UNSW Business School
ACCT2522 Management Accounting 1
Topic 2: Managing Costs -
Activity-Based Costing
(“ABC”)
Organisational Resources
Activities Processes
Value Creation
Role of Management
Accounting (MA)
Planning
Control
Introduced in COMM1170
Introduced in COMM1180; advanced
understanding in ACCT3583
Managing Costs
2. Activity-based Costing
3. Standard Costs &
Variance Analysis
1. MA &
Understanding
Processes
9. MA Information for
Decision-making
7. Responsibility
Accounting & Transfer
Pricing
8. Management Control
& Performance
Evaluation
Customers: Products & Services
Cost Quality Time
Managing Quality
4. Cost & Quality
Managing Time
5. Theory of Constraints
6. Project Management
St
ra
te
gy

Im
pl
em
en
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ACCT2522 Course Map
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.
3
Required Readings
• Langfield-Smith et al. (2022)
• Chapter 3 p. 73-74; and
• Chapter 8 including the Appendix
4
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.
5
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
6
2. Traditional or Volume-Based Costing
Systems
MOH Costs
Traditional
System
Cost Pool(s)
Cost Object
Cost Allocation Base/Driver
Budgeted
MOH costs
Budgeted
quantity
of cost driver
X
Actual
quantity
of cost
driver
Volume-based cost
drivers e.g., #DL,
#units produced
Revision: COMM1170;
Week 1 Tutorial
MOH rate =
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
8
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
9
10
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
families.
Facility level costs
– Cost relate to activities incurred to support the business as a
whole.
Reference: LS
Chapter 3 p. 73-74
11
Lecture Exercise
(Please refer to information provided in “Lecture Exercise:
Case on Karter Pens.” in order to complete this exercise.)
The cost object in this case is a Karter Pen. 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.
12
Lecture Exercise
(Cost object: 1 Karter Pen) Hierarchy Cost driver
Cost of mixing the ink (b) Batch # batches
of ink
Cost of setting up stamping
machines
(b) Batch #
production
runs
Cost of packaging individual pens
into boxes
(a) Unit # pens
produced
Cost of advertising (c) Product # product
groups
Factory-related costs associated
with running the factory
(d) Facility None
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
13
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 1 $10X1=$10 5 $10X5=$50
Machine
capacity (no. of
pens)
1000 100
Total no. of
pens produced
1000 100
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
15
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.
3.1 Assigning Overhead Costs Using ABC:
Some general principles
Resources
ABC
System
Activities
Products
Resource Drivers
Activity Drivers
Stage One:
Measuring the cost of
activities
Stage Two:
Assigning activity
costs to products
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.
– Activity drivers
• used to estimate the cost of an activity consumed by cost objects.
– Root cause cost drivers (Topic 1)
17
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
18
19
Setup
Moulding Machine
AssemblyMoulding
Overhead Costs
Etc.Moulding Machine Depreciation
Wages:
EmployeesElectricity
Etc.
# employees
(e.g., 5)
1 50% * 4
≈ 2
2
3.2.1 Stage One: Measuring cost of activities
20
Setup
Moulding Machine
AssemblyMoulding
Overhead Costs
Etc.Moulding Machine Depreciation
Wages:
EmployeesElectricity
Etc.
# machine
hours
3.2.1 Stage One: Measuring cost of activities
Lecture Example: AI Toys Ltd
AI Toys Ltd (AT) produces two AI toy lines:
1. R-dogs
2. R-cats
Required:
Using ABC, calculate the cost of one unit of R-dogs.
