UNSW Business School
ACCT2522 Management Accounting 1
Topic 2: Managing Costs – Activity-Based Costing (“ABC”)
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ACCT2522 Course Map
Introduced in COMM1180; advanced understanding in ACCT3583
Managing Costs
2. Activity-based Costing
3. Standard Costs & Variance Analysis
Managing Quality 4. Cost & Quality
Managing Time
5. Theory of Constraints 6. Project Management
7. Responsibility Accounting & Transfer Pricing
8. Management Control & Performance Evaluation
9. MA Information for Decision-making
1. MA & Understanding Processes
Value Creation
Customers: Products & Services
Cost Quality Time
Role of Management Accounting (MA)
Planning Control
Activities
Organisational Resources
Introduced in COMM1170
Strategy Implementation
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.
Required Readings
• Langfield-Smith et al. (2022)
• Chapter 3 p. 73-74; and
• Chapter 8 including the Appendix
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.
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
2. Traditional or Volume-Based Costing Systems
Traditional System
Revision: COMM1170; Week 1 Tutorial
MOH rate =
Budgeted MOH costs X
Budgeted quantity of cost driver
Actual quantity of cost driver
Cost Pool(s)
Cost Allocation Base/Driver
Volume-based cost drivers e.g., #DL, #units produced
Cost Object
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
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
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
Facility level costs
– Cost relate to activities incurred to support the business as a whole.
Reference: LS Chapter 3 p. 73-74
Lecture Exercise
(Please refer to information provided in “Lecture Exercise: Case on .” in order to complete this exercise.)
The cost object in this case is a 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.
Lecture Exercise
(Cost object: 1 )
Cost of mixing the ink
Cost of setting up stamping machines
Cost of packaging individual pens into boxes
Cost of advertising
Factory-related costs associated with running the factory
(c) Product
(d) Facility
Cost driver
# batches of ink
# production runs
# pens produced
# product groups
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
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
Machine capacity (no. of pens)
Total no. of pens produced
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
1. Explain potential problems with using traditional (aka volume-based) costing systems.
2. Describe and apply the activity hierarchy of costs and cost drivers.
4. Evaluate the appropriateness of ABC.
5. Demonstrate the ability to apply Activity-based Management (ABM)
6. Understand the limitations of ABC.
3. Use activity-based costing (ABC) systems assign costs to cost objects.
3.1 Assigning Overhead Costs Using ABC: Some general principles
Stage One: Measuring the cost of activities
Stage Two: Assigning activity costs to products
ABC System
Resource Drivers
Activities
Activity Drivers
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 drivers
• used to estimate the cost of an activity consumed by cost objects.
– Root cause cost drivers (Topic 1)
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
3.2.1 Stage One: Measuring cost of activities
Overhead Costs
Electricity
Wages: Employees
Moulding Machine Depreciation
50% * 4 ≈2
# employees (e.g., 5)
Setup Moulding Machine
Assembly Etc.
3.2.1 Stage One: Measuring cost of activities
Overhead Costs
# machine hours
Electricity
Wages: Employees
Moulding Machine Depreciation
Setup Moulding Machine
Assembly Etc.
Lecture Example: AI Toys Ltd
AI Toys Ltd (AT) produces two AI toy lines:
1. R-dogs 2. R-cats
Using ABC, calculate the cost of one unit of R-dogs.
Lecture Example: AI Toys Ltd
Table 1: Production information per month
Direct Material per unit Direct Labour rate Direct Labour hours
# of toys produced
Storm Trooper toys
$0.50 $30.00 2,500 50,000
$0.50 $30.00 500 10,000
Lecture Example: AI Toys Ltd
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
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
3.2.1 Stage One: Measuring cost of activities
• Identify major activities (includes the combination of minor activities into major activity pools)
• Identify resource drivers
• Measure quantity of resource drivers consumed by activities
• Costing activities by assigning cost (of resources) to activities (forming activity cost pools)
• Cost per resource driver = Cost of resource Quantity of resource driver
• Cost of each activity = Cost per resource driver*Quantity of resource driver
Lecture Example: AI Toys Ltd
Identify resource drivers
Resources :
Resource Drivers
Quantity of Resource Drivers
Electricity
# Kilowatt hours (kwh)
Computer depreciation
# Computers
Salaries: product developers
# Product developers
Moulding machine depreciation
# Moulding machines
Salaries: employees
# Employees
Motor vehicle related costs
# Motor vehicles
Total cost of resources
Lecture Example: AI Toys Ltd
Calculate cost per resource driver
Resources :
Resource Drivers
Quantity of Resource Drivers
Cost per resource driver
Electricity
# Kilowatt hours
Computer depreciation
# Computers
Salaries: developers
# Prod. developers
Moulding mach. deprn.
