Activity Based Costing System

Inhaltsverzeichnis

1. Introduction

2. Templates

       2.1Traditional Costing System Template

       2.2Activity Based Costing System Template

3. Quellenverzeichnis

4. Literaturverzeichnis

1. Introduction

This chapter introduces the simple costing system, also known as traditional accounting and the concept of activity-based costing, with the help of the two following templates.

Costing systems enable companies to determine the cost of product related to the revenue it generates. With regard to the traditional costing system, manufacturing overhead costs are assigned on the basis of the volume of a cost driver (factor that causes costs to incur), such as the amount of machine hours which are needed to produce a good. Unfortunately, traditional costing excludes the assignment of non-manufacturing costs that are also associated with the product, for instance selling and administrative expenses, these are treated as period expenses. However, this system aligns with Generally Accepted Accounting Principles (GAAP) and is an appropriate implementation for companies which produce only one product.[1]

In contrast, activity-based costing allocates manufacturing costs based on the activities needed to produce a good. In addition to that, it assigns all of the overhead costs, manufacturing as well as non-manufacturing, that are caused by the production of a good. Therefore, this cost method provides a greater costing accuracy. Nevertheless, substantial financial resources are required for implementing this system, hence it can be disadvantageously for companies with limited funds.[2]

All in all, activity-based costing is a costing method, which provides managers with cost information in order to support strategic decision making and is used as a supplement to the traditional costing system, rather than as a replacement. As a result, the traditional costing system is used for preparing external financial reports and the activity-based costing system is used for internal decision making and for managing activities.[3]

2. Templates

In the following, two templates are presented, which show the calculation of the operating income by applying the traditional costing system and later by applying the activity-based costing system, in order to emphasize the difference between these two costing methods. Therefore, with regard to contents, both templates refer to the identical original data. 

2.1 Traditional Costing System Template

Starting with the traditional costing system, the following example is given:

‘FS’ is a Family Supermarket which wants to increase the size of their store. It wants information about the profitability of individual product lines: these are soft drinks, fresh produce and packaged food. ‘FS’ provides the following data for 2016:[4]

Figure 1: Original Data of the Supermarket in 2016

FS currently allocates store support cost (all costs other than costs of goods sold) to product lines on the basis of cost of goods sold of each product line. The task is to calculate the operating income and the operating income percentage.[5]

In order to calculate the operating income, it is necessary to calculate the store support costs, therefore an allocation rate needs to be calculated. The total support costs equal 360.000€ by adding the cost of bottles returned, cost of purchase orders, cost of deliveries, cost of shelf-stocking and the cost of customer support. These total support cost have to be divided by the total of cost of goods sold, which equals 1.200.000€, as a result the allocation rate equals 30%. Consequently, the cost of goods sold for each product line needs to be multiplied by the allocation rate to estimate the store support costs as it is apparent on the template below.

Figure 2: Allocation Rate for the Traditional Costing System

Figure 3: Operating income/Percentage

Finally, the sum of store support costs and cost of goods sold (total costs) of each product line needs to be subtracted from its revenues to estimate the operating income. Subsequently the calculated operating income of each product line needs to be divided by its revenue to estimate the operating income percentage for each product line. 

2.2 Activity Based Costing System Template

FS allocates store support cost (all costs other than costs of goods sold) to product lines using an activity-based costing system, what would the operating income and the operating income percentage for each product line be?

By applying the ABC system, an overhead allocation for every activity area has to be calculated first, in order to enable the expedience of store support costs, since these have to be calculated for estimating the operating income. In this case the bottle return costs are not considered as indirect costs but direct cost, due to the fact that they can be directly traced to the soft drink product line. Hence, only an activity rate for the ordering, delivery, shelf-stocking and customer support activity has to be calculated by dividing the total costs of each area by their quantity of cost allocation base.

Figure 4: Total Activity Costs and Cost-Allocation Base

Figure 5: Overhead Allocation Rate

As a next step, the number of purchase orders placed, the number of deliveries received and the hours of shelf-stocking time of each product line has to be multiplied by the corresponding activity rate, that has been estimated in the previous calculation, to evaluate the ordering, delivery, shelf-stocking and customer support costs for each product line. 


Figure 6: Operating Income/Percentage by applying the ABC System

Finally, the sum of these store support costs of each product line has to be added to the cost of goods sold, resulting in total costs, which eventually have to be subtracted from the revenue of each product line, in order to calculate the operating income. Last but not least, the operating income divided by the revenue equals the operating income as a percentage.  

3.Quellenverzeichnis

[1] Cf. Johnson, R., Traditional Costing Vs. Activity-Based Costing, in: Small Business, retrieved from: http://smallbusiness.chron.com [accessed on: 26.06.2016]

[2] Cf. Johnson, R., Traditional Costing Vs. Activity-Based Costing, in: Small Business, retrieved from: http://smallbusiness.chron.com [accessed on: 26.06.2016]

[3] Cf. Garrison, Ray H./Noreen, Eric W. and Brewer, Peter C.: Managerial Accounting. 12th ed., New York: McGraw – Hill/Irwin, 2008, p. 310.

[4] Horngren, Charles T./Datar, Srikant M./Foster, George: Cost Accounting – A Managerial Emphasis. 12th ed., Pearson Prentice Hall/New Jersey, 2006.

[5] Horngren, Charles T./Datar, Srikant M./Foster, George: Cost Accounting – A Managerial Emphasis. 12th ed., Pearson Prentice Hall / New Jersey, 2006.

4. Literaturverzeichnis

Garrison, Ray H./Noreen, Eric W. and Brewer, Peter C.: Managerial Accounting. 12th ed., New York: McGraw – Hill/Irwin, 2008, p. 310.

Horngren, Charles T./Datar, Srikant M./Foster, George: Cost Accounting – A Managerial Emphasis. 12th ed., Pearson Prentice Hall/New Jersey, 2006

Johnson, R., Traditional Costing Vs. Activity-Based Costing, in: Small Business, retrieved from: smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html  

Verfasser: Delaram Shah Hosseini