Republic of the Philippines

Laguna State Polytechnic University

Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited

LSPU Self-paced Learning Module (SLM)

Course Strategic Cost Management
Sem/AY Second Semester/2024-2025
Module No. 3
Lesson Title Activity Based Costing and Pricing Decisions
Week
6-9
Duration
Date March 3-26, 2025
This lesson is about activity-based costing and deals with important pricing decision
Description concepts and the different methods of pricing a product.
of the
Lesson

Learning Outcomes
Intended Students should be able to meet the following intended learning outcomes:
Learning • Define what Activity-Based Costing (ABC) is and how it differs from traditional
Outcomes costing methods.
• Understand the core idea behind ABC – assigning costs to activities based on
their use of resources.
• Understand the various factors that influence pricing decisions.
Targets/ At the end of the lesson, students should be able to:
Objectives • Gain the ability to allocate overhead costs more accurately using ABC.
• Gain knowledge of the steps involved in implementing an ABC system in an
organization.
• Explain the pricing methods.

Student Learning Strategies

Online Activities A. Online Discussion via Google Meet

(Synchronous/ You will be directed to attend in a class discussion on the Cost Concept,
Classification and Behavior.
Asynchronous)

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
The online discussion will happen on March 3, 10, 17, 24, 5:00 -6:00 pm
and March 5, 12, 19, 26, 5:00 - 7:00 pm.

(For further instructions, refer to your Google Classroom and see the
schedule of activities for this module)

B. Learning Guide Questions:

1. Why is ABC considered more accurate for assigning overhead costs
compared to traditional costing methods?
2. How do you allocate overhead costs to products or services in ABC?
3. What are the different pricing methods?

Note: The insight that you will post on online discussion forum using Learning Management
System (LMS) will receive additional scores in class participation.

Lecture Guide
Activity-Based Costing (ABC)

Activity based Costing (ABC) is a systematic, cause & effect method of assigning
the cost of activities to products, services, customers or any cost object.

ABC is based on the principle that “products consume activities”. Traditional cost
systems allocate costs based on direct labor, material cost, revenue or other
simplistic methods. As a result, traditional systems tend to over-cost high volume
products, services and customers and under-cost low volume.
Offline Activities Activity-based costing incorporates in its costing system the basic and vital role of
(e-Learning/Self- different activities. ABC System refined costing system by focusing on individual
Paced) activities as the fundamental cost objects.
An activity is an event, task or unit of work with a specified purpose e.g.,
designing products, setting up machines, operating machines and distributing
products.
The operation of the ABC System involves the use of the following terms:
• Cost Object: It indicates an item for which cost is calculated using the
Activity-based costing System. For Example, a service, a customer or a
product.
• Cost Driver: A cost driver is any factor or force that causes a change in
the cost of an activity. Cost driver may be divided into two parts:
a) Resource Cost Driver – The quantity measure of the resources
used/consumed by an activity. It is used to assign the cost of a
resource to an activity or cost pool.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
b) Activity Cost Driver – a measure of frequency and strength of
demand, set on tasks by cost items.
Difference Between Traditional Costing and Activity-Based Costing
The basic distinction between traditional costing and ABC is as follows:
Traditional Costing Activity-Based Costing
Allocate costs to products based on Focus on activities required to
attributes of a single unit. produce each product or provide
each service based on each
product’s or service’s consumption
of the activities
Typical attributes include the Overhead costs are traced to
number of direct labor hours products and services by
required to manufacture a unit, identifying the resources, activities
purchase cost of merchandise and their costs and quantities to
resold or the number of days produce output.
occupied
Allocations vary directly with the A unit or output (a driver) is used to
volume of units produced, cost of calculate the cost of each activity
merchandise sold or days occupied consumed during any given period
by the customer. of time.

An activity-based costing system can be viewed in two different ways:

• The cost assignment view provides information about resources,
activities and cost objects.
• The process view provides operational (often non-financial) information
about cost drivers, activities and performance.
Steps to Follow in Activity-Based Costing
Activity Based Costing requires accountants to follow these steps.
Step 1: Identify the activities that consume resources.
Step 2: Assign costs to activities.
Step 3: Identify the cost driver associated with each activity. A cost driver
is a factor that causes, or "drives" an activity's cost.
Step 4: Compute a cost rate per cost driver unit.
Step 5: Assign costs to products by multiplying the cost driver rate times
the volume of cost drivers consumed by the product.

