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Lecture 6

Week 6 chapter notes

Financial Accounting
Course Code
Liang Chen

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Chapter 7 Activity-Based Costing and Management Notes
Activity-Based Costing (ABC)
Traditional Cost Accounting Systems
x traditional cost accounting systems, such as job costing and process costing, assign manufacturing production costs to individual
products in inventory and COGS, while non-manufacturing costs are recognized as period costs on the income statement
x traditional cost accounting methods are also used to allocate non-manufacturing costs for some types of contractual reporting
Activity-Based Costing Systems
x activity-based costing (ABC) Æ process of assigning overhead costs to specific activities in a manufacturing or service delivery
process; it attempts to trace costs more accurately to products or other cost objects
x activity Æ a type of task or function performed in an organization
ABC Cost Hierarchy
x accountants often use a cost hierarchy to help identify activities, and then assign costs to these activities
x ABC developers identified a number of general categories for the cost hierarchy based on different levels of operations
x these include: organization sustaining; facility sustaining; customer sustaining; product sustaining; batch level; and unit level
x organization-sustaining activities Æ tasks or functions undertaken to oversee the entire entity; these activities occur no matter
how many facilities are operated, customers are served, products are sold, batches are processed, or units are produced
x facility-sustaining activities Æ tasks or functions undertaken to provide and manage an area, location, or property; these
activities occur no matter how many customers are served, products are sold, batches are processed, or units are produced
x customer-sustaining activities Æ tasks or functions undertaken to service past, current, and future customers; those costs tend to
vary with the needs of individual customers or groups of customers
x product-sustaining activities Æ tasks or functions undertaken to support the production and distribution of a single product or
line of products; these activities are not related to units or batches, but to individual products or product lines
x batch-level activities Æ tasks or function undertaken for a collection of goods or services that are processed as a group; batch-
level costs do not relate to the number of units in the batch, but instead to the number of batches processed
x unit-level activities Æ tasks or functions undertaken to produce individual units manufactured or services produced; need to be
performed for every unit of good or service, and therefore the cost should be proportional to the number of units produced
Assigning Costs Using an ABC System
x in ABC system, the process of assigning costs is a 2-stage process similar to the process used in other cost accounting methods:
(1) overhead costs are gathered into cost pools; and (2) allocated to the cost objects, such as product line, batch, or units
x ABC differs from other cost accounting methods in that overhead costs are assigned to a larger number of activity-based cost
pools, and cost drivers are used as allocation bases]
x the following procedures are followed for the ABC method: (1) identify the relevant cost object; (2) identify activities; (3) assign
costs to activity-based cost pools; (4) for each ABC cost pool, choose a cost driver; (5) for each ABC cost pool, calculate an
allocation rate; and (6) for each ABC cost pool, allocate activity costs to the cost object
Identify the Relevant Cost Object
x the design of the system beings with identification of one or more cost objects that are relevant to managers
Identify Activities
x to identify the activities performed within the production process, the use of resources must be tracked, and in many cases,
additional information must be gathered from employees
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