ACCT 2103 · Activity-Based Costing: When Absorption Goes Wrong

Led by Margaret Vance-Foster Simulacrum

1. Module 3 ○ Open

   Activity-Based Costing: When Absorption Goes Wrong

   Led by Margaret Vance-Foster Simulacrum

   The question

   Activity-based costing as the response to traditional absorption costing's misallocation of overhead in modern operations where overhead is large and not driven by direct labour. The module covers the case for ABC, cost pools by activity (setup, materials handling, inspection, design, customer service), cost drivers (number of setups, orders, machine hours, design changes), the two-stage allocation, case studies of ABC revealing hidden cross-subsidisation, time-driven ABC as Kaplan's later refinement, and the question of when ABC pays back the implementation cost. The closing scenario reveals the truth about two customers under ABC.

   Outcome

   The student can articulate the case for ABC over traditional absorption, set up an ABC analysis with multiple cost pools and drivers, calculate ABC unit costs, identify products or customers that are cross-subsidising others under traditional costing, and decide whether ABC is worth implementing in a given operation. (Activity-based costing)

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   Practice scenarios

   The Two Customers

   Foster Simulacrum gives you data for a small B2B services company: two customers (A and B), both producing the same revenue of £200,000 per year. Under traditional costing (overhead allocated by revenue), both appear equally profitable: revenue £200k each, allocated overhead £75k each, contribution £50k each (variable cost £75k each), profit £50k each. The CFO wants to renew both contracts at similar terms. Foster Simulacrum suspects this is wrong. Activity data: Customer A places 24 orders/year, requires 8 support calls/year, uses standard pricing; Customer B places 240 orders/year, requires 96 support calls/year, demands custom pricing on every order. Total annual activity costs: order processing £36,000 (264 orders total), customer support £40,000 (104 calls total), pricing & contract admin £24,000 (Customer B requires almost all of it).

   Your goals

   • Allocate by activity: Customer A — 24/264 × £36k = £3,273 + 8/104 × £40k = £3,077 + ~£2,000 admin = ~£8,350.
   • Customer B — 240/264 × £36k = £32,727 + 96/104 × £40k = £36,923 + ~£22,000 admin = ~£91,650.
   • Recalculate profit: Customer A = £200k − £75k variable − £8.35k = ~£116,650. Customer B = £200k − £75k variable − £91.65k = ~£33,350.
   • Recommend renewal: Customer A is the high-margin account and should be retained at favourable terms. Customer B requires either a price increase, surcharges for excessive support, or simplification of order patterns.
   • Acknowledge the political difficulty: Customer B looks important to senior management because of revenue; ABC reveals it has been cross-subsidised by Customer A.

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