Activity-Based Costing

Chapter 4

Activity-Based Costing

4-1

4-2

Traditional Costing and Activity-Based Costing
Traditional Costing Systems


Allocates overhead using a single predetermined rate.
►

Job order costing: direct labor cost may be the relevant activity base.

►

Process costing: machine hours may be the relevant activity base.



Assumption was satisfactory when direct labor was a major portion of total manufacturing costs.
►

Wide acceptance of a high correlation between direct labor and overhead costs.

4-3

LO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based Costing

The Need for a New Approach


Tremendous change in manufacturing and service industries. 

Decrease in amount of direct labor usage.



Significant increase in total overhead costs.



Inappropriate to use plant-wide predetermined overhead rates when a lack of correlation exists.



Complex manufacturing processes may require multiple allocation bases; this approach is called
Activity-Based Costing (ABC).

4-4

Illustration 4-1
Traditional one-stage costing system

Traditional Costing and Activity-Based Costing

Activity-Based Costing


Allocates overhead to multiple activity cost pools and



Assigns the activity cost pools to products or services by means of cost drivers.

4-5

Traditional Costing and Activity-Based Costing

Activity-Based Costing


Activity: any event, action, transaction, or work sequence that causes a cost to be incurred in producing a product or providing a service.



Activity Cost Pool: a distinct type of activity. For example: ordering materials or setting up machines.



Cost Drivers: any factors or activities that have a direct cause-effect relationship with the resources consumed.

4-6

LO1 Recognize the difference between traditional costing and activity-based costing.

Traditional