Activity Based Costing: A Tool to Aid Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee Chapter
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Activity Based Costing: A Tool to Aid Decision Making
UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee
Chapter
DirectMaterials
DirectLabor
Mfg.Overhead
Work-in-Process
FinishedGoods
Cost-ofGoods Sold
Cost Measurement
Cost Accumulation
Cost Assignment
Goal: Accurately costed products.
Actual Costing System
Normal Costing System
Standard Costing System
Measuring Costs
Actual DMActual DL
Actual MOH
Actual DMActual DL
Estimated MOH
Standard DMStandard DL
Standard MOH
Cost Accounting SystemsProduct Costs
Job-Order Costing Process Costing
Total/Unit Cost
Assigning Manufacturing Costs
Functional Based Costing
Activity Based Costing
Activity Based Costing (ABC)
ABC is designed to ABC is designed to provide managers provide managers
with cost information with cost information for strategic and for strategic and
other decisions that other decisions that potentially affect potentially affect
capacity and capacity and therefore “fixed” therefore “fixed”
costs.costs.
ABC is agood supplement to our traditional
cost systemI agree!
Overhead rates maybe based on activity
at capacity.
Activity Based Costing (ABC)
Both manufacturingand nonmanufacturing
costs may be assigned toproducts.
Some manufacturingcosts may be excluded
from productcosts.
A numberof cost pools each
allocated to a productor cost object.
Allocation bases oftendiffer from
traditional costingsystems.
How Costs are Treated Under Activity-Based Costing
Level of C
omplexity
Overhead Allocation
Plantwide Overhead
Rate
DepartmentalOverhead
Rates
Activity BasedCosting
Functional Based (Traditional) Costing
Department1
Department2
Department3Cost poolsCost pools
IndirectLabor
IndirectMaterials
OtherOverhead
Stage One:Stage One:Costs assignedCosts assignedto poolsto pools
Departmental Overhead Rates
Products Products
Stage Two:Stage Two:Costs appliedCosts appliedto productsto products
Departmental Allocation BasesDepartmental Allocation Bases
Direct Labor Hours
MachineHours
RawMaterials
Cost
Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.
Resources
Functions
Products
EfficiencyAnalysis
Performance Analysis
Functional-Based Management Model
Cost View
Operational View
The problem with this approach is that individual products, services, etc., may use those resources in a nonuniform way.
The end result is that some products will be overcosted while others will be undercosted.
Refining a Cost System
Reclassify indirect costs as direct costs.
Define more cost pools.
Identify cost drivers.
Use Activity-Based Costing.
Resources
Activities
Products & Customers
Driver Analysis
Performance Analysis
Activity-Based Management Model
Cost View
Operational View
Designing an ABC System
Cost ObjectsCost Objects(e.g., products(e.g., productsand customers)and customers)
ActivitiesActivities
ConsumptionConsumptionof Resourcesof Resources
CostCost
Designing an ABC System
1. Identify and define activities and activity cost pools.
2. Whenever possible, directly trace costs to activities and cost objects.
3. Assign costs to activity cost pools.
4. Calculate activity rates.
Designing an ABC System
5. Assign costs to cost objects using the activity rates and activity measures.
6. Prepare management reports.
Identify and Define Activities and Activity Cost Pools
Step #1:Identify and Define Activities and Activity Cost Pools
An Activity Cost Activity Cost PoolPool is a “bucket” in
which costs are accumulated that relate to a single
activity measure in the ABC system.
$
$$ $
$$
Activity Levels (Step #1)
Activity Levels
Product Level
Customer Level
UnitLevel
BatchLevel
Organization-Sustaining Level
At Classic Brass, the ABC team, selected the following activity cost pools and activity
measures:
Activity Cost Pool Activity MeasureCustomer orders Number of customer ordersProduct design Number of product designsOrder size Machine-hoursCustomer relations Number of active customersOther Not applicable
Activity Cost Pools at Classic Brass
Step #1: Identify and Define Activities and Activity Cost PoolsStep #1 For Classic Brass
Step #1:Identify and Define Activities and Activity Cost Pools
Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders.
Product Designs - assigned all costs of resources consumed by designing products.
Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.
Step #1:Identify and Define Activities and Activity Cost Pools
Customer Relations – assigned all costs associated with maintaining relations with customers.
Other – assigned all overhead costs that are not associated with the other cost pools.
Whenever Possible, Directly Trace Overhead Costs to Activities and Cost Objects.
The overhead costs at Classic Brass
Exhibit 8-2
Assign Costs to Activity Cost Pools
The overhead costs at Classic Brass
Exhibit 8-2
Assign Costs to Activity Cost Pools
Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 25% 40% 20% 10% 5% 100%Factory equipment depreciation 20% 0% 60% 0% 20% 100%Factory utilities 0% 10% 50% 0% 40% 100%Factory building lease 0% 0% 0% 0% 100% 100%
Shipping costs **General Administrative Department
Administrative wages and salaries 15% 5% 10% 30% 40% 100%Office equipment depreciation 30% 0% 0% 25% 45% 100%Administrative building lease 0% 0% 0% 0% 100% 100%
Marketing DepartmentMarketing wages and salaries 20% 10% 0% 60% 10% 100%Selling expenses 10% 0% 0% 70% 20% 100%
Activity Cost Pools
At Classic Brass the following distribution of resource consumption across activity cost pools is determined.
