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Chapter 5

ADMS 2510 Chapter Notes - Chapter 5: General Ledger, Cost Driver, Total Absorption Costing

Administrative Studies
Course Code
ADMS 2510
Alison Beavis

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Chapter 5
Most organizations that use activity-based costing have two costing systemsthe official costing
system that is used for preparing external financial reports and the activity-based costing system that
is used for internal decision making and for managing activities.
As noted above, traditional absorption costing is designed to provide data for external financial
reports. In contrast, activity-based costing is designed for use in internal decision making.
Overhead cost pool: A group of overhead cost elements
Activity: Is any event that causes the consumption of overhead resources.
Activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the
ABC system.
Activity measure is an allocation base in an activity-based costing system. The term cost driver is also used to
refer to an activity measure because the activity measure should “drive” the cost being allocated.
The two most common types of activity measures are transaction drivers and duration drivers.
Transaction drivers are simple counts of the number of times an activity occurs such as the number of bills
sent out to customers.
Duration drivers measure the amount of time required to perform an activity such as the time spent
preparing individual bills for customers. In general, duration drivers are more accurate measures of resource
consumption than transaction drivers, but they take more effort to record. For that reason, transaction drivers
are often used in practice.
If plant wide overhead costs do not move in tandem with plant wide direct labour-hours or machine-
hours, product costs will be distorted. Activity-based costing addresses this issue by defining five levels of
activityunit-level, batch-level, product-level, customer-level, and organization-sustainingof which only the
costs and corresponding activity measures for unit-level activities relate to the volume of units produced.
Unit-level activities are performed each time a unit is produced.
Batch-level activities are performed each time a batch is handled or processed, regardless of how many units
are in the batch.
Product-level activities relate to specific products and typically must be carried out regardless of how many
batches are run or units of product are produced or sold. (ex: designing a product or advertising a product)
Customer-level activities relate to specific customers and include activities such as sales calls, catalogue
mailings, and general technical support that are not tied to any specific product.
Organization-sustaining activities are carried out regardless of which customers are served, which products
are produced, how many batches are run, or how many units are made.( heating the offices, cleaning the
offices, preparing report to stakeholders and so on).
Successful ABC implementation requires 3 characteristics. 1). Top management must strongly support
it. 2). Top managers should ensure that ABC data is linked to how people are evaluated and rewarded.3). A
cross-functional team should be created to design and implement the ABC system.
Assigning costs to cost objects under activity-based costing is a two-stage process. In the first stage,
manufacturing and non-manufacturing overhead is allocated to the activity costs pools. In the second stage,
the costs for the activities are allocated to the various cost objects.
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