1 CHAPTER 6 Activity-Based Costing © 2009 Cengage Learning
0 CHAPTER 6 Activity-Based Costing © 2009 Cengage Learning.
Dec 23, 2015
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1
CHAPTER 6
Activity-Based Costing
© 2009 Cengage Learning
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Introduction
Overhead costs have soared to 60 percent or more of total product costs in heavily automated manufacturing environments.
As overhead costs increase and make up a larger portion of the total costs of products, accuracy in overhead application has become much more important.
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Activity-Based Costing
In this chapter we introduce a different
approach to overhead allocation using Activity-
Based Cost Drivers as opposed to Volume-Based
Cost Drivers
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Categories of Overhead Costs
Unit-level costs are incurred each time a unit is produced.
Examples:Supplies for factoryDepreciation on factory machineryEnergy costs for factory machineryRepairs and maintenance of factory machinery
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Categories of Overhead Costs
Batch-level costs are incurred each time a batch of goods is produced.
Examples:Salaries related to purchasing and receivingSalaries related to moving materialQuality control costsDepreciation of setup equipment
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Categories of Overhead Costs
Product-level costs are incurred as needed to support the production of each different type of product. Examples:
Salaries of engineersDepreciation of engineering equipmentProduct development costs (testing)Quality control costs
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Categories of Overhead Costs
Facility-level costs simply sustain a facility’s general manufacturing process. Examples:
Depreciation or rent of a factory building
Salary of a plant managerInsurance, taxes, etc. Training
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Activities and Cost Drivers:
Unit LevelActivity
•Machining
•Maintenance of machines
Potential Cost Driver
•Machine hours, labor hours or number of units produced
•Machine hours
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Activities and Cost Drivers:
Product Level
Activity
Product Testing
Supervision
Potential Cost Driver
Number of change orders, number of tests, hours of testing time
Number of supervision hours
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Activities and Cost Drivers:
Batch LevelActivity
Purchasing
Receiving
Machine setups
Customer orders
Potential Cost Driver
Number of purchase orders or number of parts
Amount of material or number of receipts
Number of setups
Number of orders, number of customers
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Activities and Cost Drivers:
Facility LevelActivity
Plant Occupancy
Potential Cost Driver
Square footage, number of employees, labor hours, machine hours
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Unit-level costs are incurred each time a unit is produced. Batch-level costs are incurred each time a batch of goods is produced. Product-level costs are incurred as needed to support the production of each type of product. Facility-level costs simply sustain a facility’s general manufacturing process.
Unit-, Batch-, Product-, and Facility-Level Costs
Key Concept
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The key feature of an Activity-Based Costing system is allocating overhead costs based on activities that drive costs rather than on the volume or number of units produced.
Activity-Based Costing
Key Concept
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Traditional Overhead Allocation and ABC - An
Example
Modular-Home Builder
Builds 2 basic models and a fast-delivery
Cottage
TopSail Construction
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Estimated Manufacturing
Overhead Costs for 2008
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Costs per Unit Using Volume-Based OH
Allocation
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Stage 1: Identification of Activities
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Stage 2: Identification of Cost Drivers &
Allocation of Costs
Activity
Inspections
Purchasing
Supervision
Delivery & setup
Cost Driver
Number of inspections
Number of purchase orders
Hours of supervisor time
Setup time (days)
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Estimated Cost Driver Activity
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Calculation of Predetermined Activity
Rates
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Cost of Units Based on Activity-Based
Costing
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Cost Comparisons between Traditional and
ABC Costing
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Price Comparison between Traditional and
ABC Costing
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Activity-Based Costing
Volume-based costing systems often result in over-costing high volume products and under-costing low-volume products.
This cross subsidy is eliminated by the use of ABC.
Key Concept
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ABC Systems in Service Industries
Although ABC was developed for use
primarily by manufacturing
companies, it has gained widespread acceptance in
the service sector.
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ABC Systems in Service Industries
Problems
Type of work performed in service industries tends to be non- repetitive
Activities differ for each customer or service
Services have proportionately more facility-level costs
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ABC Systems and Nonmanufacturing
Activities
ABC is used to determine the cost of providing a selling or administrative service. Example: The U.S. Post Office used ABC to help determine the costs and benefits of allowing customers to pay using debit and credit cards.
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Benefits of Activity-Based Costing
Using ABC in the budgeting process provides more accurate estimates of resources
Provides more accurate cost information for day-to-day decision making
Costs that appeared to be indirect using volume-based costing systems are now traced to specific activities using cost drivers
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Limitations of Activity-Based Costing
High measurement costs
The higher the potential for cost distortions, the more likely the company will benefit from ABC
Distortions result from diverse products
Diverse products: products that consume resources in different proportions
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Backflush Costing
Companies using JIT generally have little or no inventory or finished goods.
All manufacturing costs are flushed directly into cost of goods soldIf the company has small amounts of
inventory on hand at the end of the period, manufacturing costs are
backflushed into the appropriate materials inventory, WIP
inventory or finished goods inventory
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