**Not included because they are directly traced to customer orders.
Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ Factory equipment depreciationFactory utilitiesFactory building lease
General Administrative DepartmentAdministrative wages and salariesOffice equipment depreciationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
Activity Cost Pools
Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%
$125,000$125,000
Production DepartmentIndirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$
Shipping costs traced to customer orders 40,000 General Administrative Department
Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000
Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000
Total overhead costs 1,850,000$
Overhead Costs at Classic Brass(Manufacturing and NonManufacturing)
Assign Costs to Activity Cost Pools
Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ Factory equipment depreciation 60,000 Factory utilitiesFactory building lease
General Administrative DepartmentAdministrative wages and salariesOffice equipment depreciationAdministrative building lease
Marketing DepartmentMarketing wages and salariesSelling expenses
Total
Activity Cost PoolsProduction Department
Indirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$
Shipping costs traced to customer orders 40,000 General Administrative Department
Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000
Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000
Total overhead costs 1,850,000$
Overhead Costs at Classic Brass(Manufacturing and NonManufacturing)
Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%
$ 60,000$ 60,000
Assign Costs to Activity Cost Pools
Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$ Factory equipment depreciation 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000 Factory building lease - - - - 80,000 80,000
General Administrative DepartmentAdministrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment depreciation 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000
Marketing DepartmentMarketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000
Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$
Activity Cost Pools
Assign Costs to Activity Cost Pools
Calculate the Activity Rates
At Classic Brass, the ABC team, selected the following activity cost pools and activity
measures:
Activity Cost Pool Activity MeasureCustomer orders Number of customer ordersProduct design Number of product designsOrder size Machine-hoursCustomer relations Number of active customersOther Not applicable
Activity Cost Pools at Classic Brass
Step #1: Identify and Define Activities and Activity Cost Pools
Activity Cost Pools For Classic Brass
Calculate Activity Rates
The ABC team determines that Classic Brass will have these total activities for each activity cost pool
. . . 1,000 customer orders1,000 customer orders 200 new designs200 new designs 20,000 machine-hours20,000 machine-hours 100 customer relations activities100 customer relations activities
Now the team can compute the individual activity rates by dividing the total cost for
each activity by the total activity levels.
Calculate Activity Rates
(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable
Computation of Activity Rates÷
Traced Traced Traced
DirectMaterials
DirectLabor
ShippingCosts Overhead Costs
Cost Objects:Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
DirectMaterials
DirectLabor
ShippingCosts Overhead Costs
Cost Objects:Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
OrderOrderSizeSize
CustomerCustomerOrdersOrders
ProductProductDesignDesign
CustomerCustomerRelationsRelations OtherOther
First-Stage Allocation
Activity-Based Costing at Classic Brass
DirectMaterials
DirectLabor
ShippingCosts Overhead Costs
Cost Objects:Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
OrderOrderSizeSize
CustomerCustomerOrdersOrders
ProductProductDesignDesign
CustomerCustomerRelationsRelations OtherOther
First-Stage Allocation
Second-Stage Allocations
$/MH $/Order $/Design $/Customer
Unallocated
Assign Costs to Cost Objects
Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one customer – Windward Yachts.
Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.3. Selling price is $34 each.4. Direct materials total $2,110.4. Direct materials total $2,110.5. Direct labor totals $1,850.5. Direct labor totals $1,850.6. Shipping costs total $180.6. Shipping costs total $180.
Custom Compass Housing (requires new design)1. One order during the year.1. One order during the year.2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .3. Selling price is $650 each.3. Selling price is $650 each.4. Direct materials total $13.4. Direct materials total $13.5. Direct labor totals $50.5. Direct labor totals $50.6. Shipping costs total $25.6. Shipping costs total $25.
Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.3. Selling price is $34 each.4. Direct materials total $2,110.4. Direct materials total $2,110.5. Direct labor totals $1,850.5. Direct labor totals $1,850.6. Shipping costs total $180.6. Shipping costs total $180.
(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable
Computation of Activity Rates
(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable
Computation of Activity Rates
Custom Compass Housing (requires new design)1. One order during the year.1. One order during the year.2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .3. Selling price is $650 each.3. Selling price is $650 each.4. Direct materials total $13.4. Direct materials total $13.5. Direct labor totals $50.5. Direct labor totals $50.6. Shipping costs total $25.6. Shipping costs total $25.
Prepare Management Reports
Product MarginsStandard
StanchionsCompass Housing
Sales 13,600$ 650$ Costs
Direct materials (2,110) (13) Direct labor (1,850) (50) Manufacturing overhead (10,000) (200)
Product margin (360)$ 387$
Traditional Traditional Cost Accounting SystemCost Accounting System
Predetermined manufacturingoverhead rate
$1,000,000 20,000 MH = $50/MH=
400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000
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