Activity based product costing

James R. Martin
CHAPTER 7
ACTIVITY BASED PRODUCT COSTING
LEARNING OBJECTIVES
After you have read and studied this chapter, you should be able to:
1. Explain how activity based costing (ABC) fits into an overall cost accounting system.
2. Describe the two main problems that tend to occur when companies use traditional costing.
3. Discuss the causes and directions of product cost distortionsthat occur in traditional costing.
4. Explain the logic underlying ABC.
5. Discuss how the concepts of fixed and variable costs are viewed in ABC.
6. Explain the distinction between production volume and activity volume.
7. Describe how activity measures are chosen when using the ABC approach.
8. Describe the ABC cost hierarchy.
9. Explain the conceptual distinction between activities,drivers and activity measures.
10. Outline four steps involved in designing an activity based costing system or sub-system.2
11. Outline three additional steps required to obtain ABC product costs.
12. Compute product cost in relatively simple ABC problems.
13. Discuss CAM-I's involvement in developing and implementing ABC concepts and techniques.
14. Discuss a controversial issue concerning howABC should be used.
15. Discuss the connection between ABC and the dichotomy of capitalism.
INTRODUCTION
The main purpose of this chapter is to introduce the concepts and terminology associated with activity based costing and to discuss how activity based concepts are used to produce more accurate product costs than those obtained in the traditional cost systems presented in Chapters 4, 5 and6. This chapter contains two relatively long sections and three fairly short sections. The first section places emphasis on the conceptual material underlying activity based costing and addresses the first nine learning objectives listed above. The second section outlines the steps involved in using the ABC technique and provides two related examples that illustrate and compare ABC with traditionalcosting. This section covers learning objectives 10 through 12. Sections three and four include a discussion of the CAM-I organization's involvement in the development and implementation of ABC concepts and a short discussion of a controversial issue concerning how ABC should be used. The last section relates the emergence of activity based costing to the dichotomy of capitalism frameworkdiscussed in Chapter 1.
ABC CONCEPTS
WHAT IS ABC?
This sub-section places activity based costing within the five part cost accounting system structure illustrated in Exhibit 2-1 of Chapter 2. Is ABC an input measurement basis, an inventory valuation method, a cost accumulation method, a cost flow assumption, a measure relating to the timing of data availability, or none of the above?
InventoryValuation Method?
From our previous discussions in Chapters 2 and 6 recall that activity based product costing may be used as an alternative to the traditional inventory valuation methods, or as a separate stand alone, microcomputer based system designed only to obtain more accurate information for management decisions. If ABC replaces traditional full absorption, or variable costing, it becomes thecompany's inventory valuation method. Then, activity based costs flow through the perpetual inventory accounts. However, if ABC is used as a separate management decision support system where activity based product cost are determined only once per year, then ABC is not serving as the company's inventory valuation method.
Resource Consumption Decision Support Model?
More importantly, whether ABC isused as a replacement for traditional inventory valuation or as a stand alone method, it provides information about how and why resources are consumed. Thus, according to ABC advocates, it is not just an inventory valuation method, or just a separate product costing method. Activity based costing is a resource consumption model that can provide a wealth of information to aid in decisions...