Hilton Maher Selto 4 Activity-Based Costing Systems McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Hilton • Maher • Selto

4Activity-Based Costing Systems

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

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yesyes

Activity based costing allocates costs based on the discreet tasks (activities) that drive those costs.

Activity based costing allocates costs based on the discreet tasks (activities) that drive those costs.

Is it important to knowhow the work of the

organization is done?

Is it important to knowhow the work of the

organization is done?

Do we need costs to provide incentives for

Improvements?

Do we need costs to provide incentives for

Improvements?

Activity-Based Costing

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4 Steps4 Steps Identify and classify the activities

related to the company’s products or services.

Estimate the costs associated with each activity.

Calculate a cost-driver rate for each activity.

Assign activity costs to products using the cost-driver rate.

4 Steps4 Steps Identify and classify the activities

related to the company’s products or services.

Estimate the costs associated with each activity.

Calculate a cost-driver rate for each activity.

Assign activity costs to products using the cost-driver rate.

4 Steps in the ABC Process

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UNIT-LEVEL ACTIVITESThe work efforts that transform resources into individual products and resources

UNIT-LEVEL ACTIVITESThe work efforts that transform resources into individual products and resources

CUSTOMER- LEVEL ACTIVITESPerformed to meet the needs of specific customers

CUSTOMER- LEVEL ACTIVITESPerformed to meet the needs of specific customers

BATCH-LEVEL ACTIVITES Manufacturing or service technology that affect multiple units of activity equally and

simultaneously

BATCH-LEVEL ACTIVITES Manufacturing or service technology that affect multiple units of activity equally and

simultaneously

PRODUCT - LEVEL ACTIVITESSupport specific products or service lines

PRODUCT - LEVEL ACTIVITESSupport specific products or service lines

FACILITY-LEVEL ACTIVITIESSupport all of the organizations processes

FACILITY-LEVEL ACTIVITIESSupport all of the organizations processes

Step 1: Identify and Classify Activities

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INTERVIEW OR INTERVIEW OR PARTICIPATIVE PARTICIPATIVE

APPROACHAPPROACHABC teams include or

interview operating employees.

INTERVIEW OR INTERVIEW OR PARTICIPATIVE PARTICIPATIVE

APPROACHAPPROACHABC teams include or

interview operating employees.

RECYCLING RECYCLING APPROACHAPPROACH

Reuses documentation of processes used for

other purposes.

RECYCLING RECYCLING APPROACHAPPROACH

Reuses documentation of processes used for

other purposes.

Step 1: Identify and Classify Activities

TOP DOWN APPROACHTOP DOWN APPROACHABC teams of middle-management or above

develop the activity dictionary.

TOP DOWN APPROACHTOP DOWN APPROACHABC teams of middle-management or above

develop the activity dictionary.

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An appropriate cost driver base should:An appropriate cost driver base should:

Have a cause-effect relationship with the activityand the use of resources (costs).

Have a cause-effect relationship with the activityand the use of resources (costs).

Be feasible to measureBe feasible to measure

Predict or explain activities’ use of resources (cost) with reasonable accuracy

Predict or explain activities’ use of resources (cost) with reasonable accuracy

Be based on the practical capacity of the resources to support activities

Be based on the practical capacity of the resources to support activities

Step 1: Identify and Classify Activities

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The ABC teams should gather date on the costs of all the activities identified in Step 1.

The ABC teams should gather date on the costs of all the activities identified in Step 1.

Step 2: Estimate the Cost of Activities

Examine accounting records for

recorded cost information.

Examine accounting records for

recorded cost information.

Ask employees to provide

information on the time they

work on various activities.

Ask employees to provide

information on the time they

work on various activities.

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Step 2: Estimate the Cost of Activities

When estimating the cost of an activity,

only the costs associated with the product should be

used (practical capacity). The cost

of “unused capacity” should not be

applied to products.

When estimating the cost of an activity,

only the costs associated with the product should be

used (practical capacity). The cost

of “unused capacity” should not be

applied to products.

EXAMPLE

Suppose we rent a 1,000 square foot warehouse for

$1,000 per month. Only 800 sq. ft. are used to store

Product A. The rest of the warehouse is “unused”.

How much rent cost should be allocated to Product A?

EXAMPLE

Suppose we rent a 1,000 square foot warehouse for

$1,000 per month. Only 800 sq. ft. are used to store

Product A. The rest of the warehouse is “unused”.

How much rent cost should be allocated to Product A?

