Activity-Based Costing
Module 4:
Inventory & Costing
Duration:
45-60 minutes
Level:
Beginner to Diploma-Level
Lesson Objectives
➛ Define Activity-Based Costing
➛ Explain how ABC differs from traditional costing methods
➛ Identify activities and cost drivers
➛ Allocate overhead using ABC
➛ Calculate cost per unit using ABC
➛ Understand the advantages and limitations of ABC
Key Vocabulary
➛ Activity-Based Costing
➛ Activity
➛ Cost Driver
➛ Cost Pool
➛ Overhead Allocation
➛ Cost Driver Rate
➛ Traditional Costing
What Is Activity-Based Costing?
Activity-Based Costing is a method that
➛ Assigns costs to products based on the activities required to produce them
Instead of using one base (like labor hours), ABC uses multiple cost drivers.
Why Use ABC?
Traditional costing can
➛ Overcost simple products
➛ Undercost complex products
ABC provides
➛ More accurate product costing
➛ Better decision-making
➛ Improved cost control
Steps in Activity-Based Costing
1. Identify Activities
Examples
➛ Machine setup
➛ Quality inspection
Packaging
2. Assign Costs to Cost Pools
Group similar costs together.
Group similar costs together.
3. Determine Cost Drivers
Examples
➛ Number of setups
➛ Machine hours
➛ Number of inspections
Examples
➛ Number of setups
➛ Machine hours
➛ Number of inspections
4. Calculate Cost Driver Rate
Cost Driver Rate = Total Cost ÷ Total Activity Units
Cost Driver Rate = Total Cost ÷ Total Activity Units
5. Allocate Costs to Products
Allocated Cost = Cost Driver Rate × Activity Used
Allocated Cost = Cost Driver Rate × Activity Used
Example Calculation
Given
Setup cost =
Total setups =
Total setups =
$30,000
150
150
Step 1
Cost Driver Rate
30,000 ÷ 150 = 200
$200 per setup
Step 2
Allocation
If a product uses 10 setups
10 × 200 = 2,000
Allocated cost = $2,000
ABC vs Traditional Costing
Feature
Cost Allocation
Accuracy
Complexity
Best for
Cost Allocation
Accuracy
Complexity
Best for
ABC
Multiple drivers
High
High
Complex production
Multiple drivers
High
High
Complex production
Traditional
Single base
Lower
Simple
Simple production
Single base
Lower
Simple
Simple production
Advantages & Limitations
Advantages
➛ More accurate costing
➛ Better pricing decisions
➛ Improved cost control
Limitations
➛ Time-consuming
➛ Expensive to implement
➛ Complex system
True or False
➛ ABC uses multiple cost drivers
➛ Traditional costing is always more accurate than ABC
➛ Activities consume resources
➛ Cost drivers cause costs
Fill in the Blanks
1. ABC stands for __________
2. A cost driver is a __________ of cost
3. Costs are grouped into __________
4. ABC improves __________ of costing
Calculation Practice
A company has
Inspection cost =
Total inspections =
Total inspections =
$40,000
200
200
Tasks
➛ Calculate cost driver rate
➛ Allocate cost to the product
Comparison
State whether the situation favors ABC or Traditional Costing
➛ Simple production with identical products
➛ Complex production with multiple activities
➛ Company wants high accuracy in costing
➛ Small business with limited resources
Mini Case Study
A company produces two products: one simple and one complex. Traditional costing shows both products have similar costs, but management suspects inaccuracies.
Questions
➛ Why might traditional costing be misleading?
➛ How can ABC improve accuracy?
➛ Which product is likely undercosted?
➛ How can ABC improve decision-making?
Quick Quiz
➛ What is Activity-Based Costing?
➛ What is a cost driver?
➛ How is cost driver rate calculated?
➛ Why is ABC more accurate than traditional costing?
➛ Name one limitation of ABC
Answers ➧ Here
Overhead Allocation ➧ Here