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CHAPTER 5

CHAPTER 5. Activity-Based Cost Systems. A Review: Direct and Indirect Cost . Direct cost: cost that are traceable to a product, activity, or department (a cost object). DM&DL

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CHAPTER 5

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  1. CHAPTER 5 Activity-Based Cost Systems

  2. A Review: Direct and Indirect Cost • Direct cost: cost that are traceable to a product, activity, or department (a cost object). • DM&DL • Indirect cost: cost that are not traceable to a cost object. Instead, this type of cost is normally common to more than one cost objects and needs to allocated. • OH, selling costs, general & administration costs. • Indirect cost needs to be allocated among the cost objects.

  3. TERMS USED IN COST ALLOCATION • Cost pools • grouping of a set of homogeneous costs whose total is allocated using one allocation base. • Cost pools can be organized along • departmental lines, e.g. Maintenance, Personnel depts. • major activities, e.g. equipment setups, inspections. • Cost object • something that you are trying to estimate the cost of, e.g., product, department, project, customer, etc. • For example, if computer costs are allocated to contracts, the contracts are the cost object

  4. TERMS USED IN COST ALLOCATION • Cost driver • something that cause cost to change, e.g., pounds of direct material, # of setups, # of inspections, etc. • Allocation base • the denominator used to assign cost. This can be a cost driver, or something convenient, e.g., # of units, machine/ labor hours. • An allocation base relates cost pool to the cost objects

  5. Historical Origins of Cost Allocation Methods Traditional volume-based costing (peanut butter costing) Original ABC: introduced in the 1980s Time-driven ABC (TDABC): A contemporary version of ABC introduced by Dr. Robert S. Kaplan and Dr. Steven Anderson in 2004.

  6. Traditional Costing vs. ABC • Traditional costing • spreading common cost evenly over units, products, departments, or other volume-based allocation basis (Peanut-butter costing) • under costing (estimated cost<actual cost), resulting in under pricing and losing money; • over costing (estimated cost>actual cost), resulting in over pricing and losing units of sales. XYZ company example (handout)

  7. Activity-Based Costing (ABC) Activity-based cost systems have been developed to eliminate distortion Activity-based cost (ABC) assign resource expenses to activities

  8. Activity Cost Drivers Activity cost drivers represent the quantity of activities used to produce individual products:

  9. Original ABC vs TDABC Kaplan and Anderson (2004) Article (handout) E5-25 Pg 200

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