Activity Based Costing Essay

2013 words - 9 pages

Activity Based Costing
Accounting 2020
Professor Richard McDermot

Traditional Costing Systems
• Product Costs
– Direct labor
– Direct materials
– Factory Overhead

• Period Costs
– Administrative expense
– Sales expense

Appear on the income
statement when
goods are sold, prior
to that time they are
stored on the balance
sheet as inventory.
Appear on the income
statement in the
period incurred.

Traditional Costing Systems
• Product Costs
– Direct labor
– Direct materials
– Factory Overhead

• Period Costs
– Administrative expense
– Sales expense

Direct labor and direct
materials are easy to
trace to products.
The problem ...view middle of the document...

• A cost driver is any factor or activity that has a
direct cause and effect relationship with the
resources consumed.

ABC Steps
• Overhead cost drivers are determined.
• Activity cost pools are created.
– A activity cost pool is a pool of individual costs
that all have the same cost driver.

• All overhead costs are then allocated to one of
the activity cost pools.

ABC Steps:
• An overhead rate is then calculated for each
cost pool using the following formula:
– Costs in activity cost pool/base
– The base is, of course, the cost driver

• Overhead costs are then allocated to each
product according to how much of each base
the product uses.

Let’s work an example . . .
• Assume that a company makes widgets
• Management decides to install an ABC system

Overhead Cost Drivers are Determined:
• Management decides that all overhead costs
only have three cost drivers—sometimes
called activities (obviously a simplification of
the real world)
– Direct labor hours
– Machine hours
– Number of purchase orders

All overhead costs are then allocated to one of the
activity cost pools.
Direct Labor

General Ledger
Payroll taxes

$1,000

Machine maintenance

$500

Purchasing Dept. labor

$4,000

Fringe benefits

$2,000

Purchasing Dept. Supplies

$250

Equipment depreciation

$750

Electricity

$1,250

Unemployment insurance

$1,500

Which overhead costs do you
think are driven by direct labor
hours?

Machine Hours

# of Purchase Orders

All overhead costs are then allocated to one of the
activity cost pools.
Direct Labor

General Ledger
Payroll taxes

$1,000

Machine maintenance

$500

Purchasing Dept. labor

$4,000

Fringe benefits

$2,000

Purchasing Dept. Supplies

$250

Equipment depreciation

$750

Electricity

$1,250

Unemployment insurance

$1,500

Overhead driver by direct labor
hours

$1,000
2,000
1,500
$4,500

Machine Hours

# of Purchase Orders

All overhead costs are then allocated to one of the
activity cost pools.
Direct Labor

General Ledger
Payroll taxes

$1,000

Machine maintenance

$500

Purchasing Dept. labor

$4,000

Fringe benefits

$2,000

Purchasing Dept. Supplies

$250

Equipment depreciation

$750

Electricity

$1,250

Unemployment insurance

$1,500

Which overhead costs are
driven by machine hours?

$1,000
2,000
1,500
$4,500

Machine Hours
$ 500
750
1,250
$2,500

# of Purchase Orders

All overhead costs are then allocated to one of the
activity cost pools.
Direct Labor

General Ledger
Payroll taxes

$1,000

Machine maintenance

$500

Purchasing Dept. labor

$4,000

Fringe benefits

$2,000

Purchasing Dept. Supplies

$250

Equipment depreciation

$750

Electricity

$1,250

Unemployment insurance

$1,500

And finally, which overhead
costs are driven by # of
purchase orders?...

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