Activity Based Costing (ABC)

The principal purpose of any costing system is to allocate the cost of production (direct materials, and manufacturing overhead) to the units purchased.
ACTIVITY BASED COSTING

It is a refinement of the traditional costing systems of allocating manufacturing overhead to the units produced. Traditional costing system always used volume related
measures, such as direct labor hours or machine hours to allocate overheads to products.
ABC allocates overheads to products on the basis of resources consumed by each activity involved in the design, production and distribution of a particular product. This is
accomplished by assigning costs to cost pools that represent specific activities and allocating these costs using the appropriate cost drivers to the product. Cost drivers are those
activities which have a direct cause and effect relationship to the investment of a particular cost.

Comparison of traditional costing system and ABC

CPAR produces products two products: L and H. Both are produce on the same equipment and use similar processes. Production data are as follows.
Product L Product H
Machine hours per unit 2 2
Direct labor hours per unit 4 4
Units produced 1,000 10,000
Total machine hours 2,000 20,000
Total direct labor hours 4,000 40,000
Number of purchase orders 80 160
Number of set -ups 40 60
The overhead cost of the activities is as follows:
Volume-related P 1 10,000
Purchasing-related 120,000
Set-up-related 210,000
Total overhead cost P 440,000*
(a) Traditional costing system:
Overhead rate per machine hour (P440,000/22,000 hours) P2
0
Overhead rate per direct labor hour (P440,000/44,000 hours) P1
Cost per unit of: 0

Product L – based on machine hours (2 hrs x P20) P4

0
Product H – based on direct labor hours (4 hrs x P10) P4
0
(b) ABC system
Volume-related Purchasing-related Set-up related
Overhead costs P110,000 P120,000 P210,000
Cost drivers 22,000 machine hrs 240 purchase orders 100 set-ups
Overhead cost per unit of

consumption P5/machine hr. P500/per order P2,100 per set-ups

Allocated costs to products:

L P10,000(2,000xP5) P40,000(80xP500) P84,000(40xP2100)

H P100,000(20,000xP5) P80,000(160xP500) P126,000(60xP2100)
Overhead cost per unit:
Product L = P134 (P10,000+P40,000+84,000)/1,000 units
Product H = P30.60 (P100,000+P80,000+P126,000)/10,000 units

1. Uratex company manufactures a variety of classroom chairs. Its job-costing systemuses an activity-based approach. There are two direct-cost categories (direct
materials and direct labor) and there indirect cost pools. The cost pools represent three activity areas at the plant.
Manufacturing Budgeted Cost Driver used Cost-allocation
Activity Area Cost for 2013 as Allocation Base rate

Materials Handling P200,00 Parts P0.25

Cutting 2,000,000 Parts 2.50
Assembly 2,000,000 direct labor hours 25,000
Two styles of chairs were produced on March, the high school chair, and the college chair. Their quantities, direct material costs, and other data for March 2013 are as follows:
Direct Direct
Units Materials Number Manufacturing
Produced Costs of Parts Labor hours

High school chair 5,000 P600,000 100,000 7,500

College chair 100 25,000 3,500 500
The direct labor rate is P20 per hour. Assume no begging or ending inventory.

What are the unit cost of the high school chair and college chair?

a. P240.50 and P571.75 respectively

b. P242.50 and 570.25 respectively
c. P252.50 and P571.25 respectively
d. P242.50 and P571.25 respectively
2. The manila company manufactures and sells packaging machines. It recently used an activity-based approach to refine the job costing system at its BulacanPlant..
The resulting job costing system has one direct-cost category (direct materials) and four indirect manufacturing cost pools. These four indirect cost pools and their allocation
bases are:
Indirect Manufacturing Cost-Allocation Budgeted Cost-
Cost Pool base Allocation rate

1. Material handling Component parts P8 per part

2. Machining machine- hours P68 p er hour
3. Assembly assembly-hours P75 p er hour
4. Inspection inspection-hours P104 p er hour
Manila Company recently sold 50 can-packaging machines to Ilocos Company. Each machine has direct material costs of P3,000 requires 50 component parts, 12 machine
hours, 15 assembly hours, and 4 inspection hours.

Manila Company’s previous costing system had one direct-cost category (direct materials) and one indirect-cost category (manufacturing overhead allocated at therate of
P100 per assembly-hour).

