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Appendix 2A
Activity–Based
Absorption Costing
Managerial Accounting
Eighteenth edition
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

2. © McGraw Hill
Learning Objectives 6
Use activity–based absorption costing to compute unit
product costs.
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Activity–Based Absorption Costing:
Overview
Activity–based absorption costing assigns all manufacturing
overhead costs to products using activity cost pools instead
of plantwide or department cost pools.
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Activity–Based Absorption Costing: Key
Definitions
Key Definitions and Concepts.
1. An activity is an event that causes the consumption of
overhead resources.
2. An activity cost pool is a “bucket” in which costs are
accumulated that relate to a single activity.
3. An activity measure is an allocation that is used as the
denominator for an activity cost pool.
4. An activity rate is used to assign costs from an activity
cost pool to products.
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Differences Between ABC Absorption and
Traditional Absorption Costing
Activity–based absorption costing differs from traditional
absorption costing in two ways:
1. The activity based approach uses more cost pools than a
traditional approach.
2. The activity–based approach includes some batch–level
and product–level activities and activity measures that do
not relate to the volume of units produced, whereas the
traditional approach relies exclusively on volume–related
overhead allocation.
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Maxtar Industries – A Traditional Approach
Maxtar Industries provides the following information for the
company as a whole and for its only two products–premium
and standard smoker/barbeque units.
Basic Data
Total estimated manufacturing overhead cost $1,520,000
Total estimated direct labor–hours 400,000 DLHs
Premium Standard
Direct materials per unit $40.00 $30.00
Direct labor per unit $24.00 $18.00
Direct labor–hours per unit 2.0 DLHs 1.5 DLHs
Units produced 50,000 units 200,000 units
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Maxtar Industries – Calculating POHR
Assuming that Maxtar’s traditional cost system relies on one
predetermined plantwide overhead rate with direct labor–
hours (DLHs) as the allocation base, then its plantwide
overhead rate is computed as follows:
$1,520,000
Predeterminedoverheadrate $3.80 per DLH
400,000DLHs
 
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Maxtar Industries – Applying POH to
Products
Maxtar’s traditional cost system would report unit product
costs as follows:
Traditional Unit Product Costs
Premium Standard
Direct materials per unit $40.00 $30.00
Direct labor $24.00 $18.00
Manufacturing overhead (2.0 DLHs × $3.80 per DLH;
1.5 DLHs × $3.80 per DLH) 7.60 5.70
Unit product cost $71.60 $53.70
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Maxtar Industry – Activity–Based
Absorption Costing
The ABC project team at Maxtar has developed the following
basic information.
Basic Data Expected
Activity
Expected
Activity
Expected
Activity
Activity Cost Pools and Activity
Measures
Estimated
Overhead Cost Premium Standard Total
Supporting direct labor (DLHs) $800,000 100,000 300,000 400,000
Setting up machines (setups) 480,000 600 200 800
Parts administration (part types) 240,000 140 60 200
Total manufacturing overhead cost $1,520,000
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Maxtar Industry – Calculating the Activity
Rates
We can calculate the following activity rates:
Computation of Activity Rates (a) (b) (a) ÷ (b)
Activity Cost Pools
Estimated
Overhead Cost
Total Expected
Activity Activity Rate
Supporting direct labor $800,000 400,000 DLHs $2 per DLH
Setting up machines $480,000 800 setups $600 per setup
Parts administration $240,000 200 part types $1,200 per part type
Using the new activity rates, let’s assign overhead to the two
products based upon expected activity.
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Maxtar Industry – Total Overhead
Assigned to Products
Assigning Overhead Costs to
Products
The Premium Product
Activity Cost Pools (a) Activity Rate (b) Activity (a) × (b) ABC Cost
Supporting direct labor $2 per DLH 100,000 DLHs $200,000
Setting up machines $600 per setup 600 setups 360,000
Parts administration $1,200 per part type 140 part types 168,000
Total $728,000
The Standard Product
Activity Cost Pools (a) Activity Rate (b) Activity (a) × (b) ABC Cost
Supporting direct labor $2 per DLH 300,000 DLHs $600,000
Setting up machines $600 per setup 200 setups 120,000
Parts administration $1,200 per part type 60 part types 72,000
Total $792,000
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Maxtar Industry – Calculating Unit Product
Cost
Activity–based unit product costs for both product lines.
Activity-Based Absorption Costing Product Costs
Premium Standard
Direct materials $40.00 $30.00
Direct labor 24.00 18.00
Manufacturing overhead ($728,000 ÷ 50,000 units;
$792,000 ÷ 200,000 units) 14.56 3.96
Unit product cost $78.56 $51.96
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Maxtar Industry – Determining Overhead
Per Unit
Activity–based unit product costs for both product lines.
Activity–Based Absorption Costing Product Costs
Premium Standard
Direct materials $40.00 $30.00
Direct labor 24.00 18.00
Manufacturing overhead ($728,000 ÷ 50,000 units;
$792,000 ÷ 200,000 units) 14.56 3.96
Unit product cost $78.56 $51.96
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Comparing the Two Approaches
Note that the unit product cost of a Standard unit decreased
from $53.70 to $51.96, while the unit cost of the Premium
unit increased from $71.60 to $78.56.
1. The activity–based approach contains two non–volume–
related cost pools –“setting up machines” which is a
batch–level activity and “parts administration” which is a
product–level activity.
2. The activity–based approach assigned these costs to
products in a way that shifted costs from the high volume
product (standard) to the low volume product (premium).
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