Project Cost

Management
Module 3
Activity Based Costing
Agenda

• Cost Types
• Traditional Based Costing
• Activity Based Costing
• Quiz 2

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Cost Types

Direct Material
A readily identifiable part of a product; these are the raw material that can be
physically and directly associated with the finished product

Direct Labour
The time spent by individuals who work specifically on manufacturing a product or
performing a service ( the wages paid to these workers); this is the work that can
be physically and directly associated with converting raw material into finished
goods

Overhead (Indirect Costs)

The indirect or supporting costs of converting materials or supplies into finished
products or services; does not include direct materials or direct labour
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 Indirect vs. Direct Costs Examples

• Cost of procurement
• Cost of processing order
• Finishing cost
• Cost of QC
• Cost of R&D
• Design cost
Indirect Cost
• Machine maintenance
• Worker’s insurance
• Electricity
• Transportation
• Packing cost
• Direct material Direct Cost
• Direct Labour

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Traditional Costing System

Direct
Costs Traced
(materials, Cost
labour) Object
(product,
service, etc.)
Indirect
Costs
(Overhead) Allocated based on a formula and
certain assumptions

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Question 1 – Traditional Costing
ABC Inc. has two major products in their portfolio: handbags and wallets. Both of
these products are made out of leather which costs $20 & $10 per unit respectively.
Each handbag consumes 2 hours of labour and wallets consume 1 hour of labour to
produce. If the overhead cost for handbag is $15 and wallet is $5 respectively; what
is the unit cost of each product under traditional costing method if 100 handbags
and 200 wallets are produced. Assume labour rate is $12/ hour.

Handbag Wallet
Direct Material $20 $10
Direct Labour $24 $12
Overhead $15 $5
TOTAL $59 $27

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Question 2 – Traditional Costing
ABC Inc. has two major products in their portfolio: handbags and wallets. Both of
these products are made out of leather which costs $20 & $10 per unit respectively.
Each handbag consumes 2 hours of labour and wallets consume 1 hour of labour to
produce. If the total overhead cost is $3000 and assigned based on the direct labour
hours; what is the unit cost of each product under traditional costing method if 100
handbags and 200 wallets are produced. Assume labour rate is $12/ hour.

Handbags Wallets
Direct Material $20 $10
Direct Labour $24 $12
Overhead $15 $7.5
TOTAL $59 $29.5

• 200hours + 200 hours = 400 hours

• 1 hour = $3000 / 400 = $7.5 / hour
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Question 3 – Traditional Costing
XYZ Inc. produces two security products: “Boot” & “Club”. Boot consumes $40 of
direct material and takes 1 hour to produce. Club consumes $30 of direct material
and takes 1 hour to produce. Total overhead cost is $900,000 between these two
products. If there were 25,000 Boot and 5,000 Club produced, what would be the
unit cost of each? Assume: labour cost is $12 / hour

25,000 hours + 5,000 hours = 30, 000 hours

30,000 hours = $900,000
1 hour = $900,000 / 30,000 hours = $30 / hour

Boot Club
Direct Material $40 $30
Direct Labour $12 $12
Overhead $30 $30
TOTAL $82 $72

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What is Activity Based Costing? ABC

https://www.investopedia.com/terms/a/abc.asp

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Traditional Costing Vs. ABC

Overhead Single Cost Product /

costs Driver Service

Traditional Costing

Activity Cost Pool Cost Driver

Product /
Overhead
costs
Activity Cost Pool Cost Driver Service

Activity Cost Pool Cost Driver

10 Activity Based Costing (ABC)

Activity Based Costing

An event that causes the

consumption of overhead
Activity
resources (e.g. kilometers driven,
gas or transportation cost)

A “cost bucket” to accumulate

(Activity) overhead costs related to a
Cost Pool particular activity (e.g. gas or
transportation cost)

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5 Levels of Activities for Establishing Cost Pools
and Allocating Cost to Cost Object
ABC defines five levels of activity
that largely do not relate to the volume of units
produced.
Unit-Level Batch-Level
Activity Activity

Manufacturing
companies typically combine
their activities into five
classifications.

Product-Level Customer-
Activity Organization- Level
12 Sustaining Activity
Activity
 Five Levels of Activities in ABC Costing

• Unit-level activities are

performed whenever a unit is
produced. E.g., providing power
to run processing equipment.

• Batch-level activities are

performed whenever a batch is
handled or processed,
regardless of how many units are
produced. E.g., setting up
equipment for batch production;
shipping customer orders.
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Public
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 Five Levels of Activity in ABC Costing
•Product-level activities relate to
product types and are carried out
regardless of batch runs or units
produced. E.g., designing or
advertising a product.
•Customer-level activities relate to
specific customers and are not tied
to products, batches, or units. E.g.,
sales calls and catalogue mailings.
•Organization-sustaining activities
are carried out at the organization
level regardless of the other four
levels. E.g., heating a factory and
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cleaning executive offices. Public
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Two Types of Activity Measures in ABC Costing

Activity measure, “cost driver” or allocation base

Two common types

Transaction Duration
driver driver
Count A measure
of the number of of the amount
times an activity of time needed
15 occurs. for an activity.
ABC Class Exercises

