CHAPTER 4

Activity-Based Costing
ASSIGNMENT CLASSIFICATION TABLE

Brief A B
Study Objectives Questions Exercises Exercises Problems Problems

*1. Recognize the difference 1, 2, 3, 1, 2 1, 2, 3, 4, 1A, 3A, 1B, 3B,

between traditional costing 4, 5 5, 6, 12, 4A, 5A 4B, 5B
and activity-based costing. 13

*2. Identify the steps in the 7

development of an activity-
based costing system.

*3. Know how companies 9 7, 8

identify the activity
cost pools used in
activity-based costing.

*4. Know how companies 6, 10, 11, 3, 4, 5, 6, 1, 3, 4, 5, 1A, 2A, 3A, 1B, 2B, 3B,
identify and use cost 12 7, 12 6, 8, 9, 10, 4A, 5A 4B, 5B
drivers in activity-based 11, 12, 13
costing.

*5. Understand the bene- 13, 14, 15 11

fits and limitations of
activity-based costing.

*6. Differentiate between 8, 16, 17 8, 9 12, 13, 14, 1A, 5A 1B, 5B

value-added and non- 15, 16
value-added activities.

*7. Understand the value of 19 10, 11, 12 17, 18

using activity levels in
activity-based costing.

*8. Apply activity-based 18 9, 10 16 5A 5B

costing to service
industries.

*9. Explain just-in-time 20

(JIT) processing.

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix
to the chapter.

4-1
ASSIGNMENT CHARACTERISTICS TABLE
Problem Difficulty Time
Number Description Level Allotted (min.)

1A Assign overhead using traditional costing and ABC; Moderate 35–45

compute unit costs; classify activities as value- or
non-value-added.

2A Assign overhead to products using ABC and evaluate Moderate 25–35

decision.

3A Assign overhead costs using traditional costing and ABC; Moderate 35–45
compare results.

4A Assign overhead costs using traditional costing and ABC; Moderate 40–50
compare results.

5A Assign overhead costs to services using traditional Moderate 35–45

costing and ABC; compute overhead rates and unit costs;
compare results.

1B Assign overhead using traditional costing and ABC; Moderate 35–45

compute unit costs; classify activities as value- or
non-value-added.

2B Assign overhead to products using ABC and evaluate Moderate 25–35

decision.

3B Assign overhead costs using traditional costing and ABC; Moderate 35–45
compare results.

4B Assign overhead costs using traditional costing and ABC; Moderate 40–50
compare results.

5B Assign overhead costs to services using traditional Moderate 35–45

costing and ABC; compute overhead rates and unit costs;
compare results.

4-2
 Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems

Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation

*1. Recognize the difference Q4-1 BE4-1 E4-5 P4-5A E4-1 P4-3A
between traditional costing Q4-2 BE4-2 E4-6 P4-1B E4-2 P4-4A
and activity-based costing. Q4-3 E4-1 E4-12 P4-4B E4-3 P4-5A
Q4-4 E4-2 E4-13 P4-5B E4-4 P4-3B
Q4-5 E4-3 P4-1A E4-5 P4-4B
E4-4 P4-4A E4-6 P4-5B
*2. Identify the steps in the Q4-7
development of an activity-
based costing system.
*3. Know how companies identify Q4-9 E4-7
the activity cost pools used in E4-8
activity-based costing.
BLOOM’S TAXONOMY TABLE

*4. Know how companies identify Q4-6 BE4-3 E4-4 E4-13 P4-2B E4-1 E4-10 P4-1A P4-4B P4-2A
and use cost drivers in Q4-10 BE4-4 E4-5 P4-1A P4-3B E4-3 E4-11 P4-2A P4-3A
activity-based costing. Q4-11 BE4-5 E4-8 P4-2A P4-4B E4-4 E4-12 P4-3A P4-4A
Q4-12 BE4-6 E4-9 P4-3A P4-5B E4-5 E4-13 P4-4A P4-2B
BE4-7 E4-10 P4-4A E4-6 P4-3A P4-1B P4-3B
BE4-12 E4-11 P4-5A E4-8 P4-3B P4-2B P4-4B

