3.3 Activity-Based Costing (ABC)

• What is the primary purpose of Activity-Based Costing (ABC)?

  Accurate cost allocation
• One key benefit of ABC is more accurate cost allocation
• Activity-Based Costing (ABC) improves cost management compared to traditional costing methods.
• What is the impact of ABC on profitability analysis?

  Enhanced profitability analysis
• The formula for ABC is $ABC =$$\frac{\text{Total Cost}}{\text{Number of Activities}}$, where the numerator represents the total cost
• Cost drivers are factors that cause the cost of activities to increase.
• Ordering supplies is an activity, and the number of orders is its driver
• What is the cost driver for setting up machines in ABC?

  Number of setups
• The number of inspections is a cost driver for quality control activities.
• If ordering supplies costs £5,000 and there are 100 orders, the cost per order is £50
• Steps to allocate costs to activities using cost drivers

  1️⃣ Identify activities

  2️⃣ Determine cost drivers

  3️⃣ Calculate cost per activity

  4️⃣ Allocate costs to products
• How do you calculate the cost per activity in ABC?

  $\frac{Total Cost}{Number of Occurrences}$
• If Product A uses 20 ordering activities and the cost per order is £50, its allocated cost is £1,000.
• If a product has total costs of £10,000 and 500 units are produced, the cost per unit is £20
• What is the formula for calculating the cost per unit in ABC?

  $\frac{\text{Total Costs}}{\text{Number of Units}}$
• Cost drivers are the primary factors that increase the cost of activities in ABC.
• Match the activity with its cost driver:

  Ordering Supplies ↔️ Number of Orders

  Setting up Machines ↔️ Number of Setups

  Quality Control ↔️ Number of Inspections
• If ordering supplies costs £5,000 and there are 100 orders, what is the cost per order?

  £50
• To calculate the cost per activity, you divide the total cost of the activity by the number of times the cost driver occurs.
• If ordering supplies costs £5,000 and there are 100 orders, the cost per order is £50
• What are the steps to calculate the cost per unit using ABC?

  Calculate total costs, divide by units
• The formula for cost per unit in ABC is Cost per unit = \frac{\text{Total Costs}}{\text{Number of Units}}</latex>, where the denominator represents the number of units
• Activity-Based Costing (ABC) allocates overhead based on cost drivers, while traditional costing uses production volume.
• In what situation is ABC more accurate than traditional costing?

  Multiple machine setups
• ABC helps improve pricing strategies by providing true cost per unit information.
• Enhanced profitability analysis using ABC can identify less profitable products or services
• What is one benefit of ABC for resource allocation?

  Efficient resource use
• High setup costs identified by ABC can lead to investments in reducing setup times.
• Activity-Based Costing helps identify products or services that are less profitable
• Understanding cost drivers in ABC allows for efficient resource allocation to high-value activities.
• List the key benefits of using ABC for decision-making.

  1️⃣ More accurate costing

  2️⃣ Better resource planning

  3️⃣ Improved pricing strategies

  4️⃣ Enhanced profitability analysis
• Accurate costing in ABC provides a clear picture of true costs
• What is the primary goal of Activity-Based Costing (ABC)?

  Accurate product costing
• Managers can use ABC to identify costly activities and optimize them.
• ABC helps managers make informed pricing decisions based on cost breakdowns.
• ABC assigns costs to activities based on their cost drivers.
• ABC allows managers to evaluate the profitability of individual products or services.
• ABC is more accurate than traditional costing because it considers cost drivers.
• What is the ultimate goal of using ABC in management decision-making?

  Informed cost-based decisions