BB/Learning Materials/Module 3/ ABC Class Exercises

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 ABC Costing – Exercise 1a
Allen Inc. is a manufacturer of quality shoes. The company has always used a plant-wide allocation
rate for allocating manufacturing overhead to its products. The plant manager believes it is time to
change to a better method of cost allocation. The accounting department has established the
following relationships between production activities and manufacturing overhead costs:

Activities Cost Drivers Allocation Rate

Material handling Number of parts $ 8 per part
Assembly Labour hours 80 per hour
Inspection Time spent by item at inspection station 12 per minute

The previous plant-wide allocation rate method was based on direct manufacturing labour
hours, and if that method is used, the allocation rate is $80 per labour hour.

a. Assume that a batch of 1,000 pairs of shoes requires 4,000 parts, 50 direct manufacturing
labor hours, and 60 minutes of inspection time. What are the indirect manufacturing
costs per pair of shoes to produce a batch of 1,000 pairs of shoes, assuming the previous
plant-wide allocation rate method is used?
Overhead allocation cost for 1 hr $80 Total Overhead cost for 1000 pairs $4,000
Manufacturing labour hours 50
pairs of shoes 1000 Total overhead cost for 1 pair $4.00
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# of parts 4000
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 ABC Costing – Exercise 1b
Allen Inc. is a manufacturer of quality shoes. The company has always used a plant-wide allocation
rate for allocating manufacturing overhead to its products. The plant manager believes it is time to
change to a better method of cost allocation. The accounting department has established the
following relationships between production activities and manufacturing overhead costs:
Activities Cost Drivers Allocation Rate
Material handling Number of parts $ 8 per part
Assembly Labour hours 80 per hour
Inspection Time spent by item at inspection station 12 per minute

The previous plant-wide allocation rate method was based on direct manufacturing labour
hours, and if that method is used, the allocation rate is $80 per labour hour.

b. What are the indirect manufacturing costs per pair of shoes to produce a batch of
1,000 pairs of shoes, assuming the activity-based method of allocation was used?
Total
ACTIVITIES Cost Drivers Allocation Rate Formula
Allocation
Material handling Number of parts $ 8 per part $32,000 $8 x4000
Assembly Labour hours 80 per hour $4,000 $80x50
Time spent by item at
Inspection 12 per minute 60X12
inspection station $720
TOTAL $36,720
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Total overhead for 1 pair $36.72 1
ABC Exercise 2a
The Silvernagel Company is attempting to institute an activity-based accounting system to
cost products. The Purchasing Department incurs costs of $473,500 per year and has five
people working in it. Because finding the best supplier takes the majority of the effort in the
department, most of the costs are allocated to this area.

Activity Allocation of Measure # of People Total Cost ($)

Finding best suppliers # of telephone calls 3 300,000
Issuing purchase order # of purchase orders 1 100,000
Reviewing receiving reports # of receiving reports 1 73,500
During the year, 150,000 telephone calls are made in the Purchasing Department, 10,000
purchase orders are issued, and 7,000 shipments are received and reports filed. Many of
the purchase orders are received in the same shipment.
A complex product manufactured by the company required the following activities in the
Purchasing Department over the year: 115 telephone calls, 36 purchase orders, and 29
receipts.
2a. What amount of Purchasing Department cost should be assigned to the manufacturing
of this product? Hint: First find the activity rates, then allocate cost to complex product
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Exercise 2a -continued

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 Exercise 2b
2b. If 200 units of product are manufactured during the year, what is the Purchasing
Department cost per unit? Assume $894.50 is the allocation for manufacturing of this
product.

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ABC Exercise 3 – Product Comparison

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 ABC Exercise 3 – Product Comparison. Cont’d
To solve, first determine cost per unit

Calculate Cost for Product A Calculate Cost for Product B

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Traditional vs. ABC Costing

https://www.google.com/search?q=traditional+costing+vs+abc+cos
ting&source=lnms&tbm=vid&sa=X&ved=2ahUKEwiOveXyiY7_AhVrj
okEHbBHCdwQ_AUoAnoECAEQBA&biw=673&bih=586&dpr=2#fpst
ate=ive&vld=cid:eb2a06c6,vid:aDycx2hJ6tg

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QUIZ #2
References
Callahan, K. R., Stetz, G.S., Brooks, L. M. (2007). Project management accounting:
Budgeting, tracking, and reporting costs and profitability

Maylor, Harvey (2010). Project Management. Essex, England: Pearson Education

Limited.

Kahneman, Daniel (2011). Thinking, Fast and Slow. Canada: Doubleday Canada.

Raiborn, C.A, Barfield, J.T, & Kinney, M.R (1993). Managerial Accounting. St. Paul, MN:
West Publishing Company .

Garrison, Libby, Webb. Managerial Accounting. 10th edition, McGraw-Hill Ryerson

Project Management Institute. (2013). A Guide to the Project Management Body of

Knowledge (PMBOK® Guide) – Fifth Edition

Weygandt, Kimmel, Kieso, & Aly (2009). Managerial Accounting: Tools for Business
Decision Making. Mississauga, Ontario: John Wiley & Sons Canada, Ltd.

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