Need or Objects of Activities-Based Costing

ABC System is needed by an organization for the purpose of accurate product
costing in cases where:
• Production overhead costs are high in comparison to the various direct
costs;
• The product range of the organization is highly diverse;

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
• Overhead resources used by various products are very different in
amounts;
• Volume or quantity of production is not a primary driving force for the
consumption of overhead resources.
Limitations of ABC System
The ABC System suffers from the following limitations:
• This system is more time-consuming due to the fact that the number of
activities to which the overhead resources of an organization have to be
related, is very large.
• It involves a high cost of operation and can be used only by large
organizations. It is not suitable for small scale units.
• In some cases, the establishment of cause and effect relationship between
Cost Driver and Costs may not be a simple affair.

Example
Huge Auto Ltd. produces three products ‘X’, ‘Y’ and ‘Z’ for which the standard
costs and quantities per unit are as follows:
Products X Y Z
Output (Units) 5,000 15,000 22,500
Direct Material per unit P100 P80 P60
Direct Wages per unit P60 P80 P100
Labor Hours per unit 3 4 5
Machine Hour per unit 4 4 7
No. of Purchase Requisitions 600 900 1000
No. of Set-ups 140 110 150
Production overhead split by departments:
Department A P550,000
Department B P750,000
P1,300,00
Department A is labor intensive while Department B is machine intensive. Total labor
hours in Department A = 55,000 Total machine hours in Department B = 150,000
Production overhead split by activity:
Receiving/Inspecting P700,000
Production Scheduling/Machine Set-up P600,000
P1,300,000
No. of Batches Received/Inspected 2,500
No. of Batches for Scheduling and Set-up 400

You are required to:

a) Prepare Product Cost Statement under traditional Absorption Costing and
Activity-based Costing Method.
b) Compare the results under two methods:

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
Solution
Traditional Absorption Costing
Calculation of overhead absorption rates: Department A = P550,000 / 55,000 Labor
hours = P10 per labor hour.
Department B = P750,000 / 150,000 Machine Hours = P5 per machine hour.
Production Cost Statement
X Y Z
Direct Material per unit P100 P80 P60
Direct Wages per unit P60 P80 P100
Production Overheads:
Department A 30 40 50
(3hrs. x P10) (4hrs. x P10) (5hrs. x P10)
Department B 20 20 35
(4hrs. x P5) (4hrs. x P5) (7hrs. x P5)
Total Cost Per Unit 210 220 245

Activity-based Costing
Calculation of Cost Driver Rates:
i. Receiving/Inspecting = P7,00,000 / 2,500 (No. of batches received/inspected)
= P280 per requisition.
ii. Production Scheduling/Machine Sets-up = P6,00,000 / 400 (No. of batches for
scheduling) = P1,500 per set-up
Production Cost Statement
X Y Z
Direct Material per unit P100 P80 P60
Direct Wages per unit P60 P80 P100
Production Overheads:
Receiving 33.60 16.80 12.44
[(P280 x 600) / [(P280 x 900) / [(P280 x 1000)
5,000] 15,000] / 22,500]
Production Scheduling 42 11 10
[(P1,500 x 140) [(P1,500 x 110) [(P1,500 x 150)
/ 5,000] / 15,000] / 22,500]
Total Cost Per Unit 235.60 187.80 182.44

Comparison of Results Under Both Costing Methods

The Traditional Absorption Costing Method and Activity-based Costing Method

show different cost results.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
Under the traditional absorption costing method, Product ‘Z’ is more expensive
while under activity-based costing method, product ‘X’ is more expensive.

If we assume that Activity-Based Costing is more accurate (which may or may not
be possible), under traditional absorption costing method, product ‘Z’ would be
over-priced while product ‘X’ would be underpriced as a result of which sales for
product ‘Z’ would be less and sales for product ‘X’ would be more leading to a loss
to the company.

