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ACCT2522 Management Accounting 1
Topic 2: Managing Costs -
Activity-Based Costing
(“ABC”)
Organisational Resources
Activities Processes
Value Creation
Role of Management
Accounting (MA)
Planning
Control
Introduced in COMM1170
Introduced in COMM1180; advanced
understanding in ACCT3583
Managing Costs
2. Activity-based Costing
3. Standard Costs &
Variance Analysis
1. MA &
Understanding
Processes
9. MA Information for
Decision-making
7. Responsibility
Accounting & Transfer
Pricing
8. Management Control
& Performance
Evaluation
Customers: Products & Services
Cost Quality Time
Managing Quality
4. Cost & Quality
Managing Time
5. Theory of Constraints
6. Project Management
St
ra
te
gy
Im
pl
em
en
ta
tio
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ACCT2522 Course Map
Topic 2: Learning Objectives
1. Explain potential problems with using traditional
(aka volume-based) costing systems.
2. Describe and apply the activity hierarchy of
costs and cost drivers.
3. Use activity-based costing (ABC) systems
assign costs to cost objects.
4. Evaluate the appropriateness of ABC.
5. Demonstrate the ability to apply Activity-based
Management (ABM)
6. Understand the limitations of ABC.
3
Required Readings
• Langfield-Smith et al. (2022)
• Chapter 3 p. 73-74; and
• Chapter 8 including the Appendix
4
Topic 2: Learning Objectives
1. Explain potential problems with using traditional
(aka volume-based) costing systems.
2. Describe and apply the activity hierarchy of
costs and cost drivers.
3. Use activity-based costing (ABC) systems
assign costs to cost objects.
4. Evaluate the appropriateness of ABC.
5. Demonstrate the ability to apply Activity-based
Management (ABM)
6. Understand the limitations of ABC.
5
1. Product Costing and its Purposes
Why do we need to cost products?
• Inventory valuations for external reporting
• Decision-making (e.g., pricing and product-mix)
• Planning and control
ACCT2522 considers 2 types of product costing
systems:
1. Traditional or Volume-Based Costing systems
(hereafter to refer as “VBC” systems)
2. Activity-Based Costing (“ABC”) systems
6
2. Traditional or Volume-Based Costing
Systems
MOH Costs
Traditional
System
Cost Pool(s)
Cost Object
Cost Allocation Base/Driver
Budgeted
MOH costs
Budgeted
quantity
of cost driver
X
Actual
quantity
of cost
driver
Volume-based cost
drivers e.g., #DL,
#units produced
Revision: COMM1170;
Week 1 Tutorial
MOH rate =
2.1 Features of Volume-based Costing
(VBC) Systems
• Manufacturing overhead costs are allocated to
products using a predetermined overhead rate(s)
• Manufacturing overhead rate is calculated using
some measure of production volume
– e.g. Number of products, direct materials, direct labour
hours or direct machine hours
• Non-manufacturing costs are not assigned to
products
8
Revision: COMM1170;
Week 1 Tutorial
2.2 Indications of Problems with Volume-Based
Costing (VBC) systems (LO1)
• When proportion of MOH costs to total manufacturing
costs increases (i.e., proportion of prime costs decrease);
AND
• Non-volume driven MOH costs increases
– Using only unit level cost drivers no longer appropriate
9
10
2.2.1 Other Cost Drivers (LO2)
Activity hierarchy:
Unit level costs
– Cost relate to activities that are performed for each unit.
Batch level costs
– Cost relate to activities performed for a group of product units.
Product level costs
– Cost relate to activities performed for specific products or product
families.
Facility level costs
– Cost relate to activities incurred to support the business as a
whole.
Reference: LS
Chapter 3 p. 73-74
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Lecture Exercise
(Please refer to information provided in “Lecture Exercise:
Case on Karter Pens.” in order to complete this exercise.)
The cost object in this case is a Karter Pen. For each cost
described, please:
(i) indicate the level of the activity hierarchy which it
belongs to:
a) Unit level cost
b) Batch level cost
c) Product level cost
d) Facility level cost
(ii) identify a cost driver.
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Lecture Exercise
(Cost object: 1 Karter Pen) Hierarchy Cost driver
Cost of mixing the ink (b) Batch # batches
of ink
Cost of setting up stamping
machines
(b) Batch #
production
runs
Cost of packaging individual pens
into boxes
(a) Unit # pens
produced
Cost of advertising (c) Product # product
groups
Factory-related costs associated
with running the factory
(d) Facility None
2.2 Indications of Problems with Volume-Based
Costing (VBC) systems (LO1)
• When proportion of MOH costs to total manufacturing
costs increases (i.e., proportion of prime costs decrease);
AND
• Non-volume driven MOH costs increases
– Using only unit level cost drivers no longer appropriate
• Non-manufacturing product related costs increases
– Increase in upstream and downstream activities (ref value chain)
• Product diversity increases
– Increase in non-manufacturing costs
– Increase in production complexity
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Proof: Increase in product complexity (issues
with using volume-based cost drivers)
Simple product
(e.g., ballpoint pen)
Complex product
(e.g., fountain pen)
No. of set ups 1 $10X1=$10 5 $10X5=$50
Machine
capacity (no. of
pens)
1000 100
Total no. of
pens produced
1000 100
MOH cost per
pen
$10/1000
= 1 cent
$50/50
= 50 cents
MOH cost per pen (allocating cost based on production volume)
= $60/1,100 = 5.5 cents
Topic 2: Learning Objectives
15
1. Explain potential problems with using traditional
(aka volume-based) costing systems.
2. Describe and apply the activity hierarchy of
costs and cost drivers.
3. Use activity-based costing (ABC) systems
assign costs to cost objects.