# Moulding mach.
Salaries: employees
# Employees
MV related costs
# Motor vehicles
Total cost of resources
Cost per resource driver = Cost of resource Quantity of resource driver
Lecture Example: AI Toys Ltd
Calculate cost of each activity
Activity Pools
Product development
Setup moulding mach.
Moulding toys
Assembling toys
Customer deliveries
Total overhead cost
Resource Consumption
25,000 kwh
2 Product developers
2 Computers
2 Employees
175,000 kwh
5 Moulding machines
5 Employees
50,000 kwh
10 employees
8 Employees
4 Motor vehicles
Activity cost = Cost per resource driver * Quantity of resource driver
Cost per Resource Driver
Cost per resource driver *qty of resource driver
Activity Cost
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
3.2.2 Stage Two: Assigning activity costs to products
Identify activity drivers
Calculate the activity cost per unit of activity driver
• Cost per activity driver = Cost of activity Quantity of activity driver
Applying cost of activities to product
• Applying activity cost to product = Cost per activity driver * Quantity of activity driver
Lecture Example: AI Toys Ltd
Calculate cost per activity driver
Activities
Activity Costs
Activity Drivers
Quantity of Activity Drivers
Cost Per Activity Driver
Product dev.
# New features
Setup moulding machines
# Moulding setups
Moulding toys
# Moulding batches
Assembling toys
Customer deliveries
# Deliveries
Cost per activity driver = Cost of activity (e.g., 83,200) Quantity of activity driver (e.g., 20)31
Cost per activity driver*Quantity of activity driver
Lecture Example: AI Toys Ltd
= $10,800 X 20 set-ups (≈ 216) 50 set-ups
• Applying cost of activities to product – taking the example of R-dog unit
Product development
Setup moulding machine
Moulding toys
Assembling toys
Customer deliveries
Cost per activity driver*Quantity of activity driver
= $10,800 X 20 set-ups (≈ 216)
# New features in development
# Moulding setups
# Moulding batches
# Deliveries
Quantity of Cost Per
R-dogs Activity Activity ($)
Drivers 50 set-ups
Driver Driver ($)
179,253.50
Lecture Example: AI Toys Ltd
• Applying cost of activities to product – taking the example of R-dog unit
Activity Drivers
Quantity of Activity Driver
Cost Per Activity Driver ($)
R-dogs ($)
Product development
# New features in development
Setup moulding machine
# Moulding setups
Moulding toys
# Moulding batches
Assembling toys
Customer deliveries
# Deliveries
179,253.50
Lecture Example: AI Toys Ltd
Cost per unit of activity
Quantity of Activity Driver
Activity Cost
Product dev.
Setup moulding machines
Moulding toys
Assembling toys
Customer deliveries
Total Overhead cost
179,253.50
Prime Costs
Direct Materials
Direct Labour
Total prime costs
Total product cost
$279,253.50
Cost per unit
3.2 Two-Stage Process of Assigning
Overhead Costs Using ABC Systems
Prime Costs
Overhead Costs
Salaries: Developers
Electricity
Salaries: Employees
Machine Depn
………First-Stage Allocation………
Product dev
Setup M. Mach.
Directly traced
Delivering
………Second Stage Allocation………
Cost Objects: R-dogs and R-cats
Lecture Exercise: AI Toys Ltd
Your turn!
Using ABC, calculate the cost of one unit of R- cats.