Pricing Decision

Pricing Strategies

Although all are geared towards the goal of maximizing wealth, different
businesses adopt different pricing strategies.

The main objectives in choosing and setting the price of a product include the
following:
1. maximize profit
2. meet target sales or market share
3. maintain a price that is stable in relation to competitors' prices.

Setting prices requires through consideration of internal and external factors.

Internal Factors in Pricing a Product

• Cost of Producing – the company wants to make profits from the costs it
incurred.
• Marketing the Product – Marketing strategies, such as product
specifications, place of distribution, and ways or promoting the product
are carefully considered.
• Capacity of the Plant – Companies may set higher prices when they are
not operating at full capacity for them to recover fixed costs even if less
units are sold. This is known as peak-load pricing.

External Factors in Pricing a Product

• Market Competition – The type of market determines the ability of a

company in setting prices.
o In industries under perfect competition, players have less to no
control over price. It is set by the market.
o Under monopolistic competition, a monopoly virtually has the
power to set prices since there are no competitors.
• Legal Factors – These pricing strategies are generally prohibited by law.
These kill healthy competition.
o Predatory pricing involves setting prices so low to drive out
competitors.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
oCollusive pricing happens when companies conspire to set very
high prices.
o Discriminatory pricing involves charging different prices from
different customers.
• The Law of Demand and Supply – Generally, the higher the demand, the
higher the price sellers will charge. The higher the supply is, the lower the
price. The sensitivity (elasticity) of price to changes in demand and
supply, and vice versa, must also be studied.

Pricing Methods

1. Cost-based pricing - Price is set by adding a certain mark-up above the

cost of producing and selling the product.
2. Value-based pricing - Rather than focusing on costs, price is based on the
value of the product as perceived by the buyer.
3. Competition-based pricing - Prices are based on competitors' prices.
This is most applicable in pure competition markets where there are
many market players.
4. Penetration pricing - Low prices are set for a new product for it to enter
the market easily. Once the product has established itself, higher prices
may then be set.
5. Price skimming - involves setting high prices for new products. The goal
of price skimming is to sell as many units as possible to customers who do
not care much about price. Once substantial amounts of cost have been
recovered, prices may then be lowered in order to expand sales.

Cost-Based Pricing

Cost-based pricing is a pricing method wherein a mark-up is added over costs

incurred to come-up with the suggested price of the product. The goal of doing
business is to maximize wealth and profits. Cost-based pricing ensures that costs
are fully recovered and desired profits are met.

The price derived from applying mark-up over the cost of the product is known as
cost-plus price.

Cost-Plus Price = Cost + Mark-up

The mark-up can be computed as a percentage of total costs, product costs,

variable manufacturing costs, or total variable costs.

For example, ABC Company identified the following costs incurred in producing
500 units of its new product. Compute for the cost-plus price assuming a mark-up
of:
1. 20% based on total costs;
2. 75% based on product costs;
3. 125% based on variable manufacturing costs; and
4. 50% based on total variable costs.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited

Per
Total
unit
Direct materials P3,000 P6.00
Direct labor P2,600 P5.20
Variable factory overhead P2,000 P4.00
Fixed factory overhead P1,500 P3.00

The company expects to incur P2,800 variable selling and administrative costs
and P1,850 fixed selling and administrative costs. (Per unit: P5.60 for VS&A and
P3.70 for FS&A)

1.) 20% based on total costs

Total cost per unit = P6.00 + 5.20 + 4.00 + 3.00 + 5.60 + 3.70 = P27.5
Price = Cost + Mark-up
Price = P27.60 + (20% x P27.60)
Price = P33.00
2.) 75% based on product costs
Total product cost per unit = P6.00 + 5.20 + 4.00 + 3.00 = P18.20
Price = P18.20 + (75% x P18.20)
Price = P31.85
3.) 125% based on variable manufacturing costs
Total product cost per unit = P6.00 + 5.20 + 4.00 = P15.20
Price = P15.20 + (125% x P15.20)
Price = P34.20
4.) 50% based on total variable costs
Total product cost per unit = P6.00 + 5.20 + 4.00 + 5.60 = P20.80
Price = P20.80 + (50% x P20.80)
Price = P31.20

Value-Based Pricing

Value-based pricing is a pricing method wherein prices are set based on the
perceived value to the buyer.

