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Traditional vs. ABC Costing Explained

The document compares traditional costing with activity-based costing (ABC) using Pear Company as an example. It details the calculation of unit costs for deluxe and regular models under both costing methods, revealing significant differences in overhead allocation. The findings suggest that ABC often results in higher overhead costs for low-volume, specialized products.

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Anh Nguyễn
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13 views13 pages

Traditional vs. ABC Costing Explained

The document compares traditional costing with activity-based costing (ABC) using Pear Company as an example. It details the calculation of unit costs for deluxe and regular models under both costing methods, revealing significant differences in overhead allocation. The findings suggest that ABC often results in higher overhead costs for low-volume, specialized products.

Uploaded by

Anh Nguyễn
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Activity-Based Costing

Let’s look at an
example comparing
traditional costing
with ABC.
P2 Traditional Costing vs. ABC
Example
Pear Company manufactures a product in regular and
deluxe models. Overhead is assigned on the basis of
direct labor hours. Budgeted overhead for the current
year is $2,000,000. Other information:

First, determine the unit cost of each model using traditional costing
methods.
P2

Traditional Costing

Overhead Estimated overhead costs


=
Rate Estimated activity

Overhead $2,000,000
= = $50 per DLH
Rate 40,000 DLH
P2

Traditional Costing

ABC will have different


overhead per unit.
Deluxe Regular
Model Model
Direct Material $ 150 $ 112
Direct Labor 16 8
Manufacturing Overhead
$50 per hour × 1.6 hours 80
$50 per hour × 0.8 hours 40
Total Unit Cost $ 246 $ 160
P2

Activity-Based Costing
Pear Company plans to adopt activity-based costing.
Using the following activity center data, determine
the unit cost of the two products using activity-
based costing.
P2

Activity-Based Costing

Overhead Units
Activity Cost Cost for of
Center Driver Activity Activity Rate
Purchasing Orders $ 84,000 1,200
Scrap Rework Orders 216,000 900
Testing Tests 450,000 15,000
Machine Related Hours 1,250,000 50,000
Total Overhead $ 2,000,000

400 deluxe + 800 regular = 1,200 total


P2

Activity-Based Costing

Overhead Units
Activity Cost Cost for of
Center Driver Activity Activity Rate
Purchasing Orders $ 84,000 1,200 $ 70 per order
Scrap Rework Orders 216,000 900 $240 per order
Testing Tests 450,000 15,000 $ 30 per test
Machine Related Hours 1,250,000 50,000 $ 25 per hour
Total Overhead $ 2,000,000

Rate = Overhead Cost for Activity ÷ Units of Activity


P2

Activity-Based Costing
P2

Activity-Based Costing

Let’s complete
the table.
P2

Activity-Based Costing
P2

Activity-Based Costing

Total overhead = $720,000 + $1,280,000 = $2,000,000


Recall that $2,000,000 was the original amount of overhead assigned to
the products using traditional overhead costing.
P2

Activity-Based Costing
P2

Traditional Costing vs. ABC


Traditional Costing ABC
Deluxe Regular Deluxe Regular
Model Model Model Model
Direct labor $ 150 $ 112 $ 150 $ 112
Direct material 16 8 16 8
Overhead 80 40 144 32
Total cost $ 246 $ 160 $ 310 $ 152

This result is not uncommon when activity-based costing is used. Many


companies have found that low-volume, specialized products have greater
overhead costs than previously realized.

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