In comparison to the traditional costing system used by Manila Company, the total manufacturing cost of the machines sold under the ABC is:

a. P114,850 higher
b. P141,850 lower
c. P114,950 higher
d. Equal

3. Believing that its traditional cost system may be providing misleading information, BMW company is considering an activity based costing approach, it now
employs a full cost system and has been applying its manufacturing overhead on the basis of machine hours.

No. 3 –Continued
The company plans on using 50,000 direct labor hours and 30,000 machine hours in the coming year. The following data show the manufacturing overhead that is
budgeted.
Activity Cost Driver Budgeted Activity Budgeted Cost
Material handling No. of parts handled 6,000,000 P720,000
Setup costs No. of setups 750 315,000
Machine costs Machine hours 30,000 540,000
Quality control No. of batches 500 225,000
Cost, sales, and production data for one of the company’s product for the coming year are as follows:

Prime Costs:
Direct material cost per unit P4.40
Direct labor cost per unit, .05 direct labor
hour@P15 p er hour 0.75
Sales and production data:
Expected sales 20,000 units
Batch size 5,000 units
Setups 2 pe r ba tch
Total parts per finished unit 5 parts
Machine hours required 90 machine hours per batch
If the company employs an activity-based costing system, the cost per unit for the product described for the coming year will be:

a. P6.00
b. P6.08
c. P6.21
d. P6.30
4. Tamiya Corporation has use a traditional costing system to apply quality control costs uniformly to all products at a rate of 14.5% of direct labor cost. Monthly direct labor
cost for its Product X is P275,000. in an attempt to distribute quality control costs more equitable, Tamiya is considering activity-based costing (ABC). The June data
shown below have been gathered for Product X.
Activity Cost Driver Cost Rates Quantity
1. Material handling Type of materials P115 per type 12 types
2. Inspection Number of units P1.40 p er unit 17,500 u nits
3. Production certification Per order P770 per order 25 orders
No. 4 – Continued
What is the monthly quality control assigned to product X using the ABC?
a. P686.40 per order
b. 5,255 higher than the traditional costing system
c. P85,000.5
d. P5,255 lower than the traditional costing system

5. Yokomo Inc. accumulated the following cost information for its products, A and B.
Product A Product B
Units produced 2,000 1,000
Total direct labor hours 5,000 20,000
Set-up cost per batch P1,000 P2,000
Batch size 100 50
Total setup cost incurred P20,000 P40,000
Direct labor hour per unit 2 1
A traditional costing system would allocate setup costs on the basis of direct labor hours. An ABC system would trace costs by spreading the cost per batch over the units
in a batch. What is the setup cost per unit of Product A under each costing system?
Traditional costing ABC
a. P4.80 P10
b. P2.40 P10
c. P40.00 P200
d. P4.80 P20

6. Mactan Enterprise is a Philippine exporter of souvenir items manufactured in the capital city of Cebu. The following overhead cost data have been accumulated.
Amount
Activity Center Cost Driver of activity Center Costs

Material handling Kilos handled 100,000 grams P50,000

Painting Units painted 50,000 u nits 200,000
Assembly Labor hours 4,000 h ours 120,000
Job RST contains 3,000 units. It weights 10,000 kilos and uses 300 hours of labor What is the total overhead cost assigned to Job RST?

a. P31,955
b. P27,750
c. P26,000
d. P32,000

Numbers 7 and 8 are based on the following data:

Omega Company is preparing its annual profit plan. As part of its analysis of the profitability of individual products, the controller estimates the amount of overhead that
should be allocated to the individual product lines from the information given as follows:
Wall Specialty
Mirrors Windows
Units pro duced 25 25
Material moves per product line 5 15
Direct labor hours per unit 200 200
Budgeted materials handling costs P50,000
Under a costing system that allocates overhead on the basis of direct labor hours
(traditional), the materials handling costs allocated to one unit of wall mirrors would be

a. P1,000
b. P500
c. P2,000
d. P5,000

8. Under activity based costing (ABC), what is the materials handling costs allocated to one unit of wall mirrors?

a. P1,000
b. P500
c. P1,500
d. P2,000

9. Delta Machine Toll Incorporated produces a varied product line without the use of direct labor. An extensive setup procedure is required. Because no single base for a
predetermined overhead rate will provide Delta with reliable product cost information, overhead is classified into two cost pools and two predetermined overhead rates
are used. For 2013, it is estimated that total overhead cost will consist of P525,000 of overhead related to setups and P900,000 of overhead related to machine usage.
Total machine usage is expected to be 3,600 hours for the year, and the total number of setups is expected to be 300.

