Chapter 7.docx - Chapter 7: Activity-based Costing: A tool...

Chapter 7: Activity-based Costing: A tool to Aid Decision Making
Activity-based costing(ABC): a costing method based on activities that is designed to provide
managers with cost information for strategic and other decisions that potentially affect capacity
an therefore fixed costs.
The treatment of Costs Under the Activity-based costing model
As noted above, traditional absorption costing is designed to provide data for external financial
reports. In contrast, ABC is designed for use in internal decision making. As a consequence, ABC
differs from traditional cost accounting in several ways. In ABC<
1. Non-manufacturing as well as manufacturing costs may be assigned to products, but
only on a cause-and-effect basis
2. Some manufacturing costs may be excluded from product costs
3. Numerous overhead cost pools are used, each of which is allocated to products and
other cost objects using its own unique measure of activity
4. Overhead rates, or activity rates, may be based on the level of activity at capacity rather
than on budgeted level of activity.
In ABC,
Activity: any event that causes the consumption of overhead resources
Activity cost pool: A “bucket” in which costs are accumulated that relate to a single activity
measure in the activity based costing system.
Activity measure: an allocation base in an activity-based costing system; idealy, a measure of the
amount of activity that drives the costs in an activity cost pool; also called a cost driver.
Transaction driver: a simple count of the number of times an activity occurs.
Duration driver: a measure of the amount of time required to perform an activity

ABC addresses this issue by defining five levels of activity—unit-level, batch-level, product-level,
customer-level, and organization-sustaining—which largely do not relate to the volume of units
produced or service provided, these levels are described as follows:
1. Unit-level activities are preformed each time a unit is produced. The costs of unit-level
activities should be proportional to the number of units produced. For example,
providing power to run processing equipment is a unit-level activity since power tens to
be consumed in proportion to the number of units produced.