[ Music ] [ Silence ] >> Welcome to module 3. In this first lesson in module 3, we'll focus on 2 objectives. The first is to understand the fundamental concepts of activity-based costing or ABC and the second, is discuss the advantage and disadvantages of ABC systems. So, what is activity-based costing? Well, the general approach is that it's a costing method and that costing method focuses on 2 key aspects. The first is that activities use resources. The focus here is on the activities. The second aspect is that we focus on the causal relationship among the activities, the resources, and the cost objects that we're trying to understand the cost of. What this buys us is an increase in the accuracy of cost information relative to a more traditional costing system. Let's turn to some fundamental concepts. First activities. So, thinking about activities very simply all that is is a description of the work performed. Now, you can think of all of the different types of activities you engage in on your daily work or as a student and the list would be quite long. So, this is no small task to identify the activities and describe the work that you're performing. More on that later. Ultimately, though we think about activities as those things that consume resources, the incur costs. We often in activity-based costing systems try to simplify the world a little bit and group activities into different pools. We'll talk more about that later as well. A second aspect is drivers. All drivers are is a measure of an activity. It measures how an activity consumes resources. And ultimately, activity-based costing buys us a more refined view of costs. What we mean there is we treat overhead quite differently in activity-based costing systems relative to more traditional simplified costing systems and that buys us a lot more information than we get from those original systems. Now, in a traditional system, on the left we have direct materials and direct labor and at the top on the right-hand side we have the third type of cost and that is overhead costs. Now, direct materials and direct labor they're pretty feasible in terms of measurement. It's pretty easy to understand what materials belong with what product that we produce and the same goes with labor. As we talked about in past modules, the nature of materials and labor that are direct mean that we can see those materials or infer the specific labor that was used for that particular cost object. Overhead on the other hand, is a big bucket or conglomerate of other types of costs, it's a catch all category and we in a traditional system might simplify things by splitting them up into 1 or 2 cost pools and then we allocate costs from those pools to the cost objects of interest. In an activity-based costing system, however, we treat overhead quite differently. First lets' look at direct materials and direct labor. Those are the same under both traditional and activity-based costing systems. Again, under traditional systems knowing what direct materials and direct labor are is fairly straight forward but overhead is the real issue and that's where we will focus our attention. Again, as we will see when we explore activity-based costing systems in this module, overhead cost is where all the action is and how we treat overhead costs in activity-based costing systems is where the real information advantage comes from.