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MS 3913 - Activity-based Costing System - ONLINE OCTOBER 2025

LECTURE NOTES

Activity-Based Cost b. Product lines are numerous, diverse, and require

1. ABC allocates overhead to multiple activity cost pools differing degrees of support services
and assigns the activity cost pools to products by means c. Overhead costs constitute a significant portion of
of cost drivers. In ABC, an activity is any event, action, total costs
transaction, or work sequence that causes the d. The manufacturing process or the number of
incurrence of cost in the production of a product or the products has changed significantly
rendering of a service. A cost driver is any factor or e. Production or marketing managers are ignoring data
activity that has a direct cause-effect relationship with provided by the existing system.
the resources consumed.
7. Hierarchy of Activity Levels
2. Misleading information when indirect-cost allocation 1. Product-sustaining costs are costs of activities
does not match resource consumption undertaken to support individual
A. Cost smoothing or peanut-butter costing: broad
products regardless of the number of units or
averages used to uniformly assign costs though
batches in which the product is produced. Costs of
resources used nonuniformly
designing processes, drawing process charts, and
A1. Product undercosting – product consumes a
making engineering changes for individual products
high level of resource but is reported to have a
are product-sustaining costs.
low cost per unit: may result in bringing in fewer
revenues than costs of resources used 2. Batch-level costs are costs of activities that are
A2. Product overcosting – product consumes a low related to a group of units of a product rather than
level of resources but is reported to have a high each individual unit of a product. Purchase order-
cost per unit: may result in losing market share related costs (including costs of receiving materials
to competitors producing similar products or and paying suppliers) are batch-level costs
providing similar services
3. Unit-level costs are costs of activities performed on
B. Production-cost cross-subsidization: if undercost a each individual unit of a product. Direct materials
product will overcost at least one other product. It output unit-level costs.
Results from cost assigned uniformly (broadly 4. Facility-sustaining costs are costs of activities that
averaged) across multiple products without cannot be traced to individual products or services
recognizing amounts of resources used by which but support the organization as a whole. Plant
products management, plant rent, and insurance costs are
facility-sustaining costs.
3. Costing system refinement - means making changes
to an existing costing system that reduces the use of Just-in-Time Processing
broad averages for assigning the cost of resources to 1. Just-in-time (JIT) manufacturing is dedicated to
cost objects and provides better measurement of the producing the right products or parts at the right time
costs of overhead resources used by different cost as they are needed. Under JIT processing, raw
objects. materials are received just in time for use in production,
Three guidelines for refinement are: subassembly parts are completed just in time for use in
1. Classify as many of the total costs as direct costs finished goods, and finished goods are completed just in
as is economically feasible. time to be sold.
2. Expand the number of indirect cost pools until 2. A primary objective of JIT is to eliminate all
each of these pools is more homogenous. manufacturing inventories. Inventories are considered
3. Use the cause-and-effect criterion, when possible, to have an adverse effect on net income because they
to identify the cost-allocation base for each tie up funds and storage space that could be made
indirect-cost pool. available for more productive purposes.
3. Three important elements in JIT processing
4. Benefits of ABC a. A company must have dependable suppliers who are
a. ABC leads to more cost pools willing to deliver on short notice exact quantities of
b. ABC leads to enhanced control over overhead costs raw materials according to precise quality
c. ABC leads to better management decisions specifications
b. A multiskilled work force must be developed
5. Limitations of ABC c. A total quality control system must be established
a. ABC can be expensive throughout the manufacturing operations
b. Some arbitrary allocation continue 4. The major benefits of implementing JIT processing are:
a. Manufacturing inventories are significantly reduced
6. When to Switch to ABC The presence of one or more of or eliminated
the following factors indicates ABC as the superior b. Product quality is enhanced
costing system: c. Rework costs and inventory storage costs are
a. Product lines differ greatly in volume and reduced or eliminated
manufacturing complexity d. Production cost savings are realized form the
improved flow of goods through the processes

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STRAIGHT PROBLEMS

PROBLEM NO. 1. Requirements:

Identify whether each of the following activity or cost is 1. Determine the total overhead cost assigned to
a unit-level, batch-level, product-level, or facility each type of data organizer using machine
sustaining level. hours as the allocation base. Calculate the
1. Production order processing gross profit per unit for each product.
2. Designing a new product 2. Determine the total overhead cost assigned to
3. Direct materials used each type of data organizer if overhead is
4. Shipping of product to customers assigned using allocation bases appropriate to
5. Receiving and inspection of deliveries the overhead costs. Calculate the gross profit
6. Property taxes per unit of each product.
7. Research and testing costs associated with the
new product PROBLEM NO. 4.
8. Plant maintenance Abra Company has a JIT system in place. Each
9. Plant depreciation manufacturing cell is dedicated to the production of a
10. Plant management salaries single product or major subassembly. One cell,
11. Inspection of units in production line dedicated to the production of guitar pickups, has four
12. Insurance of warehouse operations: machining, finishing, assembly, and
13. Materials handling qualifying (testing).
14. Cutting
15. Packaging For the coming year, the pickup cell has the following
budgeted costs and cell time (both at theoretical
PROBLEM NO. 2. capacity):
Ultimate Vision Corporation has two product lines: LCD Cell time: 8,000 hours
televisions and projection televisions. The company has Theoretical output: 60,000 pickups
budgeted the following production and overhead costs During the year, the following actual results were
for the upcoming year: obtained:
LCD Projection Actual cell time: 8,000 hours
TV’s TV’s Actual output: 50,000 pickups
Units Produced 1,500 2,250
Direct labor hours per Unit 20 30 Requirements:
Material Moves per Product 1. Compute the theoretical velocity for the cell per
Line 15 25 hour.
Budgeted Materials 2. Compute the theoretical cycle time in minutes.
Handling Cost P75,000 3. Compute the actual velocity for the cell per hour.
Total Machine Hours 10,000 16,000 4. Compute the actual cycle time in minutes.
Machine Maintenance Costs P180,000
PROBLEM NO. 5.
Compute the amount of materials handling cost to be Suppose a firm has the following unit costs (using ABC
assigned to the two product lines if the company costing):
allocates its overhead based on: Manufacturing costs:
1. direct labor hours. Materials P80
2. Number of units produced Labor 100
3. Activity-based cost system Batch level 40
Other plant overhead 80
PROBLEM NO. 3. Total manufacturing costs P300
Efficient Electronics Corporation produces two types of
electronic data organizers: basic and deluxe. The Total S&A costs P50
following information about the production process is
available: Requirements:
Basic Deluxe 1. What is the selling price assuming that the
Number produced 900,000 500,000 company is using life-cycle costs plus a 25 percent
Machine hours 75,000 30,000 markup based on life-cycle costs?
Inspection hours 9,000 45,000 2. What is the selling price assuming that the
Revenues P63,000,000 P45,000,000 company is using full manufacturing costs and
Direct costs P38,000,000 P31,000,000 wants a desired gross margin of 30 percent of
sales?
Total factory overhead is P10,000,000. Of this
overhead, P4,000,000 is related to utilities and the
remainder is related to quality control.

