Manac II Class 17 2015 (1)

Manac II

Term II –PGP 19 Batch

Pankaj BaagFaculty Block 01, Room No 21

Mob: 8943716269 Ph (O): 0495-2809121

Ext. 121Email: [email protected]

mailto:[email protected]

Activity-Based Costing

Activity–Based Costing (ABC) ABC is designed to provide managers with

cost information for strategic and other

decisions that potentially affect capacity, and

therefore, affect “fixed”as well as variable

costs.

ABC is agood supplement to our traditional

cost systemI agree!

How Costs are Treated UnderActivity–Based Costing

ABC differs from traditional cost accounting in three ways.

Manufacturingcosts

Nonmanufacturingcosts

ABC assigns both types of costs to products.

Traditionalproduct costing

ABCproduct costing


ABC does not assign all manufacturing costs to products.

Manufacturingcosts

Nonmanufacturingcosts

Traditionalproduct costing

ABCproduct costing

All Most, butnot all S

ome



Plantwide Overhead

Rate

DepartmentalOverhead

Rates

Activity–BasedCosting

Number of cost pools

Leve

l of c

ompl

exity

ABC uses more cost pools.



Each ABC cost pool has itsown unique measure of activity.

Traditional cost systems usually relyon volume measures such as direct laborhours and/or machine hours to allocate

all overhead costs to products.


ABC uses more cost pools.

ActivityAn event that causes the consumption of overhead

resources.

Activity Cost Pool

A “cost bucket” in which costs related to a single activity measure are accumulated.

$

$

$ $

$$


Activity Measure

An allocation basein an activity-based

costing system.


The term cost driver is also used to refer to an activity measure.

Simple countof the number oftimes an activity

occurs.

Transactiondriver

A measureof the amountof time neededfor an activity.

Durationdriver

Two common types of activity measures:


Activities that cause costs to be incurred are called COST DRIVERS:

Cost Driver ExamplesActivity Cost Driver

Machining operations Machine hoursSetup Setup hoursProduction scheduling Manufacturing ordersInspection Pieces inspectedPurchasing Purchase ordersShop order handling Shop ordersValve assembly support Customer requisitions

2-11

• Cost Pools : Meaningful groups under which costs are collected.

• Individual costs can be grouped in many different ways and therefore Cost Pools can be defined in many different ways.

• By Type : Labour costs, material costs etc.• By Source : Department 1, Department 2 etc.• By Responsibility : Manager 1, Manager 2 etc.

• Recall that Factory Overhead is applied to production in a rational systematic manner, using some type of averaging/predetermined manner. There are a variety of methods to accomplish this goal.

• These methods often involve tradeoffs between simplicity and realism

Simple Methods Complex MethodsUnrealistic Realistic

• Historically, firms produced a limited variety of goods while their indirect costs were relatively small.

• Allocating overhead costs was simple: use broad averages/predetermined rate to allocate costs uniformly regardless of how they are actually incurred

• The end-result: overcosting and undercosting• Overcosting – a product consumes a low level of resources but is allocated high costs

per unit• Undercosting – a product consumes a high level of resources but is allocated low

costs per unit

Cross-subsidization• The results of overcosting one product and undercosting another.• The overcosted product absorbs too much cost, making it seem

less profitable than it really is• The undercosted product is left with too little cost, making it seem

more profitable than it really is

Traditional, Volume-Based Product-Costing System

• Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.

• The following information is obtained from company records:

Mode I Mode I I Mode II IProduction: Units 10,000 20,000 4,000 Runs 1 run of 10,000

units 4 runs of

5,000 units 10 runs of 400 units

5-15

Aerotech produces three circuit boards referred to as Mode I, Mode II and Mode III. 10,000 units of Mode I are produced in 1 run. 20,000 units of Mode II are produced in 4 runs of 5,000 units. And 4,000 units of Mode III are produced in 10 runs of400 units.


Additional information includes:Mode I Mode I I Mode I I I

Direct materials 50.00$ 90.00$ 20.00$ Direct labor (hr/board) 3 4 2 Setup time (hr/run) 10 10 10 Machine time (hr/board) 1 1.25 2

Mode I Mode I I Mode II IDirect materials 50.00$ 90.00$ 20.00$ Direct labor 60.00 80.00 40.00 Manufacturing overhead 99.00 132.00 66.00 Total 209.00$ 302.00$ 126.00$

Manufacturing overhead is determined as follows

5-16

Traditional, Volume-Based Product-Costing SystemMode I Mode II Mode II I

Units produced 10,000 20,000 4,000 Direct labor (hr/unit) 3 4 2 Total hours 30,000 80,000 8,000