4. Evaluate the appropriateness of ABC.
5. Demonstrate the ability to apply Activity-based
Management (ABM)
6. Understand the limitations of ABC.
3.1 Assigning Overhead Costs Using ABC:
Some general principles
Resources
ABC
System
Activities
Products
Resource Drivers
Activity Drivers
Stage One:
Measuring the cost of
activities
Stage Two:
Assigning activity
costs to products
3.1.1 ABC Terminology
• Resources (Topic 1)
• Financial and non-financial means of an organisation
• Determines its capabilities and competencies
• Activity (Topic 1)
• a unit of work performed.
• Cost driver (Topic 1)
• a factor or activity that causes cost to be incurred
– Resource drivers
• used to estimate the cost of the resources consumed by an
activity.
– Activity drivers
• used to estimate the cost of an activity consumed by cost objects.
– Root cause cost drivers (Topic 1)
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3.2 Two-Stage Process of Assigning
Overhead Costs Using ABC Systems
Stage One: Measuring the cost of activities
• Identify major activities (includes the combination of minor
activities into major activity pools)
• Costing activities by assigning cost (of resources) to
activities (forming activity cost pools)
• Involves both tracing and allocation using resource drivers.
Stage Two: Assigning activity costs to products
• Identify activity drivers
• Calculate the activity cost per unit of activity driver
• Applying cost of activity to products
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Setup
Moulding Machine
AssemblyMoulding
Overhead Costs
Etc.Moulding Machine Depreciation
Wages:
EmployeesElectricity
Etc.
# employees
(e.g., 5)
1 50% * 4
≈ 2
2
3.2.1 Stage One: Measuring cost of activities
20
Setup
Moulding Machine
AssemblyMoulding
Overhead Costs
Etc.Moulding Machine Depreciation
Wages:
EmployeesElectricity
Etc.
# machine
hours
3.2.1 Stage One: Measuring cost of activities
Lecture Example: AI Toys Ltd
AI Toys Ltd (AT) produces two AI toy lines:
1. R-dogs
2. R-cats
Required:
Using ABC, calculate the cost of one unit of R-dogs.
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Lecture Example: AI Toys Ltd
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Table 1: Production information per month
Storm Trooper
toys R-cat
Direct Material per unit $0.50 $0.50
Direct Labour rate $30.00 $30.00
Direct Labour hours 2,500 500
# of toys produced 50,000 10,000
Table 2: Cost of resources per month
Electricity = $30,000
Computer depreciation = $10,000
Salaries – product developers = $50,000
Moulding machines depreciation = $35,000
Salaries – employees = $135,000
Motor vehicle related costs = $40,000
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Lecture Example: AI Toys Ltd
Table 3: Product related activities
1. Product development
2. Setup moulding machines
3. Moulding toys
4. Assembling toys
5. Customer deliveries
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Lecture Example: AI Toys Ltd
• Identify major activities (includes the combination of
minor activities into major activity pools)
• Costing activities by assigning cost (of resources) to
activities (forming activity cost pools)
• Identify resource drivers
• Cost per resource driver = Cost of resource
Quantity of resource driver
• Measure quantity of resource drivers consumed by activities
• Cost of each activity = Cost per resource driver*Quantity of
resource driver
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3.2.1 Stage One: Measuring cost of activities
Resources : $ Resource Drivers
Quantity of
Resource
Drivers
Electricity 30,000 # Kilowatt hours (kwh) 250,000
Computer depreciation 10,000 # Computers 2
Salaries: product developers 50,000 # Product developers 2
Moulding machine depreciation 35,000 # Moulding machines 5
Salaries: employees 135,000 # Employees 25
Motor vehicle related costs 40,000 # Motor vehicles 4
Total cost of resources 300,000
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Identify resource drivers
Lecture Example: AI Toys Ltd
Resources : $ Resource Drivers
Quantity of
Resource
Drivers
Cost per
resource
driver
Electricity 30,000 # Kilowatt hours 250,000 $0.12
Computer depreciation 10,000 # Computers 2 $5,000
Salaries: developers 50,000 # Prod. developers 2 $25,000
Moulding mach. deprn. 35,000 # Moulding mach. 5 $7,000
Salaries: employees 135,000 # Employees 25 $5,400
MV related costs 40,000 # Motor vehicles 4 $10,000
Total cost of resources 300,000
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Calculate cost per resource driver
Cost per resource driver = Cost of resource
Quantity of resource driver
Lecture Example: AI Toys Ltd
Calculate cost of each activity
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Activity Pools Resource Consumption
Cost per
Resource
Driver
$
Cost per
resource
driver *qty of
resource
driver
Activity
Cost
Product development
25,000 kwh 0.12 3,000
2 Product developers 25,000 50,000
2 Computers 5,000 10,000 63,000
Setup moulding mach. 2 Employees 5,400 10,800 10,800
Moulding toys
175,000 kwh 0.12 21,000
5 Moulding machines 7,000 35,000
5 Employees 5,400 27,000 83,000
Assembling toys 50,000 kwh 0.12 6,000 10 employees 5,400 54,000 60,000
Customer deliveries 8 Employees 5,400 43,200 4 Motor vehicles 10,000 40,000 83,200
Total overhead cost 300,000
Activity cost = Cost per resource driver * Quantity of resource driver
Lecture Example: AI Toys Ltd
3.2 Two-Stage Process of Assigning
Overhead Costs Using ABC Systems
Stage One: Measuring the cost of activities
• Identify major activities (includes the combination of minor
activities into major activity pools)
• Costing activities by assigning cost (of resources) to
activities (forming activity cost pools)
• Involves both tracing and allocation using resource drivers.
Stage Two: Assigning activity costs to products
• Identify activity drivers
• Calculate the activity cost per unit of activity driver
• Applying cost of activities to product