Using an ABC method to better assign unit-level, batch-level, product-level, and factory-
level costs can increase the per-unit costs of the low-volume products and decrease the
per-unit costs of the high-volume products.
Unit‐level activities occur every time a service is performed or a product is
made. The costs of direct materials, direct labor, and machine maintenance are
examples of unit‐level activities.
Batch‐level activities are costs incurred every time a group (batch) of units is
produced or a series of steps is performed. Purchase orders, machine setup, and
quality tests are examples of batch‐level activities.
Product‐line activities are those activities that support an entire product line but
not necessarily each individual unit. Examples of product‐line activities are
engineering changes made in the assembly line, product design changes, and
warehousing and storage costs for each product line.
Facility support activities are necessary for development and production to
take place. These costs are administrative in nature and include building
depreciation, property taxes, plant security, insurance, accounting, outside
landscape and maintenance, and plant management's and support staff's
salaries.
The costs of unit‐level, batch‐level, and product‐line activities are easily allocated to a
specific product, either directly as a unit‐level activity or through allocation of a pooled
cost for batch‐level and product‐line activities. In contrast, the facility‐level costs are
kept separate from product costs and are not allocated to individual units because the
allocation would have to be made on an arbitrary basis such as square feet, number of
divisions or products, and so on.
A batch-level cost is a cost related to a group of units, but which is not associated with specific
individual units. For example, the cost incurred to set up a production run is associated with the
batch of goods that are subsequently produced.A number of methods can be used to assist in
the cost allocation process. For example, the cost of service departments can be allocated to
production departments using the direct method. Also the cost hierarchy can be used to help
establish cost pools and identify cost drivers used to allocate costs. Organizations are also
concerned with measuring and reducing the cost of quality by categorizing quality costs into
four categories—prevention, appraisal, internal failure, and external failure. Batch-level activities
are work actions that are classified within an activity-based costing accounting system, often
used by production companies.Presumably, you can set the machinery to one setting to obtain
the desired product quality and taste. Your friend has to set the machines each time a new flavor
is produced. Although both of you produce the same total volume of ice cream, it is not hard to
imagine that your friend’s overhead costs would be considerably higher.
Abc is less expensive, than traditional costing
Cost of each activity is determined with the help of ABC. There is accuracy in indirect
cost-allocation to products. This technique is helpful in make or buys decisions and
transfer pricing.
ABC helps to reduce costs by providing meaningful information for cost-
management. It helps in making the right decision.
Cost Hierarchy
The first step in activity-based costing involves identifying activities and classifying them
according to the cost hierarchy. Cost hierarchy is a framework that classifies activities
based the ease at which they are traceable to a product. The levels are (a) unit level, (b)
batch level, (c) product level, and (d) facility level.
Unit level activities are activities that are performed on each unit of product. Batch level
activities are activities that are performed whenever a batch of the product is
produced. Product level activities are activities that are conducted separately for each
product. Facility level activities are activities that are conducted at the plant level. The
unit-level activities are most easily traceable to products while facility-level activities are
least traceable.
In Activity-Based Costing system, facility level activities and costs are
treated as period cost as they are found difficult to assign to different
products. The costs associated with the first three categories — unit
level, batch level, product level — are assigned to products, using cost
drivers that reflect the cause- and effect relationship between activity
consumption and cost.
Cost Hierarchy – Example
Suppose Company A, which uses the ABC system, manufacturers’
three different models of AC. So, how will it allocate costs?
Generally, a company that manufactures AC incurs several expenses,
but in this example, we will focus only on its three highest indirect
costs.
The first cost is the Plant utility cost, such as heating, lighting, and
more. Company A knows that it incurs it while manufacturing. So, this
is a unit-level cost, and its allocation base is machine hours.
Next is the Labor cost. Company A incurs it while setting up the
machine to produce another AC model. So, it is at the product level,
and its allocation base is set-up hours.
It may be noted that unit level activities and facility level activities are
the same as those in traditional absorption costing which will be
allocated on physical volume basis, ABC will be more useful if there is
significant size of batch level and product level activities.
