Chapter 5:
Activity-Based Costing (ABC)
& Activity-Based Management (ABM)
Horngren 13e
5 -1
A SIMPLE COSTING SYSTEM
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AN ACTIVITY-BASED COSTING SYSTEM
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ABC’s 7 Steps
Step 1: Identify the products that are the chosen cost
objects.
Step 2: Identify the direct costs of the products.
Step 3: Select the activities and cost-allocation bases to use
for allocating indirect costs to the products.
Step 4: Identify the indirect costs associated with each cost-
allocation base (activity).
Step 5: Compute the rate per unit of each cost-allocation base
(activity) used to allocate indirect costs to the
products.
Step 6: Compute the indirect costs allocated to the products.
Step 7: Compute the total costs of the products by adding all
direct and indirect costs assigned to the products.
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COST HIERARCHIES
In an ABC system, costs are categorized on the basis of the different types of
cost drivers utilized. ABC systems commonly use a cost hierarchy having
four levels. These cost drivers differ in their relationship between the indirect
cost and the product or service.
Output unit-level costs are the costs of activities performed on each
individual unit of a product or service.
– These costs increase as the number of units produced
increases.
Batch-level costs are the costs of activities related to a group of units of
products or services rather than the individual unit.
– Set-up costs are an example of batch level costs, as this cost is incurred
once for each batch, regardless of the size of the batch.
5-5
COST HIERARCHIES
Product-sustaining costs (service-sustaining costs) are the costs of activities
undertaken to support individual products or services regardless of the
number of units or batches produced.
– Design costs are an example of this type of cost.
Facility-sustaining costs are the costs of activities that cannot be traced to
individual products or services but support the organization as a whole.
– Examples of this type of cost include general administration, rent, and
building security.
– These costs usually lack a cause-and-effect relationship between the
cost and the allocation base.
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Learning Objective 1: Explain how broad averaging undercosts and overcosts
products or services . . . this problem arises when
reported costs of products do not equal their actual costs
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Learning Objective 1: Explain how broad averaging undercosts and overcosts
products or services . . . this problem arises when
reported costs of products do not equal their actual costs
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Learning Objective 2: Present three guidelines for refining a costing system . . .
classify more costs as direct costs, expand the number
of indirect-cost pools, and identify cost drivers
True or False
Indirect labor and distribution costs would most likely be in the same activity-
cost pool.
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Learning Objective 2: Present three guidelines for refining a costing system . . .
classify more costs as direct costs, expand the number
of indirect-cost pools, and identify cost drivers
True or False
Indirect labor and distribution costs would most likely be in the same activity-
cost pool.
Answer: False
Indirect labor and distribution costs would not be in the same activity-cost
pool because their cost drivers are very dissimilar. A cost driver of indirect
labor would include direct labor hours, while a cost driver of distribution costs
would include cubic feet of cargo moved.
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Learning Objective 3: Distinguish between simple and ABC systems ... unlike simple
systems, ABC systems calculate costs of individual activities
to cost products
Learning Objective 5: Cost products or services using ABC . . . use cost rates for
different activities to compute indirect costs of a product
Learning Objective 6: Explain how ABC systems are used in ABM . . . such as pricing
decisions, product-mix decisions, and cost reduction
[EXERCISE]
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[EXERCISE]
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[SOLUTION]
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Learning Objective 4: Describe a four-part cost hierarchy . . . a four-part cost hierarchy
is used to categorize costs based on different types of cost
drivers—for example, costs that vary with each unit of a product
versus costs that vary with each batch of products
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Learning Objective 4: Describe a four-part cost hierarchy . . . a four-part cost hierarchy
is used to categorize costs based on different types of cost
drivers—for example, costs that vary with each unit of a product
versus costs that vary with each batch of products
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Learning Objective 7: Compare ABC systems and department costing systems
... ABC systems are a refinement of department costing
systems into more-focused and homogenous cost pools
Learning Objective 8: Evaluate the costs and benefits of implementing ABC
systems . . . measurement difficulties versus more
accurate costs that aid in decision making
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Learning Objective 7: Compare ABC systems and department costing systems
... ABC systems are a refinement of department costing
systems into more-focused and homogenous cost pools
Learning Objective 8: Evaluate the costs and benefits of implementing ABC
systems . . . measurement difficulties versus more
accurate costs that aid in decision making
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