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CH5-ABC system-PDF

Activity-Based Costing (ABC) is a management accounting method that allocates direct and indirect costs to products and services based on the activities involved in their creation and delivery. It contrasts with traditional costing methods by tracing overhead costs to activities rather than departments, providing a more accurate cost assignment. The document includes an example illustrating how to compute total costs, cost per unit, and gross margin for two types of valves produced by a company using ABC.

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Zain Almajali
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11 views

CH5-ABC system-PDF

Activity-Based Costing (ABC) is a management accounting method that allocates direct and indirect costs to products and services based on the activities involved in their creation and delivery. It contrasts with traditional costing methods by tracing overhead costs to activities rather than departments, providing a more accurate cost assignment. The document includes an example illustrating how to compute total costs, cost per unit, and gross margin for two types of valves produced by a company using ABC.

Uploaded by

Zain Almajali
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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CH 5:

ACTIVITY-BASED
COSTING (ABC)

Part 1

Made by:
Mahmoud Alqasem
Part 1 Contents: Activity
Based
▪ What is ABC? Costing
▪ Direct and indirect costs. (ABC)
WHAT IS ABC?

 Activity Based Costing is a management


accounting approach which allocate all direct and
indirect (overhead) costs to cost objects (products
and services) in order to help management
understand critical business information.

 It allocates direct and indirect costs to products


and services based on the level of activities used
to create and deliver those products and services.
DIRECT AND INDIRECT COSTS

 Direct costs: are cost that can be directly traced


to producing specific goods or services (such as
salaries for project staff and materials required
for a particular project).

 Indirect costs: are costs that are not directly


accountable to a cost object (such as a particular
function or product). Indirect costs may be either
fixed or variable. Indirect costs include taxes,
administration, personnel and security costs, and
are also known as overhead.
DIRECT AND INDIRECT COSTS

 An activity-based costing (ABC) system for:


• Direct costs: assign it like traditional costs (Job
and Process costing).
• Indirect costs:
A. Traces overhead costs to activities,
B. then traces costs to products.
DIRECT AND INDIRECT COSTS
CH 5:
ACTIVITY-BASED
COSTING (ABC)

Part 2

Made by:
Mahmoud Alqasem
Part 2 Contents: Activity
Based
▪ ABC Vs. Traditional methods. Costing
▪ How ABC works? (ABC)
▪ Illustration example.
ABC VS. TRADITIONAL METHODS

 Functional-based costing also involves two stages; however,


overhead costs are traced to departments (instead of
activities), and then traced to products.
 Functional-based costing and activity -based costing are
compared below:
HOW ABC WORKS?

 Activity-based cost assignment consists of the


following steps:
1. Identify and define activities using interviews and
surveys, then build an activity dictionary.

2. Assign costs to activities.

3. Assign costs to products.


HOW ABC WORKS?

Step 1: Identify and define activities using interviews


and surveys, then build an activity dictionary.
 An activity dictionary lists activities and activity attributes—
financial and nonfinancial information that describes the
activities. Information includes:
• activity name—usually consists of an action verb and an
object.
• a description of the tasks that make up the activity.
• classification as a primary activity (activity consumed by a
product or customer) or a secondary activity (activity
consumed by other primary or secondary activities).
• activity driver—a measure of activity output.
HOW ABC WORKS?

Step 2: Assign costs to activities.


 Determine the cost of resources (such as materials, labor, and
capital) consumed by each activity.
• If the resource is exclusive to the activity (such as
materials), use direct tracing.
• If the resource is shared by several activities, use driver
tracing to assign costs to the activities. Resource drivers
are factors that measure the consumption of resources by
activities.
• The costs of secondary activities are ultimately assigned to
primary activities using activ ity drivers.
HOW ABC WORKS?

Step 3: Assign costs to products.