Value-based pricing is common for professional services, such as audit, medical

consultation, legal fees, architectural, and other customized services.

The business has to work within a target budget to ensure that it makes profit
from its quoted price.

Target Costing

When charging value-based price, the seller still considers relevant costs. Though
mark-up is not directly computed on the basis of cost, the selling price must be

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
enough to cover for the costs to be incurred. Generally, those that use value-based
pricing tend to ask for relatively high prices; hence, enough to cover costs.

Sometimes, the reverse of cost-plus pricing happens in value-based pricing. The

price is quoted first and then target costs are determined to achieve a profit. The
seller will have to work on a certain budget to meet a desired income. When this
happens, costs must be minimized without sacrificing customer satisfaction.

For example, Mr. Cruz wishes to have his car, a 1969 Cadillac Coupe, restored. It
has been sitting in his barn for a while and rust has eaten most of its parts. He
approached CustomCarz Company to do the job. Based on the estimated value of a
restored Cadillac legend, the company quotes an all-in price of P1,500,000. Mr.
Cruz agrees to the price as he believes that it is a fair measure of the benefit he
will receive.

CustomCarz now has to work within a budget and make sure that the total cost it
will incur will be within P1,500,000 if it wishes to make a profit. If the company
wishes to earn at least P100,000, then target costs must be set at up to 1,400,000.
However, the satisfaction of the customer must not be sacrificed. The perceived
value must still be met.

Competition-Based Pricing

Competition-based pricing is a pricing method that makes use of competitors'

prices for the same or similar product as basis in setting a price. This pricing
method focuses on information from the market.

The price of competing products is used a benchmark. The business may sell its
product at a price above or below such benchmark. Setting a price above the
benchmark will result in higher profit per unit but might result in less units sold
as customers would prefer products with lower prices. On the other hand, setting
a price below the benchmark might result in more units sold but will cause less
profit per unit.

In a perfectly competitive market, sellers almost have no control over prices. It is

solely determined by the supply and demand, and products are sold at the market
price or going rate.

Advantages of Competition-Based Pricing

• No complex computations are required.
• In a highly competitive market, the burden of price-based marketing is
lifted.

When sellers adopt the same price as those charged by competitors, certain
marketing efforts must be made to attract sales since price is not a major factor.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
Additional efforts include:
• aggressive advertising
• better customer support
• market saturation

Penetration Pricing

Penetration pricing involves setting low prices with the intention of quickly
introducing a new product to the market.

Penetration pricing aims to attract customers away from competitors by offering

lower prices initially. Once the product has been accepted and has established its
brand in the market, prices may be increased to yield greater margins.

Advantages of Penetration Pricing

• Gets the new product diffused into the market quickly.
• Help the business establish market dominance.

Disadvantages of Penetration Pricing

• Setting substantially low prices might cause customers to question the
quality of the product.
• Once prices are increased, buyers may not be willing to make repeat
purchases anymore.

Price Skimming

Price skimming involves setting high initial prices to recover costs and make huge
profits in the early stages of the product's life cycle. It is very common in
technological markets and for companies with established brands.

Once the upper-class market has been served, the price is lowered to cater to a
larger target market. Those who were not able to afford the product during its
initial offering will be able to buy it after subsequent price adjustments. This
results in a larger market share hence, continuous sales.

Advantages of Price Skimming

• Higher profits in the early stages of the product's life cycle.
• High costs, such as research and developments costs in technological
markets are recovered early on by setting high selling prices.
• Customers often associate high prices with good quality.

Disadvantages of Price Skimming

• A business that adopts price skimming limits its sales.
• When the price is dropped later on, customers might not be as excited as
when the product was first released.

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited

Learning Resources

[Link]

[Link]

LSPU SELF-PACED LEARNING MODULE: STRATEGIC COST MANAGEMENT

Prepared by: Gladys Mae Q. Ademe