21
Lecture Example: AI Toys Ltd
22
Table 1: Production information per month
Storm Trooper
toys R-cat
Direct Material per unit $0.50 $0.50
Direct Labour rate $30.00 $30.00
Direct Labour hours 2,500 500
# of toys produced 50,000 10,000
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
23
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
24
Lecture Example: AI Toys Ltd
• 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)
• Identify resource drivers
• Cost per resource driver = Cost of resource
Quantity of resource driver
• Measure quantity of resource drivers consumed by activities
• Cost of each activity = Cost per resource driver*Quantity of
resource driver
25
3.2.1 Stage One: Measuring cost of activities
Resources : $ Resource Drivers
Quantity of
Resource
Drivers
Electricity 30,000 # Kilowatt hours (kwh) 250,000
Computer depreciation 10,000 # Computers 2
Salaries: product developers 50,000 # Product developers 2
Moulding machine depreciation 35,000 # Moulding machines 5
Salaries: employees 135,000 # Employees 25
Motor vehicle related costs 40,000 # Motor vehicles 4
Total cost of resources 300,000
26
 Identify resource drivers
Lecture Example: AI Toys Ltd
Resources : $ Resource Drivers
Quantity of
Resource
Drivers
Cost per
resource
driver
Electricity 30,000 # Kilowatt hours 250,000 $0.12
Computer depreciation 10,000 # Computers 2 $5,000
Salaries: developers 50,000 # Prod. developers 2 $25,000
Moulding mach. deprn. 35,000 # Moulding mach. 5 $7,000
Salaries: employees 135,000 # Employees 25 $5,400
MV related costs 40,000 # Motor vehicles 4 $10,000
Total cost of resources 300,000
27
 Calculate cost per resource driver
Cost per resource driver = Cost of resource
Quantity of resource driver
Lecture Example: AI Toys Ltd
 Calculate cost of each activity
28
Activity Pools Resource Consumption
Cost per
Resource
Driver
$
Cost per
resource
driver *qty of
resource
driver
Activity
Cost
Product development
25,000 kwh 0.12 3,000
2 Product developers 25,000 50,000
2 Computers 5,000 10,000 63,000
Setup moulding mach. 2 Employees 5,400 10,800 10,800
Moulding toys
175,000 kwh 0.12 21,000
5 Moulding machines 7,000 35,000
5 Employees 5,400 27,000 83,000
Assembling toys 50,000 kwh 0.12 6,000 10 employees 5,400 54,000 60,000
Customer deliveries 8 Employees 5,400 43,200 4 Motor vehicles 10,000 40,000 83,200
Total overhead cost 300,000
Activity cost = Cost per resource driver * Quantity of resource driver
Lecture Example: AI Toys Ltd
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
29
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
30
Calculate cost per activity driver
31
Activities Activity Costs Activity Drivers
Quantity of
Activity
Drivers
Cost Per
Activity
Driver
$ $
Product dev. 63,000 # New features 9 7,000.00
Setup moulding machines 10,800 # Moulding setups 50 216.00
Moulding toys 83,000 # Moulding batches 75 1,106.67
Assembling toys 60,000 # Toys 60,000 1.00
Customer deliveries 83,200 # Deliveries 20 4,160.00
Cost per activity driver = Cost of activity (e.g., 83,200)
Quantity of activity driver (e.g., 20)
Lecture Example: AI Toys Ltd
Lecture Example: AI Toys Ltd
• Applying cost of activities to product – taking the
example of R-dog unit
32
Activity Activity Drivers
Quantity of
Activity
Driver
Cost Per
Activity
Driver ($)
R-dogs
($)
Product
development
# New features
in development 4 7,000.00 28,000.00
Setup moulding
machine
# Moulding
setups 20 216.00 4,320.00
Moulding toys # Moulding batches 50 1,106.67 55,333.50
Assembling toys # Toys 50,000 1.00 50,000.00
Customer
deliveries
# Deliveries 10 4,160.00 41,600.00
Total 179,253.50
Cost per activity driver*Quantity of activity driver
= $10,800 X 20 set-ups (≈ 216)
50 set-ups
Cost per activity driver*Quantity of activity driver