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Step 2: Estimate the Cost of Activities

20%, or $200 should 20%, or $200 should be assigned to be assigned to

“unused capacity”“unused capacity”

80%, or $800 80%, or $800 should be assigned should be assigned

to Product Ato Product A

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EXAMPLE #1EXAMPLE #1XCo has 4 employees in its Quality Control Dept. Salaries and costs for the department total $360,000 per year. XCo produces 500,000

units of product a year. What is the appropriate activity, # of

employees or units of product? What is the cost-driver rate?

EXAMPLE #1EXAMPLE #1XCo has 4 employees in its Quality Control Dept. Salaries and costs for the department total $360,000 per year. XCo produces 500,000

units of product a year. What is the appropriate activity, # of

employees or units of product? What is the cost-driver rate?

EXAMPLE #1EXAMPLE #1The proper activity in this case is the # of units produced.

The cost-driver rate would be:$360,000 ÷500,000 units = $.72 per unit

EXAMPLE #1EXAMPLE #1The proper activity in this case is the # of units produced.

The cost-driver rate would be:$360,000 ÷500,000 units = $.72 per unit

Step 3: Compute the Cost-Driver Rates

Two pieces of information are

required to compute the cost-driver rate:

•Activity Cost

•Activity Volume

Two pieces of information are

required to compute the cost-driver rate:

•Activity Cost

•Activity Volume

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EXAMPLE #2EXAMPLE #2

XCo has a customer service center where customers can call to ask questions. Customers

pay a fixed fee for each call they make to the service center. In addition, other XCo

departments also use the service center. It costs XCo $1,260,000 a year to operate the center. The center receives 120,000 calls per year. The center

handles 1,000,000 minutes of calls.

What is the appropriate cost driver; total minutes per call or number of calls?

What is the cost-driver rate?

EXAMPLE #2EXAMPLE #2

XCo has a customer service center where customers can call to ask questions. Customers

pay a fixed fee for each call they make to the service center. In addition, other XCo

departments also use the service center. It costs XCo $1,260,000 a year to operate the center. The center receives 120,000 calls per year. The center

handles 1,000,000 minutes of calls.

What is the appropriate cost driver; total minutes per call or number of calls?

What is the cost-driver rate?

EXAMPLE #2EXAMPLE #2

Since customers are charged “per call”, the proper activity in this case is the # of

calls handled by the center.

The cost-driver rate would be:

$1,260,000 ÷120,000 units = $10.50 per call

EXAMPLE #2EXAMPLE #2

Since customers are charged “per call”, the proper activity in this case is the # of

calls handled by the center.

The cost-driver rate would be:

$1,260,000 ÷120,000 units = $10.50 per call

Step 3: Compute the Cost-Driver Rates

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Step 4: Assign Activity Costs to Products

1. Identify all the activities related to a

given product or service.

1. Identify all the activities related to a

given product or service.

2. Determine how many

units of each activity are

used per unit of product.

2. Determine how many

units of each activity are

used per unit of product.

3. Assign costs to products

using the cost-driver rates for each activity

3. Assign costs to products

using the cost-driver rates for each activity

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Step 4: Assign Activity Costs to Products

Example: Yazz, Inc. produces 130,000 units of Product A and 400,000 units for Product B. Using the following

cost information, how much overhead should be allocated to Product A?

Example: Yazz, Inc. produces 130,000 units of Product A and 400,000 units for Product B. Using the following

cost information, how much overhead should be allocated to Product A?

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Step 4: Assign Activity Costs to Products

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Product and Customer Profitability

Companies will often look at the profitability for individual products or customers. Information required for each product

or customer includes:Revenue, costs that can be traced, costs that can not be traced.

Companies will often look at the profitability for individual products or customers. Information required for each product

or customer includes:Revenue, costs that can be traced, costs that can not be traced.

Exh.4.7

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When Should a Company Use ABC?

ABC is often considered as an option when one or more of the following conditions exist:

Indirect costs are significant in proportion to direct costs and use only one or two cost-drivers.

Goods are complex, requiring many inputs and processes. Simple, high-volume products perform more poorly than complex,

low-volume products. Different departments believe costs are assigned inaccurately. The company loses bids it thought were low, and wins bids it

thought were high. Operations have changed significantly, but the costing system has

not changed.

ABC is often considered as an option when one or more of the following conditions exist:

Indirect costs are significant in proportion to direct costs and use only one or two cost-drivers.

Goods are complex, requiring many inputs and processes. Simple, high-volume products perform more poorly than complex,

low-volume products. Different departments believe costs are assigned inaccurately. The company loses bids it thought were low, and wins bids it

thought were high. Operations have changed significantly, but the costing system has

not changed.

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Why Companies Use ABC

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End of

Chapter 4