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22.2 Calculate Activity-Based Product Costs

ABC Costing Process​

To calculate activity-based product costs, follow these steps:

Step 1: Identify Activities and Create Cost Pools​

Identify Major Activities:

  • Setup activities
  • Processing activities
  • Inspection activities
  • Ordering activities
  • Packaging activities
  • Other activities

Create Cost Pools:

  • Group related costs into activity cost pools
  • Each pool represents an activity

Step 2: Assign Costs to Activities​

Trace or Allocate Costs:

  • Direct costs: Trace directly to activities
  • Indirect costs: Allocate to activities based on usage

Example:

  • Setup activity: €5,000 (setup labor, setup materials)
  • Processing activity: €15,000 (processing labor, equipment)
  • Inspection activity: €3,000 (inspection labor, equipment)
  • Ordering activity: €2,000 (purchasing staff, systems)
  • Total overhead: €25,000

Step 3: Identify Cost Drivers​

Cost Driver: Factor that causes or drives the cost of an activity.

Examples:

  • Setup activity: Number of setups
  • Processing activity: Machine hours or direct labor hours
  • Inspection activity: Number of inspections
  • Ordering activity: Number of purchase orders

Step 4: Calculate Activity Rates​

Formula: Activity Rate = Total Activity Cost ÷ Total Cost Driver Volume

Example:

  • Setup activity cost: €5,000

  • Number of setups: 100

  • Setup rate: €5,000 ÷ 100 = €50 per setup

  • Processing activity cost: €15,000

  • Machine hours: 3,000

  • Processing rate: €15,000 ÷ 3,000 = €5 per machine hour

  • Inspection activity cost: €3,000

  • Number of inspections: 200

  • Inspection rate: €3,000 ÷ 200 = €15 per inspection

  • Ordering activity cost: €2,000

  • Number of orders: 50

  • Ordering rate: €2,000 ÷ 50 = €40 per order

Step 5: Allocate Costs to Products​

For Each Product:

  • Determine activity consumption
  • Multiply activity rate by consumption
  • Sum all activity costs
  • Add direct materials and direct labor

Example: Product A

Direct Costs:

  • Direct materials: €100
  • Direct labor: €80
  • Total direct: €180

Activity Costs:

  • Setups: 2 setups × €50 = €100
  • Processing: 10 machine hours × €5 = €50
  • Inspections: 1 inspection × €15 = €15
  • Ordering: 1 order × €40 = €40
  • Total activity costs: €205

Total Product Cost:

  • Direct costs: €180
  • Activity costs: €205
  • Total: €385

Complete Example: Restaurant Menu Items​

Marie's Restaurant - ABC Analysis:

Overhead Activities and Costs:

  • Menu planning: €2,000 (cost driver: number of menu items)
  • Food preparation setup: €3,000 (cost driver: number of setups)
  • Cooking: €8,000 (cost driver: cooking hours)
  • Plating/presentation: €2,000 (cost driver: number of plates)
  • Cleanup: €1,500 (cost driver: cleanup hours)
  • Total overhead: €16,500

Cost Driver Volumes:

  • Menu items: 20 items
  • Setups: 300 setups per month
  • Cooking hours: 400 hours
  • Plates served: 2,000 plates
  • Cleanup hours: 150 hours

Activity Rates:

  • Menu planning: €2,000 ÷ 20 = €100 per menu item
  • Setup: €3,000 ÷ 300 = €10 per setup
  • Cooking: €8,000 ÷ 400 = €20 per cooking hour
  • Plating: €2,000 ÷ 2,000 = €1 per plate
  • Cleanup: €1,500 ÷ 150 = €10 per cleanup hour

Menu Item: Signature Dish

Direct Costs:

  • Ingredients: €8
  • Direct labor: €5
  • Total direct: €13

Activity Consumption:

  • Menu planning: 1 item (shared across all items, but allocated)
  • Setup: 2 setups per day × 30 days = 60 setups
  • Cooking: 0.2 hours per dish
  • Plating: 1 plate per dish
  • Cleanup: 0.1 hours per dish

Activity Costs (per dish):

  • Menu planning: €100 ÷ (average dishes per item) = €0.10 (simplified)
  • Setup: (60 setups ÷ dishes served) = €0.30 (simplified calculation)
  • Cooking: 0.2 hours × €20 = €4.00
  • Plating: 1 × €1 = €1.00
  • Cleanup: 0.1 × €10 = €1.00
  • Total activity costs: €6.40

Total Cost per Dish:

  • Direct: €13.00
  • Activity: €6.40
  • Total: €19.40

Selling Price: €25 Profit: €25 - €19.40 = €5.60 (22.4% margin)

Luxembourg Compliance Note​

In Luxembourg:

  • ABC provides more accurate costs
  • Use for internal management
  • Consider implementation costs
  • May improve pricing decisions
  • PCN accounts support ABC
  • Can enhance profitability analysis

Think It Through​

How does activity-based costing provide more accurate product costs than traditional costing? What information is needed to implement ABC?