Page 3 - ABC Notes

Activity Based Costing

Merits of ABC
1. ABC recognises it is activities which cause cost, not products and it is
products which consume activities. The key idea of ABC is to focus attention
on what factors cause or drive costs. ie. cost drivers.
2. More overheads can be traced to the product. In modern factories there are a
growing number of non-factory floor activities. ABC is concerned with all
activities so takes product costing beyond the traditional factory floor basis.
3. ABC recognises the complexity and diversity of modern production by the use
of multiple cost drivers, many of which are transaction based rather than based
solely on production volume.
4. ABC focuses attention on the real nature of cost behaviour and helps in
reducing costs and identifying activities which do not add value to the
products.

Example
Two products X and Y are made using similar equipment and methods. The data for
last period are

X Y
Units produced 6,000 8,000
Labour hours per unit 1 2
Machine hours per unit 4 2
Set-ups in period 15 45
Orders handled in the period 12 60

Overheads for the period
Relating to production set-ups €179,000
Relating to order handling €30,000
Relating to machine activity €55,000

Requirement

Calculate the overheads to be absorbed per unit of each product based on:

1. Conventional absorption costing using a labour hour absorption rate
2. An ABC approach using suitable cost drivers

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