Total hours required 118,000

Budgeted manufacturing overhead $3,894,000 Budgeted direct-labor hours 118,000 = $33 per hour

Mode I Mode I I Mode I I IDirect labor (hr/unit) 3 4 2 Overhead rate per hour 33$ 33$ 33$ Overhead per unit 99$ 132$ 66$

5-17

Aerotech applies manufacturing overhead using a predetermined overhead rate based on direct-labor hours. The total direct labor hours was estimated to be 118,000. The budgeted manufacturing overhead cost was estimated at $3,894,000. The estimated cost is divided by the estimated hours resulting in a predetermined overhead rate of $33 per hour. The overhead per unit is calculated by multiplying the direct labor hours per unit times the predetermined overhead rate per hour


With these product costs, Aerotech established target selling prices (Cost × 125%).

Mode I Mode I I Mode I I IDirect materials 50.00$ 90.00$ 20.00$ Direct labor 60.00 80.00 40.00 Manufacturing overhead 99.00 132.00 66.00 Total 209.00$ 302.00$ 126.00$

Mode I Mode II Mode I I ICost per unit 209.00$ 302.00$ 126.00$ Target selling price 261.25 377.50 157.50

209.00 x 1.25

5-18

Now that Aerotech -estimated the production cost per unit, the target selling price can be set. The company’s pricing policy has been to set a target price for each grill equal to 125 percent of the full product cost. The estimated unit cost is multiplied by 1.25 to arrive at the target selling price

Activity Based Costing System (ABC)ABC systems follow a two-stage procedure to

assign overhead costs to products.Stage One: Identify significant activities and assign overhead costs to each activity in proportion to resources used.Stage Two: Identify cost drivers appropriate to each activity and allocate overhead to the products.

5-19

Assigning Overhead to product costs is a difficult process.Lets begin by identifying our major activities. The first stage identifies significant activities in the production process and assigns overhead costs to each activity in accordance with the cost of the organization’s resources used by the activity. The overhead costs assigned to each activity comprise an activity cost pool. Overhead assigned to activities are called “activities cost pools.”

After assigning overhead costs to activity cost pools in stage one, cost drivers appropriate for each cost pool are identified in stage two. Then the overhead costs are allocated from each activity cost pool to each product line in proportion to the amount of the cost driver consumed by the product line.


Traditional cost systems usually rely on volumemeasures such as direct labor hours and/or machine

hours to allocate all overhead costs to products.

ABC definesfour-five levels of activitythat largely do not relate

to the volume of unitsproduced.

Manufacturingcompanies typically combine

their activities into fiveclassifications.

Unit-LevelActivity

Batch-Level Activity

Product-LevelActivity

Customer-LevelActivityOrganization-

sustainingActivity


In an activity-based cost system, companies typically combine their activities into the following five classifications:

Unit-level activities are performed each time a unit is produced. For example, providing power to run processing equipment would be a unit-level activity.

Batch-level activities are performed each time a batch is handled or processed, regardless of how many units are in the batch. For example, setting up equipment and shipping customer orders are batch-level activities.

Product-level activities or product sustainable level activities relate to specific products and must be carried out regardless of how many batches are run or units are produced or sold. For example, designing or advertising a product would be product-level activities.

Facility-level activities are required in order for the entire production process to occur. Customer-level activities relate to specific customers and are not tied to any specific

product. For example, sales calls and catalog mailings would be customer-level activities.

Organization-sustaining activities are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. For example, heating a factory and cleaning executive offices are organization-sustaining activities.

• Aerotech identified eight activity cost pools, which fall into four broad categories: unit level, batch level, product-sustaining level and facility level.

• The activity at the unit level must be applied to each unit produced.

• The activity at the batch level must be performed one time for each batch that goes into production.

• The product-sustaining activities are required to support the entire product line, but not needed for each unit or batch.

• Facility-level activities are required in order for the entire production process to occur.

Overhead CostsTotal budgeted cost = $3,894,000

ActivityCostPools

Machinerycost pool

$1,212,600

Setupcost pool$3,000

Engineeringcost pool$700,000

Facilitycost pool$507,400

UnitLevel

BatchLevel

Product-Sustaining

LevelFacilityLevel

Identificationof ActivityCost Pools

Activitymust bedone oneach unitproduced.

Activityperformed

on eachbatch

produced.

Activities needed to supportan entire product line

Activity required in orderfor the productionprocess to occur.

