C HAPTER 7: ACTIVITY -BASED C OSTING AND M ANAGEMENT
Non-Unit Related Overhead Costs
Unit-Level Activities are activities that are performed each time a unit is produced. They
increase or decrease in proportion to the levels of unit activities.
Non-Unit Level Activities These costs are unlikely to vary with units produced.
Batch Level varies with the number of batches produced.
Product Sustaining Varies with the number of product lines
Facility Sustaining Necessary to operate the plant facility but does not vary with
units, batches or product lines
Product re-engineering activity authorized by document called engineering work order.
Activity Drivers factors that measure the consumption of activities by product and other
cost objects and can be classified as unit-level or non-unit level
Non-Unit Level Activity Drivers are factors that measure the consumption of
non-unit level activities by products and other cost objects
Unit-Level Activity Drivers measure the consumption of unit-level activities
Product Diversity is the products consume overhead activities in systematically different
proportions. Cost will be distorted whenever the quantity of unit-based overhead that a
product consumes does not vary in direct proportion to the non-unit-based overhead.
The proportion of each activity consumed by a product is Consumption Ratio
Activity Based Costing (ABC) accumulates overhead costs for each of the
organization’s activities and then assigns the cost of activities to the products, services or
other cost objects that caused those activities.
Because labor-related costs in an automated system is only a small percentage companies
are using machine hours as they are best related to the cause of most overhead
Activity-based cost assignment consists of the following three-steps:
1. Identify and define activities using interviews and surveys Build list of activities
(Activity Dictionary). Lists Activity Attributes
a. Primary Activity (Activity consumed by a product or consumer)
b. Secondary Activity (Consumed by another primary or secondary
2. Assign Costs to Activities Determine the cost of resources (materials, labor and
a. If resource is exclusive to activity (material) use direct tracing
b. If resource is shared by several activities, use drivers to trace and measure
the consumption of resources by each activity
c. Cost of secondary activities are ultimately assigned to primary activities
using activity drivers
1 C HAPTER 7: ACTIVITY-B ASED C OSTING AND M ANAGEMENT
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.
Cost assigned to product = Predetermined activity rate x Actual usage of activity
Problems with ABC:
1. Does not conform to GAAP so can only be used for internal use.
2. Substantial time is needed to properly identify / analyze activities so ABC is
costly to implement.
3. ABC requires a lot of support throughout the firm.
Cost Drivers factor that drives or causes costs. Usually more than one cost driver causes
costs, so the one that has the greatest impact on costs is chosen.
Value-Added Activities and Non-Value-Added Activities
Value-Added Activity increases the value of a product or service to a customer and is one
for which the customer is willing to pay. Value added activities result in more efficient
production methods, continuous operating improvements and better operational
control and reduced time for completing the operation cycle.
Activities needed to comply with the law (reporting, legalities) are valued added
Discretionary activities are classified as value-added provided it simultaneously
satisfied three conditions: 1. Produces a change of state 2. Change of state was not
achievable by preceding activities 3. Activity enables other activities to be
Value-Added Costs are the costs to perform value-added activities with perfect
Non-Value Added Activity increases the time / cost without increasing its worth. May
be necessary from a business perspective but not from a customers. (Scheduling, moving,
waiting, inspecting and storing)
Can be attributed to systematic, physical and human factors.
Zero-based budgeting perspective is the best way to determine the value of an
Time it takes to perform necessary functions to manufacture a product / service is
processing or service time this time adds value.
NVA includes: Idle Time (waiting) Transfer Time (Moving inventories /
products around) Inspection Time (performing quality control)
Non-Value Added Costs are the costs that are caused either by non-value added
activities or by the inefficient performance of value-added activities.
2 C HAPTER 7: ACTIVITY -BASED C OSTING AND M ANAGEMENT
Cost Reduction occurs in four ways:
1. Activity Elimination Once activities that fail to add value are identified, the
organization should get rid of these activities.
2. Activity Selection involves choosing different sets of activities of competing
strategies. Different strategies cause different activities. Lower-cost activities
should be chosen.
3. Activity Reduction Decreases the time and resources required by an activity.
Aimed at improving the efficiency of necessary activities. (Finding ways to
reduce set-up time)
4. Activity Sharing increases efficiency of necessary activities by using economies
of scale. Lowers per-unit cost of the cost driver and amount of cost traceable to
the products that consume the activity.
Cycle Time The length of time from ordering to selling an item in retail environment
In service company cycle time refers to the time between service order and
Assigning Costs to Activities Most difficult task is to determine how much it costs to
perform each activity. Becomes necessary to assign resource costs to activities by using
direct and driver tracing.
Work Distribution Matrix identifies the amount of labor consumed by each
activity and is derived from the interview process.
Resource Drivers are factors that measure the consumption of resources by
activities. Once these are identified, then cost of the resource can be assigned to
Activity-Based Customer Costing and Activity Based Supplier Costing
ABC is used to more accurately determine the upstream of costs of suppliers and the
downstream of costs of customers.
10% of customers were responsible for 90% of its profits. Actually losing profit
on 50% of its customers.
Whale Curve customers to the left of the peak increase company’s profitability
while customers to the right decrease the profitability.
Customers can consume customer-driven activities in different proportions sources of
customer diversity include: Order frequency, delivery frequency, geographic distance,
sales and promotional support and engineering support requirements
Customer Costing vs. Product Costing Assigning costs of customer service to
customers is the same as assigning manufacturing costs to products.
The smaller customers cost more, attribute to smaller, more frequent orders and
the evident need for the sales force to engage in more nego