4-3
E4-1 E4-12 P4-1B E4-9 P4-3B
*5. Understand the benefits and Q4-13 E4-11 E4-11
limitations of activity-based Q4-14
costing. Q4-15
*6. Differentiate between value- Q4-8 BE4-8 E4-13 E4-16 BE4-8 E4-15
added and non-value-added Q4-16 BE4-9 E4-14 P4-1A BE4-9 P4-5A
activities. Q4-17 E4-12 E4-15 P4-1B E4-14 P4-5B
*7. Understand the value of Q4-19 BE4-10 BE4-10
using activity levels in BE4-11 E4-17
activity-based costing. BE4-12 E4-18
*8. Apply activity-based costing Q4-18 BE4-9 P4-5A E4-16 P4-5B P4-5A P4-5A
to service industries. BE4-10 P4-5B P4-5A P4-5B P4-5B
*9. Explain just-in-time (JIT) Q4-20
processing.
Broadening Your Perspective Exploring the Web Managerial Analysis Decision Making Decision Making Managerial Anal.
Across the Across the Real-World Focus
Organization Organization Ethics Case
Real-World Focus Communication
Communication
 STUDY OBJECTIVES

1. RECOGNIZE THE DIFFERENCE BETWEEN TRADITIONAL

COSTING AND ACTIVITY-BASED COSTING.

2. IDENTIFY THE STEPS IN THE DEVELOPMENT OF AN

ACTIVITY-BASED COSTING SYSTEM.

3. KNOW HOW COMPANIES IDENTIFY THE ACTIVITY

COST POOLS USED IN ACTIVITY-BASED COSTING.

4. KNOW HOW COMPANIES IDENTIFY AND USE COST

DRIVERS IN ACTIVITY-BASED COSTING.

5. UNDERSTAND THE BENEFITS AND LIMITATIONS OF

ACTIVITY-BASED COSTING.

6. DIFFERENTIATE BETWEEN VALUE-ADDED AND NON-

VALUE-ADDED ACTIVITIES.

7. UNDERSTAND THE VALUE OF USING ACTIVITY

LEVELS IN ACTIVITY-BASED COSTING.

8. APPLY ACTIVITY-BASED COSTING TO SERVICE

INDUSTRIES.

*9. EXPLAIN JUST-IN-TIME (JIT) PROCESSING.

4-4
 CHAPTER REVIEW

Traditional Costing And Activity-Based Costing

1. (S.O. 1) Often the most difficult part of computing accurate unit costs is determining the proper
amount of overhead cost to assign each product, service or job. For job order costing we
assumed the direct labor cost was the relevant activity base for assigning overhead costs to a job
and for process costing we assumed that machine hours was the relevant activity base.

2. Activity-based costing (ABC) allocates overhead to multiple activity cost pools and assigns the
activity cost pools to products and services by means of cost drivers. In ABC, an activity is any
event, action, transaction, or work sequence that causes the incurrence of cost in producing a
product or providing a service. A cost driver is any factor or activity that has a direct cause-effect
relationship with the resources consumed.

3. ABC allocates overhead in a two-stage process: In the first stage, overhead costs are allocated to
activity cost pools, rather than to departments. Each is a distinct type of activity. In the second
stage, the overhead allocated to the activity cost pools is assigned to products using cost drivers
which represent and measure the number of individual activities undertaken or performed to
produce products or provide services.

4. (S.O. 2) Activity-based costing involves the following four steps:

a. Identify and classify the major activities involved in the manufacture of specific products and
allocate manufacturing overhead costs to the appropriate cost pools.
b. Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool.
c. For each cost pool, compute the activity-based overhead rate per cost driver.
d. Assign manufacturing overhead costs for each cost pool to products, using the overhead
rates (cost per driver).

Unit Costs Under ABC

5. (S.O. 3) A well designed activity-based costing system starts with an analysis of the activities
performed to manufacture a product or provide a service. This analysis should identify all
resource-consuming activities. It requires a detailed, step-by-step walk through of each operation,
documenting every activity undertaken to accomplish a task.

6. (S.O. 4) After costs are allocated to the activity cost pools, the cost drivers for each cost pool
must be identified. The cost driver must accurately measure the actual consumption of the activity
by the various products. To achieve accurate costing, a high degree of correlation must exist
between the cost driver and the actual consumption of the overhead costs in the cost pool.

7. An activity-based overhead rate per cost driver is computed by dividing the total estimated
overhead per activity by the number of cost drivers expected to be used per activity. The formula
for this computation is as follows:

Estimated Overhead Per Activity Activity Based

=
Expected Use of Cost Driver Per Activity Overhead Rate

4-5
8. In assigning overhead costs, it is necessary to know the expected use of cost drivers for each
product. To assign overhead costs to each product, the activity-based overhead rates are
multiplied by the number of cost drivers expected to be used per product.