Job RST requires parts and materials costing P56,000, 70hours of machine time, and four setups.

What is the cost of Job RST?

a. P80,500
b. P78,500
c. P83,050
d. P79,500

1. High school chair:

Direct m aterials P600,000
Direct labor (7,500xP20) Overhead: 150,000

Material handling (100,000xP0.25) P25,000

Cutting (100,000x2.50) 250,000
Assembly (7,500xP25) 187,500 462,500
Total cos t P1,212,500
Units pro duced /5,000
Unit cost P242.50*

College chair:

Direct m aterials P25,000

Direct la bor (5 00xP20) Overhead: 10,000

Material handling (3,500xP0.25) P875

Cutting (3,500xP2.50) 8,750
Assembly (500xP25) 12,500 22,125
Total cos t P57,125
Units pro duced /100
Unit cost P571.25*
2. Traditional costing system:

Direct materials (50xP3,000) P150,000

Overhead (50x15)xP100 75,000
Total cos t P225,000

Activity based costing system:

P150,000

Direct materials Overhead:

Materials handling (50x50)xP8 20,000
Machining (50x12)xP68 40,800
Assembly (50x15)xP75 56,250
Inspection (50x14)xP104 72,800 P339,850
Higher P114,850*

3. Overhead rates:

Material handling (P720,000/6,000,000 parts) P0.12

Setup costs (P315,000/750 setups) 420
Machining costs (P540,000/30,000 hours) 18.00
Quality control activity (225,000/500 batches) 450

Overhead costs:

Material handling (20,000 units x 5 parts)xP0.12 P12,000

Setup cost activity (20,000 units / 5,000 x 2 setups)xP420 3,360
Machining activity (20,000 units / 5,000 x 80 hrs.)xP18 5,760
Quality control activity (20,000 units / 5,000)xP450 1,800
Total P22,920*

Overhead cost per unit (P22,920/20,000 units) P1.15

Direct material cost per unit 4.40
Direct labor cost per unit 0.75
Total un it cos t P6.30*

4. ABC:

Material handling (115x12) P1,380 Inspection (P1.40x17,500) 24,500

Production certification (P770x25) 19,250 P45,130

Traditional costing (P275,000x14.5%) 39,875
ABC higher than the traditional costing by p5,255*

5. Traditional costing [(60,000/25,000)x2 direct labor hours)] P4.80*

ABC (P1 ,000/100) P10.00*

6. Cost Assignment:

Materials handling (P50,000/100,000)x10,000 P5,000

Painting (P200,000/50,00)x3,000 12,000
Assembly (P120,000/4,000)x300 9,000
Total P26,000*
7. The P50,000 of costs is allocated over 10,000 hours [(P25x200 hours)/(25x200 hours)]. Thus, the overhead cost per hour is P5 (P50,000/10,000hrs.),and the per unit
overhead cost of wall mirrors is P1,000 (P5x200 direct labor hours).

Answer (b) is incorrect because P500 is the allocation based on number of material moves. Answer (c) is incorrect because P2,000 assumes that all the overhead is allocated to
the wall mirrors. Answer (d) is incorrect because P5,000 assumes overhead of P250,000.

8. ABC allocates overhead costs on the basis of some casual relationship between the incurrence of cost and activities. Because the moves for wall mirrors constitute
25% (5/20) of total moves, the mirrors should absorb 25% of the total materials handling costs, or P12,500 (25%xP50,000). The remaining P37,500 is allocated to
specialty windows. The cost per unit of wall mirrors is P500 (P12,500/25)

Answer (a) is incorrect because P1,000 uses direct labor as the allocation basis. Answer (c) is incorrect because P4,500 is the allocation per unit of specialty windows.
Answer (d) is incorrect because P2,500 is not based on the number of material moves.
9. Overhead rates:
Per machine hour P900,000/3,600 machine hours P250*
Per setup P525,000/300 s etups P1,750*

Cost of Job RST:

Parts an d m aterials P56,000
Applied overhead:
Machine hours (70xP250) P17,500
Setup (4xP1,750) 7,000 24,500
Total co st of Jo b RS T P80,500*