ACCT20001 Lecture Notes - Lecture 6: Cost Accounting, Fidelity Investments, Resource Consumption
16 May 2018
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Activity-based costing (ABC)
Over/under costing
•Product-cost cross-subsidisation means that at least one miscosted product is resulting in the
miscosting of other products in the organisation
•A classic example arises when a cost is uniformly spread across multiple users without
recognition of their difference resource demands
-E.g. Each person at a restaurant orders separately and some order expensively and some
order less. At the end, the bill is split - expensive person under-paid and cheaper person over-
paid
•Need to better reflect the resources consumed for pricing, profits and allocation of resources
•Poorly defined costing may inhibit sound decision making
•Improvement:
-Identify more direct costs
-Use more indirect cost pools
Activity-based costing systems
•An activity is a type of task or function performed in an organisation
•Seeks to identify more costs as direct
•Views costs through an activity lens
•Uses more cost pools than traditional systems for indirect costs
•Assigns overhead costs to specific activities performed in a manufacturing or service delivery
process
•Costs of various activities become the building blocks used to compile total costs for products or
other cost objects
Activity-based costing (ABC) and conventional costing
•Cost accounting systems have adapted over time to suit changes in:
-Operational environments
-Technology
-Cost structures
-Management reporting requirements
-Organisational structure, particularly those focusing on the value chain
•Some have argued that this adaptation has historically, been slow.
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Conventional cost accounting systems
•Inappropriate pooling of indirect costs and poor choices for cost drivers can lead to the incorrect
costs of products or services
-Possible with any allocation system
•However, it is more likely to produce distorted cost data with the use of:
-Few direct costs categories
-Limited number of cost pools
-Cost driver and allocation bases centred around volume particularly in more complex
operating environments
-E.g. multiple products/services, frequent production in small lot sizes, complex customer
demands/environments
Activity-based costing systems
•Multiple cost pools used to reflect various activities performed
•ABC focuses on fundamental characteristic driving cost pool identification and cost pool selection
•Two steps:
1. Cost of overhead resources assigned to activity cost pools
2. Activity costs allocated to individual products or services
•More activity based cost pools and allocation bases
ABC Costing Framework
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The cost hierarchy
•Not all costs vary with volume
Example:
•Facility-sustaining: Manufacturing facility $1.5m
•Product-sustaining: Product development cost $1.25m
•Batch-level: Product set up $750,000
•Unit-level: Materials handling $850,000, Production-line labour costs $2.5m, Power $500,000
•Cost driver/allocation base for each of these is different
Applying ABC Model
1. Identify the relevant cost object
2. Identify activities
3. Assign cost to activity-based cost pools
4. For each ABC cost pool, choose a cost driver/allocation basis
5. For each ABC cost pool, calculate a cost driver/allocation rate
6. For each ABC cost pool, allocate activity costs to the cost object
•An allocation basis and cost driver not always the same thing. !
However, often the allocation base will reflect the cost driver.
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