ACTIVITY BASED COSTING

Prepared by: Olivo, CPA, MBA

- Focuses on non-direct cost to be allocated to various activities/cost drivers

- As oppose to traditional costing which uses only one driver, usually the labor hours, ABC uses multiple cost driver

Example of Cost drivers:

o Direct labor
o Machine hours
o Set ups
o Batches
o Orders
o Any other activity / cost driver

- This costing system is a two-staged procedure that uses multiple drivers to predict and allocate costs to products and services
o Stage 1 – Significant activities are identified, and costs are assigned to activity cost pools based on the way resources
are consumed by such activities.
o Stage 2 – Costs are allocated from each activity cost pool to each cost target (jobs, products, customers) in proportion
to the amount of cost driver consumed by the cost target

- Differences between ABC and traditional costing:

Activity-Based Costing Traditional Costing

Assume that cost objects consume Assume that cost objects consume
activities resources
Uses drivers at various levels Uses volume-related allocation bases
Process-Oriented Structure-Oriented

PROBLEM 1

Sampaguita Company has used a traditional cost accounting system to apply quality control costs uniformly to all products at a rate
of P20 per direct labor hour. The average monthly direct labor hours for its main product are 9,600 hours.

The Company wants to shift to ABC system in order to allocate quality control costs to its products in a more equitable manner. To
start with, process value analysis was conducted. Quality control activities were determined, as well as the appropriate cost drivers
and cost driver rates. The analysis yielded the following:

Activity Cost Driver Rate Quantity for main

product
Inspection of materials Classes of materials P500 pre class 20 classes
deliveries
Inspection of goods in Number of units P10 per unit 12,000 units
process
Final inspection before Number of orders P200 per order 100 orders
delivery of finished goods

1. The quality control cost that would be assigned to the main product using the traditional costing system is ___________.
2. The quality control cost that would be assigned to the main product using ABC system is __________.

PROBLEM 2

The cost accountant of Above the Ankle is considering to use the ABC system in determining the cost of its products.

At present, the company uses the traditional costing system wherein factory overhead costs are allocated based on direct labor hours.
The cost accountant believes that the present system maybe providing misleading cost information, hence, the plan to change to the
ABC system. For the coming period, the company is planning to use 5,000 direct labor hours, and its total budgeted factory overhead
amounts to P90,000, broken down as follows:

Activity Cost Driver Budgeted Activity Budgeted Cost

Setup costs Number of set ups 40 P20,000
Production monitoring Number of batches 20 P40,000
Quality control Number of inspections 1,000 P30,000

Projected data for one of the Company’s product, Product B, for the coming period are as follows:

Production and sales 1,000 units Number of inspections 200

Direct labor hours 2,000 hours Direct material cost P10 per unit
Units per batch 500 Direct labor rate P20 per hour
Number of setups 4

1. If the Company will use the traditional full cost system, the cost per unit of product B for the coming period will be
____________.
2. If the Company will use the ABC system, the cost per unit of product B for the coming year will be _________.

PROBLEM 3

Sheldon Cooper operates Daddy’s Nursery which provides baby-sitting services for children between 2 to 5 years old. Working mothers
leave their children at 8:00 am and pick them up after office hours.

Sheldon converted his house into a nursery home where children are provided with sleeping areas, play pen and study areas, as well
as meals, milk, and snacks. Nursery fee is computed by adding a mark up to the total cost of service provided to each child.

At present, Sheldon uses the traditional costing system in computing the cost of service per child, where the total cost is divided by
the number of children served.

During the previous month, the nursery served100 children, for which the company incurred P50,000 total cost of service. Sheldon
observed, however, that it is not right to just divide the total cost by the number of children because incurrence of some costs may
vary depending on some factors. For example, children between 2 to 3 years old need more attention and are provided more services
that those above 3 years old.

Considering this, Sheldon, plans to apply ABC system in determining the cost of service per child. He conducted a study of the previous
month’s operations, and the following results came out:

Cost Category Cost Cost Driver Cost Driver Quantity

Meals, Snacks, Supplies P20,000 Number of children 100 children
Caregiving hours P30,000 Staff hours 1,200 staff

Children Category Number of children Staff hours

Babies (2-3 years old) 60 1,000
Kiddies (above 3 years old) 40 200

1. If the traditional costing system were used and nursery fee was computed at 300% of the cost of service per child, Daddy’s
Nursery could have charged each child a fee of _________.
2. If the ABC system were used, nursery fee per child should have been _________.