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MULTIPLE CHOICE QUESTIONS

1. The "Rule of One" underlies the premise that all costs 9. With traditional costing systems, products
are manufactured in small batches and in small annual
a. variable. c. unit-based. volumes may be ________ because batch-related and
b. fixed. d. short-term. product-sustaining costs are assigned using unit-
related drivers.
2. Engaging in which of the following will result in radical a. Overcosted c. Undercosted
changes being made to an organization's processes? b. Fairly costed d. Ignored
a. Continuous improvement
b. Benchmarking 10. Unit-level cost drivers are most appropriate as an
c. Reengineering overhead assignment base when:
d. Mass customization a. several complex products are manufactured
b. only one product is manufactured
3. Of the following, which is the best reason for using c. direct labor costs are low
activity-based costing? d. factories produce a varied mix of products
a. to keep better track of overhead costs
b. to more accurately assign overhead costs to cost 11. When designing a costing system, it is easiest to
pools so that these costs are better controlled a. calculate total costs first and then per-unit cost
c. to better assign overhead costs to products b. calculate per-unit costs first and then total costs
d. to assign indirect service overhead costs to direct c. calculate long-term costs first and then short-term
overhead cost pools costs
d. calculate short-term costs first and then long-term
4. Traditionally, managers have focused cost reduction costs
efforts on
a. activities. c. departments. 12. A well-designed, activity-based cost system helps
b. processes. d. costs. managers make better decisions because information
derived from an ABC analysis:
5. Traditional overhead allocations result in which of the a. can be used to eliminate nonvalue-added activities
following situations? b. is easy to analyze and interpret
a. Overhead costs are assigned as period costs to c. takes the choices and judgment challenges away
manufacturing operations. from the managers
b. High-volume products are assigned too much d. emphasizes how managers can achieve higher sales
overhead, and low-volume products are assigned
too little overhead. 13. A key reason for using an ABC system rather than a
c. Low-volume products are assigned too much, and department-costing system is because ABC assigns
high-volume products are assigned too little indirect costs:
overhead. a. using broader averages
d. The resulting allocations cannot be used for financial b. more simply than a department-costing system
reports. c. in a less costly manner
d. to reflect differences required by different processes
6. Activity-based costing (ABC) can eliminate cost as well as customers
distortions because ABC:
a. develops cost drivers that have a cause-and-effect 14. It ONLY makes sense to implement an ABC system
relationship with the activities performed when:
b. establishes multiple cost pools a. ABC provides information to make better decisions
c. eliminates product variations b. its benefits exceed implementation costs
d. recognizes interactions between different c. ABC traces more costs as direct costs
departments in assigning support costs d. there is a strong cause-and-effect relationship
between costs in the cost pools and their cost-
7. Each of the following statements is true EXCEPT allocation bases
a. traditional product costing systems seek to assign
all manufacturing costs to products 15. Which of the following is a sign that an ABC system
b. ABC product costing systems seek to assign all may be useful?
manufacturing costs to products a. There are small amounts of indirect costs
c. traditional product costing systems are more refined b. Products make diverse demands on resources
than an ABC system because of differences in volume, process steps,
d. cost distortions occur when a mismatch (incorrect batch size, or complexity
association) occurs between the way indirect costs c. Products a company is less suited to produce and
are incurred and the basis for their assignment to sell show small profits
individual products d. Operations staff agrees with accountants about the
costs of manufacturing and marketing products and
8. Put the following ABC implementation steps in order: services
A Compute the allocation rates.
B Compute the total cost of the products. 16. An example of a nonvolume-related overhead base
C Identify the products that are the cost objects. would be:
D Select the cost allocation bases. a. Direct materials cost c. Direct Labor cost
a. DACB c. BADC b. Machine hours d. Number of setups
b. DBCA d. CDAB
17. Which of the following is not typical of traditional
costing systems?

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a. Use of a single predetermined overhead rate. labor hours). Three overhead functions are needed for
b. Use of direct labor hours or direct labor cost to each product. Product A uses 2 hours of Function 1 at P10
assign overhead. per hour, 1 hour of Function 2 at P7 per hour, and 6 hours
c. Assumption of correlation between direct labor of Function 3 at P18 per hour. Product B uses 1, 8, and 1
and incurrence of overhead cost. hours of Functions 1, 2, and 3, respectively. Pelican
d. Use of multiple cost drivers to allocate overhead. produces 800 units of A and 8,000 units of B each period.