= $10,800 X 20 set-ups (≈ 216)
50 set-ups
• Applying cost of activities to product – taking the
example of R-dog unit
33
Activity Activity Drivers
Quantity of
Activity
Driver
Cost Per
Activity
Driver ($)
R-dogs
($)
Product
development
# New features
in development 4 7,000.00 28,000.00
Setup moulding
machine
# Moulding
setups 20 216.00 4,320.00
Moulding toys # Moulding batches 50 1,106.67 55,333.50
Assembling toys # Toys 50,000 1.00 50,000.00
Customer
deliveries
# Deliveries 10 4,160.00 41,600.00
Total 179,253.50
Lecture Example: AI Toys Ltd
34
R-dogs
Activity
Cost per unit
of activity
Driver
Quantity of
Activity
Driver
Activity
Cost
$ $
Product dev. 7,000 4 28,000
Setup moulding machines 216 20 4,320
Moulding toys 1,106.67 50 55,333.50
Assembling toys 1 50,000 50,000
Customer deliveries 4,160 10 41,600
Total Overhead cost 179,253.50
Prime Costs
Direct Materials 0.50 50,000 25,000
Direct Labour 30.00 2,500 75,000
Total prime costs 100,000
Total product cost $279,253.50
Cost per unit $5.59
Lecture Example: AI Toys Ltd
3.2 Two-Stage Process of Assigning
Overhead Costs Using ABC Systems
35
Cost Objects: R-dogs and R-cats
Directly
traced
DL DM
Prime Costs
Product
dev
Setup
M. Mach. DeliveringAssemblyMoulding
Overhead Costs
Salaries:
Developers Computers MV
Machine
Depn
Salaries:
EmployeesElectricity
………Second Stage Allocation…......
………First-Stage Allocation…......
Your turn!
Required:
Using ABC, calculate the cost of one unit of R-
cats.
36
Lecture Exercise: AI Toys Ltd
Activity Cost per unit ofactivity 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
Calculate: Cost of one R-cat
Topic 2: Learning Objectives
38
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.
4. When is ABC or VBC appropriate?
1. (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.
39Note: for ACCT2522, the significance threshold will be 10% of costs
R-dogs R-cats ABCproduct cost
VBC
product cost
Activity Costs $ $ $
Product development 28,000 35,000 63,000
Setup moulding machines 4,320 6,480 10,800
Moulding toys 55,333.50 27,666.75 83,000 153,800
Assembling toys 50,000 10,000 60,000
Customer deliveries 41,600 41,600 83,200
Total overhead cost 179,253.50 120,746.50 300,000 153,800
Prime Costs 100,000 20,000 120,000 120,000
Product cost 279,253.50 140,746.50 420,000 273,800
1. (i) MOH is a significant portion of manufacturing costs AND (ii) a
significant proportion of MOH is non-volume driven?
(rounding)
Yes(i) MOH/Total manufacturing cost: 153.8k/273.8k = 56.2%,
273,800
Note: for ACCT2522, the significance threshold will be 10% of costs
Lecture Example: AI Toys Ltd
R-dogs R-cats ABCproduct cost
VBC
product cost
Activity Costs $ $ $
Product development 28,000 35,000 63,000
Setup moulding machines 4,320 6,480 10,800
Moulding toys 55,333.50 27,666.75 83,000 153,800
Assembling toys 50,000 10,000 60,000
Customer deliveries 41,600 41,600 83,200
Total overhead cost 179,253.50 120,746.50 300,000 153,800
Prime Costs 100,000 20,000 120,000 120,000
Product cost 279,253.50 140,746.50 420,000 273,800
1. (i) MOH is a significant portion of manufacturing costs AND (ii) a
significant proportion of MOH is non-volume driven?
(rounding)
Yes(i) MOH/Total manufacturing cost: 153.8k/273.8k = 56.2%,
93,800
(ii) Non-vol-based MOH/Total MOH: 93.8K/153.8k = 61.0%, Yes
Use
ABC!
Note: for ACCT2522, the significance threshold will be 10% of costs
Lecture Example: AI Toys Ltd
4.1 Proof of ABC being Superior to VBC:
Allocating of MOH costs
42
R-dogs R-cats
$ $
Total per unit Total
per
unit
Direct Material 25,000 0.50 5,000 0.50
Direct Labour (rate x DL hrs) 75,000 1.50 15,000 1.50
Total overhead cost
[$153.8k/(50k+10k) x units] 128,166.67 2.56 25,633.33 2.56
Total product cost 228,166.67 4.56 45,633.33 4.56
Using no. of units produced as a cost driver.