 After the cost of primary activities is calculated, assign the cost
of these activities to products based on usage of the activity as
measured by activity drivers. Costs assigned to products are
calculated as follows :

Cost assigned to product =


Predetermined activity rate × Actual usage of activity
Example: Friends company, a manufacturer of
valves, produces and sells two types of valves: Gas EXAMPLE
Safety Valves(GSV) and MSC Valves(MSC). Friends
company has following data for two products :

GSV MSC
Production volume 10,000 5,000
Selling price/unit $78.00 $130.00
Unit prime cost $21.00 $35.00 Illustration
In addition, Friends company has identified the
following activities, costs, and activity consumption
cost drivers:
Activity Cost Driver Budgeted Cost
Machine set-ups Number of set-ups $100,000
Machine running Machine hours $400,000
Inspection Inspection hours $70,000
Packing No. of packing order $30,000
Total $600,000
Friends company also collected the activity data for
each product: EXAMPLE
Cost Driver GSV MSC Total

Number of sets-ups 80 260 340

Machine hours 18,000 36,000 54,000

Inspection hours 3,000 4,000 7,000

Number of packing orders 2,100 3,500 5,600 Illustration

 Required, by using ABC system compute:


1. Total cost of each product.
Continue…
2. Cost per unit.
3. Gross margin.
Solution:
EXAMPLE
1. Compute total costs:
Step 1: compute the activity cost per unit:
• activity cost unit =
Predetermined activity rate × Actual usage of activity

Activity cost
Cost driver calculation
unit
Illustration

No. of set ups = $100,000 / 340 294.12

Machine hours = $400,000 / 54,000 7.41 Continue…

Inspection hours = $70,000 / 7,000 10

No. of packing orders = $30,000 / 5,600 5.36


Solution:
EXAMPLE
1. Compute total costs:
Step 2: Total costs equation:
• Total costs =
Prime costs + (MOH activity 1 + MOH activity 2 + ...)

A. Total costs for “GSV” product: (10,000 units)


Cost type calculation Total costs Illustration
Prime costs = 10,000 * $21 210,000.00

MOH – set ups = 80 * $294.12 23,529.60

MOH – Machine = 18,000 * $7.41 133,380.00 Continue…

MOH – Inspection = 3,000 * $10 30,000.00

MOH – Packing = 2,100 * $5.36 11,256.00

408,165.60
Solution:
EXAMPLE
1. Compute total costs:
Step 2: Total costs equation:
• Total costs =
Prime costs + (MOH activity 1 + MOH activity 2 + ...)

B. Total costs for “MSC” product: (5,000 units)


Cost type calculation Total costs Illustration
Prime costs = 5,000 * $35 175,000.00

MOH – set ups = 260 * $294.12 76,471.20

MOH – Machine = 36,000 * $7.41 266,760.00 Continue…

MOH – Inspection = 4,000 * $10 40,000.00

MOH – Packing = 3,500 * $5.36 18,760.00

576,991.20
Solution:
EXAMPLE
2. Compute cost per unit:
• Cost per unit =
Total costs / No. of produced units

• GSV product:
= 408,165.60 / 10,000
= $40.82 / unit Illustration

• MSC product:
= 576,991 .20 / 5,000 Continue…
= $115.40 / unit
Solution:
EXAMPLE
2. Compute cost per unit:

Illustration

Continue…
Solution:
EXAMPLE
3. Compute gross margin:
• Gross margin =
Sale price per unit – cost per unit

GSV MSC

Selling price per unit $78.00 $130.00


Illustration
Less: Cost price per unit (40.82) (115.40)

Gross margin per unit 37.18 14.60


Continue…
Gross margin % 47.67% 11.24%
Solution:
EXAMPLE
Comparing:
ABC Vs. Traditional (Volume) costs

ABC system Traditional system

GSV MSC GSV MSC


Illustration
Selling price per unit $78.00 $130.00 $78.00 $130.00

Less: Cost price per unit (40.82) (115.40) (57.00) (83.00)

Gross margin per unit 37.18 14.60 21.00 47.00


Continue…

Gross margin % 47.67% 11.24% 26.92% 36.15%


The end of this
Chapter

Be Responsible
Stay Home

Made by:
Mahmoud Alqasem

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