18. The first step in activity-based costing is to 24. If total overhead is assigned to A and B on the basis
a. assign manufacturing overhead costs for each of units produced, Product A will have an overhead
activity cost pool to products. cost per unit of
b. compute the activity-based overhead rate per a. P 88.64. c. P135.00.
cost driver. b. P123.64. d. none of the above.
c. identify and classify the major activities involved
in the manufacture of specific 25. If total overhead is assigned to A and B on the basis
products. of direct labor hours, Product A will have an overhead
d. identify the cost driver that has a strong cost per unit of
correlation to the activity cost pool. a. P51.32. c. P461.88.
b. P205.28. d. none of the above.
19. As compared to a high-volume product, a low-volume
product 26. If total overhead is assigned to A and B on the basis
a. usually requires less special handling. of overhead activity hours used, the total product cost
b. is usually responsible for more overhead costs per per unit assigned to Product A will be
unit. a. P86.32. c. P115.50.
c. requires relatively fewer machine setups. b. P95.00. d. none of the above.
d. requires use of direct labor hours as the primary
cost driver to ensure proper allocation of 27. Uniformly assigning the costs of resources to cost
overhead. objects when those resources are actually used in a
nonuniform way is called:
20. The primary benefit of ABC is it provides a. Overcosting
a. better management decisions. b. Undercosting
b. enhanced control over overhead costs. c. peanut-butter costing
c. more cost pools. d. department costing
d. more accurate product costing.
28. Refining a cost system includes:
21. The last step in activity-based costing is to a. classifying as many costs as indirect costs as is
a. identify the major activities that pertain to the feasible
manufacture of specific products b. creating as many cost pools as possible
b. allocate manufacturing overhead costs to activity c. identifying the activities involved in a process
cost pools d. seeking a lesser level of detail
c. Identify the cost drivers that accurately measure
each activity’s contribution to the finished product 29. Design of an ABC system requires:
d. Assign manufacturing overhead costs for each a. that the job bid process be redesigned
activity cost pool to products b. that a cause-and-effect relationship exists
between resource costs and individual activities
Use the following information for the next two questions. c. an adjustment to product mix
Barnes Corporation manufactures two models of office d. Both B and C are correct
chairs, a standard and a deluxe model. The following activity
and cost information has been compiled: 30. ABC systems:
Product Number of Number of Number of direct a. highlight the different levels of activities
set-ups components labor hours b. limit cost drivers to units of output
Standard 22 8 375 c. allocate costs based on the overall level of activity
Deluxe 28 12 225 d. generally undercost complex products

22. Assume a traditional costing system applies the 31. Traditional cost systems distort product costs
P60,000 of overhead costs based on direct labor because:
hours. What is the total amount of overhead costs a. they do not know how to identify the appropriate
assigned to the standard model? unit
a. P24,800 c. P22,500 b. competitive pricing is ignored
b. P35,200 d. P37,500 c. they emphasize financial accounting requirements
d. they apply average support costs to each unit of
23. Assume a traditional costing system applies the product
P60,000 of overhead costs based on direct labor
hours. What is the total amount of overhead costs 32. Which of the following costs should not be included in
assigned to the deluxe model? product costs for internal management reports that
a. P22,500 c. P35,200 are used for decision-making?
b. P24,800 d. P37,500 a. Costs of unit-level activities.
b. Costs of batch-level activities.
Use the following information for the next three questions. c. Costs of product-level activities.
Pelican Co. produces two products (A and B). Direct d. Costs of organization-sustaining activities.
material and labor costs for Product A total P35 (which
reflects 4 direct labor hours); direct material and labor 33. Which of the following would probably be the most
costs for Product B total P22 (which reflects 1.5 direct accurate measure of activity to use for allocating the

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costs associated with a factory's purchasing 35. Consider the following statements regarding
department? traditional costing systems:
a. Machine-hours I. Overhead costs are applied to products on the
b. Direct labor-hours basis of volume-related measures.
c. Number of orders processed II. All manufacturing costs are easily traceable to
d. Cost of materials purchased the goods produced.
III. Traditional costing systems tend to distort unit
34. If substantial batch-level or product-level costs exist, manufacturing costs when numerous goods are
then overhead allocation based on a measure of made that have widely varying production
volume such as direct labor-hours alone: requirements.
a. is a key aspect of the activity-based costing
model. Which of the above statements is (are) true?
b. will systematically overcost high-volume products a. I only.
and undercost low-volume products. b. II only.
c. will systematically overcost low -volume products c. III only.
and undercost high-volume products. d. I and III.
d. must be used for external financial reporting since
activity-based costing cannot be used for external
reporting purposes.

“Success seems to be connected with action. Successful people keep moving. They make mistakes, but they don’t
quit.” Conrad Hilton

– end -

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