Traditional Costing:
Use one predetermined overhead rate to allocate overhead costs to the product

Activity Based Costing:
You must identify the activity that causes the costs to occur and a cost driver to
accurately assign costs to products and customers.

Group your costs by major activities and divide by the amount of the total cost
driver associated to get the cost every time you do the cost driver.

Uses more than one predetermined overhead rate per activity because you have more
than one activity.

Activity:
Something that is done in support of a product or customer

Example: customer support, quality inspections, purchasing, warehouse

Cost Driver/Activity Driver:
A measurable event that occurs and causes cost to occur

Example: customer orders, inspections, purchase orders, material receipts
(sometimes called a transaction driver)

Activity Cost Pool:
Accumulation of all costs relate to a single type of activity

Example: all costs associated with processing a customer order is the cost pool for the
activity of order processing would consist of customer service wages, computers used
by customer service personnel, space required, supervisors’ salaries

Types of Activities

Unit level activities: performed each time a unit is produced
(electricity to run equipment, direct labor, direct materials)

Batch level activities: performed each time a batch is handled or processed
(purchase orders, equipment set-up, customer invoicing)

Product level activities:
Relate to specific products and must be carried out regardless of # units
(design a product, advertising, plant manager’s salary)

Customer level activities:
Relate to customers in general
(sales calls, catalog mailings, tech support)

Organization Sustaining:
Carried out regardless of how many products are sold
(computer network, executive salaries, insurance, corp. expenses)

Steps to take to implement ABC costing:

1) Identify activities: the company does over and over that causes the
company to incur overhead costs

2) Identify the cost pools that match the activity (put costs in cost pools) – accumulate all the costs that are incurred specifically to carry out each activity.

Divide your total overhead costs into groups of costs for each activity.

3) Calculate the activity rate:

Total cost pool $
    Total activity = $ rate per activity

You will have an activity rate for every activity.

4) Assign Costs to Cost Objects using the activity rate and # of activity:

A cost object is normally a product or a customer

     $ rate per activity
x  # activity for that product/customer
= total costs assigned to the product or customer

Total costs assigned
    Number of units = Overhead cost per unit 

Traditional Product Costing has one overhead allocation rate and one activity

Only manufacturing costs are assigned to products (required by GAAP)

Costs of doing an activity is spread over all products whether or not they require equal amounts of that activity 

ABC: more than one overhead allocation rate and more than one activity

Non manufacturing costs and manufacturing costs are assigned to products
(This is not according to GAAP, but useful for internal management)

Cost of doing an activity is allocated to the product based on how often the activity actually occurs

Organization sustaining costs and idle capacity costs are not typically assigned
to products

ABC Costing is more expensive and time consuming – data related to many activities must be collected and analyzed. 

Benefit of ABC Costing: Identify areas that benefit from process improvements that are inefficient and add no value. Allows you to determine what it costs every time an activity occurs.