the product
- Overhead cost assigned = Predetermined overhead rate × Quantity of cost driver consumed
- Total overhead cost assigned to a product is the sum of the overhead costs assigned from each cost pool
- Example application of ABC overhead rates:
- Product A consumes 100 setups, 500 material moves, and 800 inspections
- Machine setup cost assigned to Product A: 10,000
- Material handling cost assigned to Product A: 10,000
- Quality inspection cost assigned to Product A: 16,000
- Total overhead cost assigned to Product A: 10,000 + 36,000
- ABC provides more accurate product costs compared to traditional allocation methods
- Assigns overhead costs based on the activities that drive those costs (machine setups, quality inspections)
- Recognizes that products consume different amounts of overhead resources (low-volume vs. high-volume products)
- Helps managers make better pricing, product mix, and cost reduction decisions based on more accurate cost information
Cost Accounting and Product Costing
- is a broader field that encompasses various methods for determining the cost of products, services, and activities
- is a specific aspect of cost accounting that focuses on assigning costs to individual products
- ABC is a product costing method that aims to provide more accurate cost information by considering the activities and resources consumed in the production process
- is a key concept in both traditional and ABC methods, involving the distribution of indirect costs to cost objects (e.g., products, services)
Key Terms to Review (34)
ABC (Activity-Based Costing): ABC is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to the products and services. It is used to accurately determine the cost of a product or service by tracing overhead costs to the activities that drive those costs, rather than simply allocating them based on a single volume-based driver like direct labor hours or machine hours.
Activity analysis: Activity analysis is a method used to identify and evaluate the various activities that a business performs, along with their associated costs. This approach helps organizations understand how resources are utilized, which activities drive costs, and how to optimize operations. By focusing on activities and their cost drivers, businesses can better allocate resources, enhance efficiency, and calculate more accurate product costs.
Activity Cost Drivers: Activity cost drivers are the factors that determine the consumption of resources by a particular activity within a business. They are the primary causes of costs associated with an activity and are used in activity-based costing (ABC) to accurately assign indirect costs to products or services.
Activity Rates: Activity rates refer to the measures used to quantify the level of activity or consumption of cost drivers within a cost accounting system. These rates are crucial in the context of calculating activity-based product costs, as they help allocate overhead costs more accurately to individual products or services based on their actual resource consumption.
Activity-based costing: Activity-Based Costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. It identifies specific activities within an organization and assigns the cost of each activity to all products and services according to the actual consumption by each.
Activity-Based Costing: Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to the various products and services according to the actual consumption by each. It is a more accurate way of allocating overhead costs compared to traditional volume-based costing methods.
Batch-level cost: Batch-level costs are expenses associated with producing a batch of products rather than individual units. These costs remain constant regardless of the size of the batch produced.
Cost Accounting: Cost accounting is a branch of managerial accounting that focuses on the identification, measurement, analysis, and reporting of an organization's costs. It provides valuable information to managers for decision-making, planning, and control of an organization's operations.
Cost Allocation: Cost allocation is the process of assigning indirect or overhead costs to specific cost objects, such as products, services, or departments, based on a rational and systematic method. It is a crucial concept in managerial accounting that helps organizations accurately determine the true cost of their operations and make informed decisions.
Cost Drivers: Cost drivers are the factors that directly influence the incurrence of costs within an organization. They are the underlying causes that determine the level of resources consumed and the resulting costs associated with business activities or operations. Cost drivers play a crucial role in various managerial accounting concepts, including the estimation of variable and fixed costs, the application of job order and process costing methods, the calculation of activity-based product costs, and the analysis of overhead variances.
Cost per unit: Cost per unit is the total expenditure incurred to produce, store, and sell one unit of a product. It plays a crucial role in pricing decisions and profitability analysis in managerial accounting.
Cost Pools: Cost pools are groups of indirect costs that are accumulated and then allocated to cost objects, such as products, services, or departments, based on a common cost driver. They are an essential component in various costing methods, including job order costing and activity-based costing, as they help to accurately assign overhead costs to the appropriate cost objects.
Direct Labor Hours: Direct labor hours refer to the total number of hours worked by employees directly involved in the production of a specific product or service. This metric is crucial in job order cost systems, traditional overhead allocation methods, cost driver identification, and activity-based costing, as it serves as a key input for various cost accounting calculations and analyses.
Factory-level cost: Factory-level costs are overhead expenses that support the entire production process and cannot be traced directly to individual products. These costs generally include maintenance, utilities, and factory management salaries.
Full-cost accounting: Full-cost accounting (FCA) is an approach to accounting that takes into account all direct and indirect costs associated with a product or activity, including environmental and social costs. It aims to provide a more comprehensive view of the true cost of business operations.