Benefits of ABC

9. (S.O. 5) The primary benefit of ABC is more accurate product costing because:
a. ABC leads to more cost pools.
b. ABC leads to enhanced control over overhead costs.
c. ABC leads to better management decisions.

Limits of ABC

10. Although ABC systems often provide better product cost data than traditional volume-based
systems, there are the following limitations:
a. ABC can be expensive.
b. Some arbitrary allocations continue.

When to Use ABC

11. The presence of one or more of the following factors would point to possibly using ABC:
a. Product lines differ greatly in volume and manufacturing complexity.
b. Product lines are numerous, diverse, and require differing degrees of support services.
c. Overhead costs constitute a significant portion of total costs.
d. The manufacturing process or the number of products has changed significantly.
e. Production or marketing managers are ignoring data provided by the existing system and are
instead using “bootleg” costing data or other alternative data when pricing or making other
product decisions.

Value-Added Versus Non-Value-Added Activities

12. (S.O. 6) Activity-based management (ABM) is an extension of ABC from a product costing
system to a management function that focuses on reducing costs and improving processes and
decision making.
a. Value-added activities increase the worth of a product or service to customers. Examples
include engineering design, machining, assembly, painting, and packaging.
b. Non-value-added activities are product- or service-related activities that simply add cost to,
or increase the time spent on, a product or service without increasing its market value.
Examples include repair of machines, the storage of inventory, the moving of raw materials,
assemblies, and finished product; building maintenance; inspections; and inventory control.
Examples for service enterprises might include taking appointments, reception, bookkeeping,
billing, traveling, ordering supplies, advertising, cleaning, and computer repair.

13. The purpose of ABM is to reduce or eliminate the time and cost devoted to non-value-added
activities.

4-6
Classification of Activity Levels

14. (S.O. 7) The recognition that some activity costs are not driven by output units has led to the
development of a classification of ABC activities, consisting of four levels. The four levels are
classified and defined as follows:
a. Unit-level activities. Activities performed for each unit of production.
b. Batch-level activities. Activities performed for each batch of products rather than each unit.
c. Product-level activities. Activities performed in support of an entire product line, but are not
always performed every time a new unit or batch of products is produced.
d. Facility-level activities. Activities required to support or sustain an entire production
process.

Activity-Based Costing in Service Industries

15. (S.O. 8) The general approach to identifying activities, activity cost pools, and cost drivers is the
same for service companies and for manufacturers. Also, the labeling of activities as value-added
and non-value-added, and the attempt to reduce or eliminate non-value-added activities as much
as possible is just as valid in service industries as in manufacturing operations.

16. Implementation of activity-based costing in service industries is sometimes more difficult because
there is a larger proportion of overhead costs which are company-wide costs that cannot be
directly traced to specific services provided by the company.

Just-In-Time Processing

*17. (S.O. 9) Just-in-time (JIT) manufacturing is dedicated to having the right amount of materials,
products, or parts at the time they are needed. Under JIT processing, raw materials are received
just in time for use in production, subassembly parts are completed just in time for use in finished
goods, and finished goods are completed just in time to be sold.

*18. A primary objective of JIT is to eliminate all manufacturing inventories. Inventories are considered
to have an adverse effect on net income because they tie up funds and storage space that could
be made available for more productive purposes.

*19. There are three important elements in JIT processing:

a. A company must have dependable suppliers who are willing to deliver on short notice exact
quantities of raw materials according to precise quality specifications. This may even include
multiple deliveries within the same day.
b. A multiskilled work force must be developed.
c. A total quality control system must be established throughout the manufacturing operations.

*20. The major benefits of implementing JIT processing are:

a. Manufacturing inventories are significantly reduced or eliminated.
b. Product quality is enhanced.
c. Rework costs and inventory storage costs are reduced or eliminated.
d. Production cost savings are realized from the improved flow of goods through the processes.

4-7
 LECTURE OUTLINE

A. Traditional Costing Systems

1. A traditional costing system allocates overhead to products on the basis

of predetermined plantwide or departmentwide volume of unit-based
output rates such as direct labor or machine hours.

2. Direct labor is sometimes the appropriate basis for assigning overhead

cost to products when

a. It constitutes a significant part of total product cost, and

b. A high correlation exists between direct labor and changes in the

amount of overhead costs.

B. Activity-Based Costing.

1. Activity-based costing (ABC) allocates overhead to multiple activity cost

pools, and it then assigns the activity cost pools to products and
services by means of cost drivers.