50K 10K
4.1 Proof of ABC being Superior to VBC:
Allocating of MOH costs
43
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 2.56 4.56
R-cat costs 25,633.33 2.56 4.56
Activity based cost drivers
R-dog costs 109,653.50 2.19 4.19 5.59
R-cat costs 44,146.75 4.41 6.41 14.07
Comparing based on MOH allocation:
R-dogs is over-costed $4.56 > $4.19
R-cats is under-costed $4.56 < $6.41
High vol
Low vol
4. When is ABC or VBC appropriate?
1. (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.
2. 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
44Note: for ACCT2522, the significance threshold will be 10% of costs
Unit-level
activities80% 20%
Non-unit-level
activities 80%20%
Activities Costs
Total
Activity
Drivers
R-dogs R-cats
# Drivers Consumption Ratio # Drivers
Consumption
Ratio
Product development
9 4 44.4% 5 55.6%
Setup moulding machines 50 20 40% 30 60%
Moulding toys
Assembling toys
Customer deliveries
Unit level cost driver
$153,800 60,000 50,000 83.3% 10,000 16.7%
4.2 Consumption Ratios
45
5/94/9
“the proportion of each activity consumed by a product”
Consumption ratio: # activity drivers consumed by a product
Total # activity drivers
30/5020/50
4.2 Proof of ABC being superior to VBC:
Consumption Ratios
Activities Costs
Total
Activity
Drivers
R-dogs (ABC) R-cats (ABC)
# Drivers Consumption Ratio # Drivers
Consumption
Ratio
Product development 9 4 44.4% 5 55.6%
Setup moulding machines 50 20 40% 30 60%
Moulding toys 75 50 66.7% 25 33.3%
Assembling toys 60,000 50,000 83.3% 10,000 16.7%
Customer deliveries 20 10 50% 10 50%
46
2. 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 Yes Use ABC!
4. When is ABC or VBC appropriate?
1. (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.
2. 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
– VBC not appropriate: assume products consume non-unit-level activities in
the same proportion as unit-level activities (as volumed-based cost drivers)
3. Non-manufacturing costs is a significant proportion of total product cost.
– VBC not appropriate: does not allocate non-manufacturing costs
47Note: for ACCT2522, the significance threshold will be 10% of costs
R-dogs R-cats ABCproduct cost
VBC
product cost
Activity Costs $ $ $
Product development 28,000 35,000 63,000
Setup moulding machines 4,320 6,480 10,800
Moulding toys 55,333.50 27,666.75 83,000 153,8000
Assembling toys 50,000 10,000 60,000
Customer deliveries 41,600 41,600 83,200
Total overhead cost 179,253.50 120,746.50 300,000 153,800
Prime Costs 100,000 20,000 120,000 120,000
Product cost 279,253.50 140,746.50 420,000 273,800
4.3 Proof of ABC being Superior to VBC:
Non-MOH vs total overhead costs
3. Non-manufacturing costs significant proportion of total product cost?
(rounding)
Non-manufacturing/Total product cost=(63K+83.2K)/(420K)=34.8% Yes
Use
ABC!
1. (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.
2. 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
– VBC not appropriate: assume products consume non-unit-level activities in
the same proportion as unit-level activities (as volumed-based cost drivers)
3. Non-manufacturing costs is a significant proportion of total product cost.
– VBC not appropriate: does not allocate non-manufacturing costs
4. “Costs” associated with making inappropriate decisions based on
inaccurate product costs are high.
– Cost benefit analysis => VBC is associated with more costly errors.
49Note: for ACCT2522, the significance threshold will be 10% of costs
4. When is ABC or VBC appropriate? Adapted LS p. 345
4. High costs associated with inaccuracy?
4.4 Proof of ABC being superior to VBC:
Costs due to inappropriate decisions
Product
Using VBC,
cost per
Using ABC,
cost per
$ $
R-dogs 4.56 5.59
R-cats 4.56 14.07
Based on VBC: Difference ($) Difference (%)
R-dogs 1.03 18.4%
R-cats 9.51 67.6%
Yes Use ABC!