5-24

Receiving/Inspectioncost pool $200,000

Material-Handlingcost pool $600,000

Quality-Assurancecost pool $421,000

Packaging/Shippingcost pool $250,000

Machinerycost pool

$1,212,600




UnitLevel

BatchLevel

Product-Sustaining

LevelFacilityLevel

5-25

There are five cost pools at the batch level: setup, receiving and inspection, material-handling, quality assurance and the packaging and shipping cost pool.

For Aerotech, only the machinery cost pool is at the unit level.

The engineering cost pool is at the product-sustaining level and the facility cost pool is at the facility level.

Machinery Cost PoolTotal budgeted cost = $1,212,600

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

Activitycostpool

STAGE ONE

Various overheadcosts relatedto machinery

5-26

Aerotech estimated the costs of maintenance, lubrication, depreciation, electricity, computer support and calibration. These costs are added together. The sum is the machinery cost pool budgeted cost.

Calculatethe pool

rate

Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour

CostAssignment

STAGE TWO

=

=

Mode I:$28.20 per hr.

1 hr. per unit$28.20 per unit

Mode II:$28.20 per hr.

1.25 hr. per unit$35.25 per unit

Mode III:$28.20 per hr.

2 hr. per unit$56.40 per unit

5-27

Aerotech selected machine hours for the cost driver, since a product that uses more machine hours should bear a larger share of machine-related costs.

The budgeted machinery costs are divided by the budgeted number of machine hours to arrive at the machinery cost pool rate.

Then, for each circuit board, the machinery cost pool rate is multiplied by the number of machine hours per board

Calculation oftotal setup cost

Setup Cost PoolTotal budgeted cost = $3,000

Activitycostpool

STAGE ONE

Total budgeted setup cost$20 per hour10 hr. per setup

$200 cost per setup15 production runs

3,000$ Total

5-28

The budgeted cost for the setup cost pool is determined by multiplying the setup cost per hour by the number of hours required per setup then multiplying that by the number of production runs.

Calculatethe pool

rate Budgeted Setup Costs $3,000Planned Production Runs 15 runs $200 per run

CostAssignment

STAGE TWO

=

=

Mode I: (1 Run)

= $.02 per unit

$200 per run10,000 units per run

Mode II: (4 Runs)

= $.04 per unit

$200 per run5,000 units per run

Mode III: (10 Runs)

= $.50 per unit

$200 per run400 units per run

5-29

The budgeted setup costs are divided by the planned production runs to arrive at the setup cost pool rate. Then, for each circuit board, the setup cost pool rate is divided by the number of units per run to arrive at the setup cost per unit

Various overheadcosts related

to engineering

Engineering salaries

Engineering supplies

Engineering software

Depreciation

Engineering Cost PoolTotal budgeted cost = $700,000

Activitycostpool

STAGE ONE

5-30

Aerotech estimated the costs of engineering salaries, supplies, software and depreciation. These costs are added together. The sum is the engineering cost pool budgeted cost

Allocate basedon engineering

transactions

CostAssignment

STAGE TWO

Engineering Cost PoolTotal budgeted cost = $700,000

Mode I:

= $17.50 per unit

25% × $700,00010,000 units

Mode II:

= $15.75 per unit

45% × $700,00020,000 units

Mode III:

= $52.50 per unit

30% × $700,0004,000 units

5-31

The engineering department has estimated that 25% of its time is spent on Mode I, 45% on Mode II and 30% spent on Mode III. For each board, the percentage of engineering time is multiplied by the budgeted engineering cost then divided by the number of units to be produced.

The result is the engineering cost per unit.

Various overheadcosts related

to generaloperations

Plant depr.

Plant mgmt.

Plant maint.

Property taxes

Insurance

Security

Facility Cost PoolTotal budgeted cost = $507,400

Activitycostpool

STAGE ONE

5-32

Aerotech estimated the costs of plant depreciation, management salaries, maintenance, property taxes, insurance and security. These costs are added together. The sum is the facility cost pool budgeted cost.

Budgeted Facilities Cost $507,400Budgeted Direct-Labor Hours 118,000 $4.30/hour

CostAssignment

STAGE TWO

=

=

Mode I:$4.30 per hr.

× 3 hr. per unit$12.90 per unit

Mode II:$4.30 per hr.


Mode III:$4.30 per hr.


Calculatethe pool

rate

5-33

Aerotech has selected to use direct labor hours as the cost driver for facilities cost.

The budgeted facilities cost is divided by the budgeted direct labor hours to arrive at the facilities cost per hour.

The facilities cost per unit is calculated by multiplying the facilities cost per hour by the number of direct labor hours required per board.