2. In ABC, an activity is any event, action, transaction, or work sequence

that incurs cost when producing a product or providing a service.

3. ABC allocates overhead in a two-stage process. The first stage allocates

overhead costs to activity cost pools. The second stage assigns the
overhead allocated to the activity cost pools to products, using cost
drivers.

4. Cost drivers measure the number of individual activities undertaken or

performed to produce products or provide services.

4-8
 TEACHING TIP

ILLUSTRATION 4-1 provides examples of activities and related cost drivers that
measure each activity’s contribution to the finished product.

C. Unit Costs Under ABC.

1. Activity-based costing involves the following steps:

a. Identify and classify the major activities involved in the manufacture

of specific products, and allocate manufacturing overhead costs to
the appropriate cost pools.

b. Identify the cost driver that has a strong correlation to the costs
accumulated in the cost pool.

c. Compute the overhead rate for each cost driver.

d. Assign manufacturing overhead costs for each cost pool to products,

using the overhead rates (cost per driver).

TEACHING TIP

ILLUSTRATION 4-2 presents the steps involved in an activity-based costing

system.
Also available as teaching transparency.

2. A well designed activity-based costing system starts with an analysis of

the activities performed to manufacture a product or provide a service.

3. It requires a detailed, step-by-step review of each operation, documenting

every activity undertaken to accomplish a task.

4. Next, the system assigns overhead costs directly to the appropriate activity
cost pool.

4-9
D. Identify Cost Drivers, Compute Overhead Rates, and Assign Overhead
Costs to Products.

1. After costs are allocated to the activity cost pools, the company must
identify the cost drivers for each cost pool.

2. A high degree of correlation must exist between the cost driver and the
actual consumption of the overhead costs in the cost pool to achieve
accurate costing.

3. The company computes an activity-based overhead rate per cost driver

by dividing the estimated overhead per activity by the number of cost
drivers expected to be used per activity.

TEACHING TIP

ILLUSTRATION 4-3 provides formulas for the activity-based overhead rate, the
overhead costs assigned to products, and the overhead cost per unit.
Also available as teaching transparency.

4. In assigning overhead costs, it is necessary to know the expected use of

cost drivers for each product.

5. The company multiplies activity-based overhead rates per cost driver by

the number of cost drivers expected to be used per product to assign
overhead costs to each product.

6. Under ABC, overhead costs are usually shifted from a high-volume

product to a low-volume product. This shift results in more accurate
costing because:

a. Low-volume products often require more special handling, (i.e.-

more machine setups and inspections), than high-volume products.

b. Assigning overhead using ABC will usually increase the cost per
unit for low-volume products (and decrease the cost per unit for
high-volume products).

4-10
E. Benefits of ABC.

1. The primary benefit of ABC is more accurate product costing because

a. ABC leads to more cost pools being used to assign overhead costs
to products.

b. ABC leads to enhanced control over overhead costs; companies

can trace many overhead costs directly to activities under ABC.

c. ABC leads to better management decisions; more accurate product

costing should contribute to desired product profitability levels.

TEACHING TIP

ILLUSTRATION 4-4 presents the benefits of activity-based costing. Point out

that ABC allocates overhead costs in a more accurate manner than traditional
costing.

2. The limitations of ABC are:

a. ABC can be expensive to use; identifying multiple activities and

applying numerous cost drivers results in increased costs.

b. Some arbitrary allocations continue; certain overhead costs still

have to be allocated by some arbitrary volume-based cost driver
(i.e.-labor hours).

3. The presence of one or more of the following factors would point to

ABC’s possible use.

a. Product lines differ greatly in volume and manufacturing complexity.

b. Product lines are numerous and diverse, and they require differing
degrees of support services.

c. Overhead costs constitute a significant portion of total costs.

4-11
 d. The manufacturing process or the number of products has changed
significantly.

e. Production or marketing managers are ignoring data provided by

the existing system and are instead using other alternative data
when making pricing decisions.

F. Value-Added Versus Non-Value-Added Activities.

1. A refinement of activity-based costing used in activity-based management

(ABM) is the classification of activities as either value-added or non-
value-added.

2. Value-added activities increase the worth of a product or service, for

which the customer is willing to pay.

3. Value-added activities are the activities of actually manufacturing a

product or performing a service (i.e., engineering design, assembly,
packaging).

4. Non-value-added activities are production- or service-related activities

that simply add cost to, or increase the time spent on, a product or
service without increasing its market value (i.e. machine repair, building
maintenance, inventory control).