Calculate: Cost of one R-cat
Cost per unit of activity driver
Quantity of activity driver
Activity cost
Product development
Setup moulding machines
Moulding toys
Assembling toys
Customer deliveries
Total Overhead cost
Prime Costs
Direct Materials
Direct Labour
Total prime costs
Total product cost
Cost per R-cat
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.
5. Demonstrate the ability to apply Activity-based Management (ABM)
6. Understand the limitations of ABC.
4. Evaluate the appropriateness of ABC.
4. When is ABC or VBC appropriate?
(i) MOH costs are a significant proportion of total manufacturing costs; AND (ii) a significant proportion of MOH are driven by non-volume based cost drivers.
– VBC not appropriate: allocates cost using volume-based cost drivers.
Note: for ACCT2522, the significance threshold will be 10% of costs
Lecture Example: AI Toys Ltd
1. (i) MOH is a significant portion of manufacturing costs AND (ii) a
significant proportion of MOH is non-volume driven? (i) MOH/Total manufacturing cost: 153.8k/273.8k = 56.2%,
Activity Costs
Product development
Setup moulding machines
Moulding toys (rounding)
Assembling toys
Customer deliveries
Total overhead cost
Prime Costs
Product cost
179,253.50
279,253.50
120,746.50
140,746.50
ABC product cost
VBC product cost
Note: for ACCT2522, the significance threshold will be 10% of costs
Lecture Example: AI Toys Ltd
1. (i) MOH is a significant portion of manufacturing costs AND (ii) a significant proportion of MOH is non-volume driven?
(i) MOH/Total manufacturing cost: 153.8k/273.8k = 56.2%, Yes (ii) Non-vol-based MOH/Total MOH: 93.8K/153.8k = 61.0%, Yes
Activity Costs
Product development
Setup moulding machines
Moulding toys (rounding)
Assembling toys
Customer deliveries
Total overhead cost
Prime Costs
Product cost
179,253.50
279,253.50
120,746.50
140,746.50
ABC product cost
VBC product cost
Note: for ACCT2522, the significance threshold will be 10% of costs
4.1 Proof of ABC being Superior to VBC: Allocating of MOH costs
Using no. of units produced as a cost driver.
Direct Material
Direct Labour (rate x DL hrs) Total overhead cost
25,000 0.50 75,000 1.50
128,166.67 2.56
10K R-cats
5,000 0.50 15,000 1.50
25,633.33 2.56
[$153.8k/(50k+10k) x units]
Total product cost
228,166.67 4.56
45,633.33 4.56
4.1 Proof of ABC being Superior to VBC: Allocating of MOH costs
Total MOH cost
MOH cost per toy
Cost per toy
Using ABC, cost per toy
Volume based cost drivers
R-dog costs
128,166.67
R-cat costs
Activity based cost drivers
R-dog costs
109,653.50
R-cat costs
Comparing based on MOH allocation: R-dogs is over-costed $4.56 > $4.19 R-cats is under-costed $4.56 < $6.41
4. When is ABC or VBC appropriate?
(i) MOH costs are a significant proportion of total manufacturing costs; AND (ii) a significant proportion of MOH are driven by non-volume based cost drivers.
– VBC not appropriate: allocates cost using volume-based cost drivers.
Product diversity: Products consume non-unit-level activities in proportions that differ substantially from unit-level activities.
– Test: Consumption ratios of non-unit-level activities differ from the consumption ratio of unit-level activities
Unit-level activities
Non-unit-level activities
Note: for ACCT2522, the significance threshold will be 10% of costs
4.2 Consumption Ratios
“the proportion of each activity consumed by a product”
Activities Costs
Total Activity Drivers
50 20 40% 30 60%
Consumption # Drivers Consumption Ratio Ratio
R-dogs R-cats
Product development Setup moulding machines
Moulding toys Assembling toys
Customer deliveries
4 4/9 44.4% 55/9 55.6%
Consumption ratio: # activity drivers consumed by a product Unit level cost driver
$153,800 60,000 50,000 83.3% 10,000 16.7% Total # activity drivers
4.2 Proof of ABC being superior to VBC: Consumption Ratios
2. Product diversity: Products consume non-unit-level activities in proportions that differ substantially from unit-level activities
• Test: Consumption ratios of non
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