Receiving/Inspectioncost pool $200,000

Material-Handlingcost pool $600,000

Quality-Assurancecost pool $421,000

Packaging/Shippingcost pool $250,000

Machinerycost pool

$1,212,600




UnitLevel

BatchLevel

Product-Sustaining

LevelFacilityLevel

5-34

There are five cost pools at the batch level: setup, receiving and inspection, material-handling, quality assurance and the packaging and shipping cost pool.

For Aerotech, only the machinery cost pool is at the unit level.

The engineering cost pool is at the product-sustaining level and the facility cost pool is at the facility level.

• Aerotech has four other batch level cost pools: receiving and inspection, material handling, quality assurance, and packaging and shipping.

• Each of these departments has estimated the costs and the percentage of time spent on each of the three circuit boards.

• The budgeted costs are multiplied by the percentage to determine the cost per unit for each board.

Other Overhead CostsBoard Overhead × % ÷ Units = Cost/UnitMode I 200,000$ × 6% ÷ 10,000 = 1.20$ Mode II 200,000 × 24% ÷ 20,000 = 2.40 Mode III 200,000 × 70% ÷ 4,000 = 35.00

Receiving and Inspection Cost Pool

Board Overhead × % ÷ Units = Cost/UnitMode I 600,000$ × 7% ÷ 10,000 = 4.20$ Mode II 600,000 × 30% ÷ 20,000 = 9.00 Mode III 600,000 × 63% ÷ 4,000 = 94.50

Material-Handling Cost Pool


Quality-Assurance Cost Pool


Packaging and Shipping Cost Pool

5-36


Packaging and Shipping Cost Pool


Quality-Assurance Cost Pool

Other Overhead CostsBoard Overhead × % ÷ Units = Cost/UnitMode I 200,000$ × 6% ÷ 10,000 = 1.20$ Mode II 200,000 × 24% ÷ 20,000 = 2.40 Mode III 200,000 × 70% ÷ 4,000 = 35.00

Receiving and Inspection Cost Pool


Material-Handling Cost Pool

$14.82

5-37

The cost per unit for each of these batch level costs is added together for each board.

Product Cost from ABC

Mode I Mode II Mode IIIDirect materials 50.00$ 90.00$ 20.00$ Direct labor 60.00 80.00 40.00 Machinery 28.20 35.25 56.40 Setup 0.02 0.04 0.50 Engineering 17.50 15.75 52.50 Facilities 12.90 17.20 8.60 Other 14.82 23.57 212.85 Total 183.44$ 261.81$ 390.85$

These are the new product costs when Aerotech uses ABC.

5-38

Now Aerotech has new product costs for each board. It is the sum of the costs for direct materials, direct labor, machinery, setup, engineering, facilities and costs accumulated as other costs.

Distorted Product Costs Both original and ABC target selling prices are based on (Cost × 125%).

Mode I Mode II Mode IIITraditional costing 209.00$ 302.00$ 126.00$ ABC costing 183.44 261.81 390.85

Original target selling price 261.25 377.50 157.50 ABC target selling price 229.30 327.26 488.56

[$209.00 × 1.25] [$183.44 × 1.25]

The selling price of Mode I and II are reducedand the selling price for Mode III is increased.

5-39

Using the existing target pricing policy, the unit cost based on ABC costing is multiplied by 1.25 to arrive at the ABC target selling price. Under ABC costing, the selling price for Mode I and Mode II boards has decreased, but the selling price for the Mode III board has increased significantly.

Can you identify any problems Aerotech is likely to face as a result of this distortion?

Mode I Mode II Mode IIITraditional costing 209.00$ 302.00$ 126.00$ ABC costing 183.44 261.81 390.85 Cost distortion per unit 25.56 40.19 (264.85) Units produced 10,000 20,000 4,000 Total cost distortion 255,600 803,800 (1,059,400)

Traditional costing understates the cost of complex, low volume products

Distorted Product Costs

5-40

The cost per unit under ABC costing is deducted from the traditional costing unit cost. This is cost distortion per unit. The problem with cost distortion is more evident when the cost distortion per unit is multiplied by the number of units produced. The essence of the problem is that the traditional, volume-based costing system was over costing the high-volume product lines (Modes I and II) and under costing the complex, relatively low volume product line (Mode III). The high-volume products basically subsidized the low volume line. The activity-based costing system revealed this problem by more accurately assigning overhead costs to the three product lines. When the costs are understated, so is the selling price. See problem 1&2

Manac II Class 17 2015 (1)

Documents

types of costs

manufacturing costs

indirect costs

material costs

labour costs

variable costs

individual costs

traditional cost accounting