Managerial Accounting
2008
William F. O’Brien, MBA, CPA
Session IX
Activity Based Costing
Session IX Objectives
Understand the differences between ABC and
traditional costing.
Compute ABC related unit costs.
Applying Activity Based Management (ABM) to
the ABC results.
Understand the limitations of ABC.
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Activity Based Costing
One stage allocation
Two stage allocation--functional
Activity based costing--ABC
Activity based management--ABM
Activity based organizations--ABO
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Implementing ABC
Select the area
Identify 5-10 major activites
Determine the costs for those activities
Identify the “cost drivers”
Assign costs to the final cost objectives (FCO)
on the basis of the drivers
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Gulfstream Recreation
Gulf Stream Recreation, a major sporting goods firm in California has two major
products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was
planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine
hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers.
The cost structure for each product is as follows:
Racer Cruiser
Direct Material $35 $50
Direct Labor 25 13
Machine Hours 2 1
GSR is considering some type of activity based costing system. Sandra Jones, the cost
accounting manager, suggested the following drivers:
Driver Relationship to FCO
Driver Total Activity Cost Total Racer Cruiser Activity
P.O.'s (#) $300K 2000 1250 750 Purchasing
Rework Hrs. (Hrs) $200 450 200 250 Quality Control
Invoices (#) $200 600 150 450 Billing
Change Orders (#) $150 300 150 150 Mfg. Eng.
1. Calculate the unit costs of each product under the traditional method.
2. Calculate the unit costs of each product under activity based costing.
3. What pricing implications are inherent in this example.
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Gulfstream Recreation
Solution
Standard Overhead Rate:
$850K / 70K Hrs. = $12.14 per Machine Hour
Traditional Cost Structure:
Racer Cruiser
Direct Materials $35 $50
Direct Labor $25 $13
Overhead $24 $12
$84 $75
ABC Overhead Rate:
Racer Cruiser
Purchasing $187.50 $112.50
Quality Control $ 88.90 $111.10
Billing $ 50.00 $150.00
Manufacturing Eng. $ 75.00 $ 75.00
Total $401.40 $448.60
Per Unit $ 40.10 $ 8.97
ABC Cost Structure:
Racer Cruiser
Direct Materials $35 $50
Direct Labor $25 $13
Overhead $40 $9
$100 $72
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Benefits of ABC
Benefits
Multiple Cost Pools
Costs applied on the basis of effort/activity
New perspective on costs
Not just for applied mfg. costs
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Limitations of ABC
Implementation is time consuming.
ABC is costly to maintain.
Change management is never easy.
ABC may result in over-application of costs.
Careful analysis of results is key
ABC does not equal “true costs”.
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Key Points-Session IX
Careful determination of the ABC activities and
related costs is key.
Be cautious regarding over-allocation of fixed
costs.
Do not use the results blindly.
ABC is useless if action (ABM) does not follow.
ABC does not equal “true costs”.
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