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Lecture 4

ADM 3346 Lecture Notes - Lecture 4: Cost Driver

Course Code
ADM 3346
Tiemei L I

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Chapter 5 - Activity-Based Costing and Management
Learning Objectives
Q1: How is ABC different from traditional costing?
Q2: What process is used to assign costs in an ABC system?
Q3: What is ABM?
Q1: How is ABC different from traditional costing?
Product Cost Cross Subsidization
Inappropriate pooling of indirect costs and poor choices for cost drivers can lead to the
incorrect costs of products or services.
If one product is under-costed, then other products may be over-costed resulting in
product cost cross subsidization.
Cost Cross-Subsidization
The over costed product absorbs too much cost, making it seem less profitable than it
really is.
The under costed product is left with too little cost, making it seem more profitable than
it really is.
The over costed products are subsidizing the under costed products.
Activity-Based Costing (ABC)
ABC is a method of cost system refinement.
Indirect costs are divided into “sub-pools” of costs of activities.
Activity costs are then allocated to the final cost object using a cost allocation base (more
commonly called cost drivers in ABC).
Activities are measurable, making it more likely that cost drivers can be found so that a final cost
object will absorb indirect costs in proportion to its use of the activity.
Traditional Costing
Also called cost smoothing or peanut butter costing
Spreads the costs of conversion uniformly among products and services
Appropriate if:
Indirect costs are a small proportion of total costs
Activities are consumed uniformly in the production process
May lead to over costing or under costing of products and services
Traditional Costing to Activity-Based
Traditional overhead allocation:
Allocates total overhead over
one allocation rate: the “peanut butter”
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