TEACHING TIP

ILLUSTRATION 4-5 provides examples of activities that are classified as value-

added and non-value-added. Point out that not all non-value-added activities are
totally wasteful or easily eliminated.
Also available as teaching transparency.

5. Companies often use activity flowcharts to help identify the ABC activities.

4-12
 6. Not all non-value-added activities are totally wasteful, nor can they be
totally eliminated, but managers are motivated to minimize them as
much as possible.

G. Classification of Activity Levels.

1. A classification of ABC activities consisting of four levels are defined as

a. Unit-level activities: activities performed for each unit of production.

b. Batch-level activities: activities performed for each batch of products

rather than each unit.

c. Product-level activities: activities performed in support of an entire

product line.

d. Facility-level activities: activities required to support an entire

production process.

TEACHING TIP

ILLUSTRATION 4-7 provides the types of activities and examples of cost drivers
for each of the four different levels of ABC activities.
Also available as teaching transparency.

2. Companies may achieve greater accuracy in overhead cost allocation by

recognizing the different levels of activities and developing specific
activity cost pools and their related cost drivers.

3. Nonrecognition of this classification of activities is one of the reasons

that volume-based cost allocation causes distortions in product costing.

4. The resources consumed by batch-, product-, and facility-level supporting

activities do not vary at the unit level, nor can managers control them at
the unit level.

4-13
 5. Companies can control batch-, product-, and facility-level costs only by
modifying batch-, product-, and facility-level activities, respectively.

H. Activity-Based Costing in Service Industries.

1. The overall objective of ABC in service firms is no different than it is for a

manufacturing company: The objective is to identify the key activities
that generate costs and to keep track of how many activities are
performed for each service provided.

2. The general approach to identifying activities, activity cost pools, and

cost drivers is the same for service companies and for manufacturers.

3. A larger proportion of overhead costs are company-wide costs that

cannot be directly traced to specific services rendered by the company,
which sometimes makes implementation of ABC difficult in service
industries.

*I. Just-in-Time Processing.

1. Traditionally, continuous process manufacturing has been based on a

just-in-case philosophy: inventories of raw materials are maintained just
in case some items are of poor quality or a key supplier is shut down by
a strike. This philosophy results in a “push approach”, in which raw
materials are pushed through each process and often results in the
buildup of extensive manufacturing inventories.

2. Many U.S. firms have switched to just-in-time (JIT) processing. Under

JIT processing, companies receive raw materials just in time for use in
production, they complete subassembly parts just in time for use in
finished goods, and they complete finished goods just in time to be sold.

3. JIT strives to eliminate inventories by using a pull approach in manufacturing.

This approach begins with the customer placing an order with the
company which starts the process of pulling the product through the
manufacturing process.

4-14
 4. JIT processing consists of three important elements:

a. Suppliers must be dependable and willing to deliver on short notice

exact quantities of materials, and to specified work stations. Online
computer linkage between the company and its suppliers facilitates
this arrangement.

b. Workers must be multiskilled in order to operate and maintain several

different types of machines.

c. The company must establish total quality control throughout the manu-
facturing operations, which tolerates no defects. Continuous monitoring
by both employees and supervisors at each work station is required.

TEACHING TIP

ILLUSTRATION 4-6 presents the elements in JIT processing. Point out that JIT’s
primary objective is to eliminate all manufacturing inventories.

5. The major benefits of JIT processing include:

a. Significant reduction or elimination of manufacturing inventories.

b. Enhanced product quality.

c. Reduction or elimination of rework costs and inventory storage costs.

d. Production cost savings from the improved flow of goods through

the processes.

6. One of the major accounting benefits of JIT is the elimination of separate

raw materials and work-in-process inventory accounts.

4-15
 20 MINUTE QUIZ

Circle the correct answer.

True/False

1. In today’s automated environment, direct labor is sometimes the appropriate basis for
assigning overhead cost to products.
True False

2. In the first stage of activity-based costing, overhead is assigned to products using cost
drivers.
True False

3. The first step in activity-based costing is to identify and classify the major activities
involved in the manufacture of specific products, and allocate manufacturing overhead to
the appropriate cost pools.
True False

4. Before costs are allocated to the cost pools, the cost drivers for each cost pool must be
identified.
True False

5. Under ABC, overhead costs are shifted from the high-volume product to the low-volume
product.
True False

6. Activity-based costing does not change the amount of overhead costs, but it does
allocate those costs in a more accurate manner.
True False