(VBC-ABC)
ABC
Summary: Should AI Toys use ABC?
1. (i) MOH is a significant portion of manufacturing costs AND (i) a
significant proportion of MOH is non-volume driven?
a) MOH/Total manufacturing cost: 153.8k/273.8k = 56.2%
b) Non-vol-based MOH/Total MOH = 93.8k/153.8k = 61.0%
2. Product diversity: Products consume non-unit-level activities in
proportions that differ substantially from unit-level activities?
3. Non-manufacturing costs is a sig proportion of total product cost
– (Prod. dev.+ Cust. del.)/ Tot product cost = $146.2k/420k = 34.8%
– VBC does not allocate non-manufacturing costs
4. High cost associate with inaccuracy?
Costing method VBC ABC Diff
R-dogs $4.56 $5.59 22.6%
R-cats $4.56 $14.07 208.6%
ABC? Yes
ABC? Yes
ABC? Yes
Activities Drivers Consumed R-dogs R-cats
Product development 44.4% 55.6%
Setup moulding machines 40% 60%
Moulding toys 66.7% 33.3%
Assembling toys 83.3% 16.7%
Customer deliveries 50.0% 50.0%
Consumption ratios differ from
unit-level ones
ABC? Yes
Cost vs
Benefit!
Topic 2: Learning Objectives
52
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.
5. Activity-Based Management (ABM) LO5
53
“Using information from activity-
based costing to analyse
activities, cost drivers and
performance so that customer
value and profitability are
improved”
LS p. 725.
Reference: LS
Chapter 16 p. 724-725
Topic 2: Learning Objectives
54
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.
6. Limitations of ABC (LO6)
• Facility level costs
– If allocated, an arbitrary allocation base is used
– If not allocated, the cost must still be recouped
• “Unitised costs” (Use of average costs)
• Incorporated in cost per unit includes batch-level,
product-level, and facility level cost that does not vary
with no. of unit produced.
• Complexity
– Detailed data collection and recording
– Constant updating required if company is changing
rapidly
• Behavioral issues when implementing ABC
55
56
Review Questions
1. Why would a sales manager wanting to drop a profitable product be
an indication of an outdated product costing system?
2. Which of the following are batch level costs if the cost objective is a
meal in a cafe?
a) Cost of cleaning the kitchen
b) Cost of pouring milk and performing latte art
c) Cost of baking cupcakes
3. Identify the three types of cost drivers adopted in an ABC system and
discuss their differences.
4. Which of the following support the adoption of ABC systems?
a) MOH costs are 10% or more of total manufacturing costs.
b) 10% or more of MOH are driven by non-volume based cost drivers.
c) If both (a) and (b) are true
5. What do you understand by activity-based management?
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Review Questions
6. The consumption ratios in the table are similar and therefore VBC
should be used. True or False?
7. Which of the following are limitations of ABC systems?
a) They require significantly more data than VBC systems.
b) They require extensive updating if the product range changes.
c) They exclude facility level costs which reduce the accuracy of cost per
unit.
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Guidance to Review Questions
1. See probable cause as indicated in the first row of Exhibit 8.1
2. (c) – baking activity is performed for a tray (i.e., batch) of cupcakes
and the cost of baking does not vary whether you have one cupcake
or 20 on the tray. (a) is a facility level cost, and (b) a unit level cost.
3. See definitions provided on LS p. 335.
4. (c) – if (a) is true, ABC is only potentially more accurate than VBC
given the sig proportion of MOH costs. If (b) is false and <10% of
MOH costs are driven by vol-based cost drivers, ABC is not
substantially more accurate than VBC but more costly to adopt.
5. See explanation on LS p. 725 for a starting point.
6. False: Although the consumption ratios for the non-volume based
activities are similar for each product, they are substantially different
from the consumption ratio of the unit level activity.
7. (a) and (b): see slide on limitations. (c) is incorrect – ABC systems
generally include facility level costs but accuracy is not improved.
Topic 2: Learning Objectives
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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.
Next week…
• Topic 3: Standard Costing and Variance
Analysis
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