# 16.4.4 Activity-Based Product Cost Estimation

### Intended learning outcomes: Produce an overview on Determining the process cost rate and process quantity for supplier management. Explain determining the process cost rate as well as the process costs for external procurement of a single item: “standard component” versus “exotic component.” Present in detail an ABC process plan and activity-based product cost estimation for a produced item as well as for a procured item.

Figure 16.4.4.1 shows another example, taken again from [Schm92]. Here, “supplier management” is a subprocess of the main process “materials purchasing.”

Fig. 16.4.4.1       Determining the process cost rate and process quantity for supplier management.

The process costs are recorded for a period of time (in this case, six months). The process variable is the supplier. The process cost rate is determined by dividing the process costs by the number of suppliers. The number of different items procured from the supplier and the usage for each of these items over the time period determines process quantity. This provides the process quantity of each component that is incorporated into one product.

Figure 16.4.4.2 provides a quantitative example using simple data for illustrative purposes. It reveals the difference between the process costs for supplier management with just one supplier and a large number of purchased items with a high turnover and the process costs for one supplier with just a few purchased items and a correspondingly lower turnover.

Fig. 16.4.4.2       Determining the process cost rate for a single item in the “supplier ma­nagement” process: “standard component” versus “exotic component.”

Figure 16.4.4.3 extends the supplier management example to include a costing for the entire purchasing process.

Fig. 16.4.4.3       Determining the process costs for external procurement of a single item: “standard component” versus “exotic component.”

Again, the difference in process costs mentioned above stands out clearly. With conventional costing, in contrast, if the same additional percentage for material costs is applied to both the standard component and the exotic component, the loaded fixed material costs will be the same, even though the one is much more expensive to purchase than the other.

The next two examples show the activity-based product cost estimation for a manufactured item and a purchased item, each based on an ABC process plan. Figure 16.4.4.4 relates to the main processes and subprocesses of a product manufactured in-house that were shown in Figure 16.4.3.1. The individual positions are very similar to those that would be found on a normal routing sheet. In this case, however, “Process ID” replaces the work center. The administrative process plan positions for order management and stock issues/receipts, for example, would also be shown in addition to the operations. To calculate the cost of goods manufactured, we would also normally include the operations found on the normal routing sheet. They would be used only to calculate the variable costs, however.

Fig. 16.4.4.4       An ABC process plan and activity-based product cost estimation for a produced item.

Figure 16.4.4.5 represents the ABC process plan and the activity-based product cost estimation for a purchased item. Main process and subprocesses correspond to those shown in Figure 16.4.3.2, using the example in Figure 16.4.4.3. Therefore, we should allocate \$37 to fixed material costs for each built-in “power supply” component. The similarity to a routing sheet is obvious. Standard ERP software can be used to store the ABC process plan.

Fig. 16.4.4.5       An ABC process plan and activity-based product cost estimation for a procured item.

## Course section 16.4: Subsections and their intended learning outcomes

• ##### 16.4 Activity-Based Costing

Intended learning outcomes: Disclose the limits of traditional product costing. Explain activity-based costing: aim, basic premise, requirements, and technique. Present typical processes (activities) and process variables as well as the activity-based product cost estimation.

• ##### 16.4.1 Limits of Traditional Product Costing

Intended learning outcomes: Describe allocating fixed costs to products with conventional cost accounting using two cost types. Explain the potential for error in traditional product costing.

• ##### 16.4.2 Introducing Activity-Based Costing: Aim, Basic Premise, Requirements, and Technique

Intended learning outcomes: Produce an overview on activity-based costing. Identify ABC process, process variable and process cost rate. Describe the ABC process plan and the process quantity. Explain allocating fixed costs using activity-based cost accounting.

• ##### 16.4.3 Typical Processes (Activities) and Process Variables for Activity-Based Costing

Intended learning outcomes: Explain determining main processes and subprocesses, using the example of circuit board assembly. Describe determining main processes and subprocesses using the example of procurement.

• ##### 16.4.4 Activity-Based Product Cost Estimation

Intended learning outcomes: Produce an overview on Determining the process cost rate and process quantity for supplier management. Explain determining the process cost rate as well as the process costs for external procurement of a single item: “standard component” versus “exotic component.” Present in detail an ABC process plan and activity-based product cost estimation for a produced item as well as for a procured item.