7. Overhead costs are not allocated by means of arbitrary volume-based cost drivers under
ABC.
True False

8. Value-added activities increase the worth of a product or service to customers and

involve resource usage that customers are willing to pay for.
True False

9. Product-level activities in ABC are required to support or sustain an entire production

process.
True False

*10. Just-in-time processing strives to eliminate inventories by using a “pull approach” in

manufacturing.
True False
4-16
Multiple Choice

1. The last step in activity-based costing is to

a. identify the major activities involved in the manufacture of specific products.
b. compute the overhead rate per cost driver.
c. identify the cost driver that has a strong correlation to the costs accumulated in the
cost pool.
d. assign manufacturing overhead costs for each cost pool to products.

2. Machine hours would be an accurate cost driver for

a. assembly costs.
b. inspecting costs.
c. machining costs.
d. machine setup costs.

3. All of the following are benefits of ABC except it leads to

a. less cost pools used to assign overhead.
b. more accurate cost data.
c. enhanced control over overhead costs.
d. better management decisions.

4. The level of ABC activities performed in support of an entire product line are classified as
a. batch-level activities.
b. facility-level activities.
c. product-level activities.
d. unit-level activities.

*5. Just-in-time processing strives to eliminate inventories by using a

a. just in case approach.
b. pull approach.
c. push approach.
d. process approach.

4-17
 ANSWERS TO QUIZ

True/False

1. True 6. True
2. False 7. False
3. True 8. True
4. False 9. False
5. True *10. True

Multiple Choice

1. d.
2. c.
3. a.
4. c.
*5. b.

4-18
ILLUSTRATION 4-1
ACTIVITIES AND COST DRIVERS

Activities Cost Drivers

Assembling Number of parts
Inspecting Number of inspections
Machining Machine hours
Ordering Number of purchase orders
Setting up machines Number of setups
Storing Amount of square footage
Supervising Number of employees

4-19
ILLUSTRATION 4-2
STEPS IN ACTIVITY-BASED COSTING SYSTEM

Step 1 Identify and classify the major

activities involved in the manufacture
of specific products, and allocate
manufacturing overhead costs to
the appropriate cost pools.
Step 2 Identify the cost driver that has a
strong correlation to the costs
accumulated in the cost pool.
Step 3 Compute the overhead rate
for each cost driver.
Step 4 Assign manufacturing overhead costs for
each cost pool to products, using the
overhead rates (cost per driver).

4-20
 ILLUSTRATION 4-3

Activity-Based Estimated Overhead Per Activity

Overhead Rate
= Expected Use of Cost Drivers Per Activity

Overhead Cost Activity-Based Number of Cost Drivers

4-21
Assigned
= Overhead Rate
× Expected to Be Used

Overhead Cost Total Overhead Total Units

Per Unit
= Cost Assigned Produced
COMPUTING ACTIVITY-BASED OVERHEAD RATE
ILLUSTRATION 4-4
BENEFITS OF ABC

Benefits:
1. ABC leads to more cost pools being
used to assign overhead costs.
2. ABC leads to enhanced control over
overhead costs.
3. ABC leads to better management
decisions.

4-22
ILLUSTRATION 4-5
VALUE-ADDED AND NON-VALUE-ADDED ACTIVITIES

ACTIVITIES
Value-added Non-value-added
Assembly Building maintenance
Engineering design Inspections
Machining Moving of materials
Packaging Repair of machines
Painting Storage of inventory

4-23
ILLUSTRATION 4-6
CLASSIFICATION OF ACTIVITY LEVELS

Four Levels Types of Activities Examples of Cost Drivers

Unit-Level Activities Machine-related: Machine hours
Drilling, cutting,
milling, trimming,
pressing

Labor-related: Direct labor hours or cost

Assembling, painting,
sanding, sewing
Batch-Level Activities Equipment setups Number of setups/setup time
Purchase ordering Number of purchase orders
Inspection Number of inspections/
inspection time
Material handling Number of material moves
Product-Level Activities Product design Number of product designs
Engineering changes Number of changes

Facility-Level Activities Plant management Number of employees

salaries managed
Plant depreciation Square footage
Property taxes Square footage
Utilities Square footage

4-24
ILLUSTRATION 4-7
ELEMENTS OF JIT PROCESSING

Elements:
1. Suppliers must be willing to deliver
on short notice exact quantities of
materials according to precise quality
specifications.
2. A multiskilled work force to operate
and maintain different types of machines.
3. The company must establish total
quality control throughout the
manufacturing process.

4-25