Machine Hours: Machine hours refer to the total number of hours that a production machine is in operation during a specific period. This metric is crucial in various managerial accounting contexts, as it helps understand and analyze the relationship between machine usage, costs, and production efficiency.
Machine Setup Costs: Machine setup costs refer to the expenses incurred when preparing a production machine or equipment for a new manufacturing process or product. These costs are associated with the time and resources required to adjust, calibrate, and ready the machine for a different task or output.
Machine Setups: Machine setups refer to the process of preparing and configuring a production machine or equipment to perform a specific task or produce a particular product. This term is particularly relevant in the context of activity-based costing, where machine setups are considered an important cost driver that can significantly impact product costs.
Manufacturing overhead costs: Manufacturing overhead costs are indirect costs associated with the production process but not directly traceable to a specific product. They include expenses like utilities, depreciation, and factory supplies.
Material Handling: Material handling refers to the movement, protection, storage, and control of materials and products throughout the manufacturing, distribution, consumption, and disposal processes. It is a critical component in both cost drivers and activity-based costing within an organization.
Material Handling Costs: Material handling costs refer to the expenses associated with the movement, storage, and management of raw materials, work-in-process, and finished goods within a manufacturing or distribution facility. These costs are an important consideration in the calculation of activity-based product costs, as they can significantly impact the overall cost of production.
Overhead Allocation: Overhead allocation is the process of assigning indirect costs, or overhead, to the products or services produced by a business. It is a critical component in determining the full cost of a product or service and is essential for both activity-based costing and the analysis of overhead variances.
Overhead Costs: Overhead costs are indirect expenses incurred by a business that cannot be directly attributed to the production of a specific product or service. These costs support the overall operations of the organization but are not directly related to the manufacturing or delivery of a particular item. Overhead costs are an important consideration in various cost accounting topics, including traditional cost allocation methods, cost driver identification, and activity-based costing systems.
Overhead Rates: Overhead rates are the predetermined cost rates used to allocate indirect costs, such as rent, utilities, and administrative expenses, to individual products or services. These rates are an essential component in the calculation of activity-based product costs, which aims to more accurately capture the true cost of producing a specific item or providing a particular service.
Predetermined overhead allocation rate: A predetermined overhead allocation rate is a method used to assign indirect costs to products based on a consistent formula. It is calculated before the period begins and involves estimating total overhead costs and selecting an allocation base.
Predetermined Overhead Rates: Predetermined overhead rates are a method used in cost accounting to allocate overhead costs to products or services. They are calculated by estimating the total overhead costs for a given period and then dividing them by an activity measure, such as direct labor hours or machine hours, to determine a rate that can be applied to each unit of production.
Product Costing: Product costing is the process of determining the total cost associated with producing a specific product or service. It involves identifying and allocating all the relevant costs, including direct materials, direct labor, and overhead expenses, to the individual products or services. Product costing is a fundamental concept in managerial accounting, as it provides essential information for decision-making, pricing, and performance evaluation.
Product-level cost: Product-level costs are expenses associated with activities performed to support a particular product line, regardless of the number of units produced. These costs include design, research and development, and marketing specific to that product.
Quality Inspection Costs: Quality inspection costs refer to the expenses incurred by a company to ensure that its products or services meet specified quality standards. These costs are a critical component in the calculation of activity-based product costs, as they represent the resources devoted to verifying the quality of the outputs produced during the manufacturing process.
Quality Inspections: Quality inspections are a crucial component of activity-based product costing, ensuring the accuracy and reliability of cost information. They involve the systematic examination and evaluation of products or processes to verify that they meet predetermined standards and specifications, enabling informed decision-making about resource allocation and pricing strategies.
Resource Consumption: Resource consumption refers to the utilization and depletion of various resources, both tangible and intangible, required for the production of goods and services. It is a fundamental concept in understanding the efficiency and cost structures of an organization's operations.
Resource-Consuming Activities: Resource-consuming activities refer to the specific actions or processes within a business that consume or utilize organizational resources, such as labor, materials, and equipment, in the production of goods or provision of services. These activities are a crucial component of activity-based costing (ABC), as they form the basis for accurately allocating indirect costs to individual products or services.
Traditional Costing: Traditional costing is an approach to cost accounting that allocates overhead costs to products based on a single volume-based cost driver, such as direct labor hours or machine hours. This method is in contrast to activity-based costing, which utilizes multiple cost drivers to more accurately assign overhead costs to products.
Unit-level cost: Unit-level cost refers to the expenses incurred for every single unit of production. These costs vary directly with the number of units produced.