21b - 1Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Appendix 21B: Activity-based Costing
Objectives Describe and develop activity-based
costs (ABC) Decide when ABC is most likely to pass
the cost-benefit test
21b - 2Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
David, Matt, and Marc:Total expenses = $900
Cost allocated = $300 per person
Rent and Electricity $570Cable TV 50High speed Internet access 40Groceries 240Total $900
Refining Cost Systems
21b - 3Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Refining Cost Systems
More Refined Allocation
David Matt Marc TotalRent and Electricity $190 $190 $190 $570Cable TV 25 – 25 50Internet access – 40 – 40Groceries – 80 160 240Total costs allocated $215 $310 $375 $900Original cost allocation 300 300 300 900Difference $(85) $ 10 $ 75 $ 0
21b - 4Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Sharpening the Focus: From Business Functions to Activities
PANEL A—Companywide Business Functions in the Value ChainR&DDesignProductionMarketingDistributionCustomer Service
PANEL B—Production Departments/Product LinesServersNotebook ComputersDesktop Computers
Inventoriable costs for financial reporting
Inventoriable costs for financial reporting
21b - 5Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Sharpening the Focus: From Business Functions to Activities
PANEL C—Activities for Desktop Product Line1. Kitting—preparing all items for assembly2. Motherboard preparation—snapping in
CPU and memory modules3. Assembly into chassis4. Software downloading5. Testing6. Boxing
Inventoriablecosts forfinancialreporting
21b - 6Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Describe and developactivity-based costs
(ABC).
Objective 1
21b - 7Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Example of Activities and Cost Drivers:
Activities:Material purchasingMaterial handlingProduction schedulingQuality inspectionsPhotocopyingWarranty service
Cost Drivers:No. of purchase ordersNo. of partsNo. of batchesNo. of inspectionsNo. of pages copiedNo. of service calls
Activity-Based Costing
21b - 8Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Traditional versus Activity-Based
Costing Systems Chemtech produces large quantities of
“commodity” chemicals. It also manufactures small quantities of
specialty chemicals. In the past, Chemtech’s manufacturing
department has used direct labour hours as its single allocation base at a 200% rate.
21b - 9Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Traditional versus Activity-Based
Costing Systems Among its many products, the
department produces Aldehyde (a commodity chemical used by producing plastics) and...
Phenylephrine Hydrochloride (PH), which is a specialty chemical.
A single customer uses PH in manufacturing blood-pressure medications.
21b - 10Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Traditional versus Activity-Based
Costing SystemsChemical Manufacturing Department Overhead
DirectLabour
Cost
ChemicalA
ChemicalB
ChemicalC
DepartmentalIndirect CostPool
CostAllocationBase
ProductCostObjects
21b - 11Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Traditional versus Activity-Based
Costing SystemsChemical Manufacturing Department Overhead
No. ofMachine
Hours
ChemicalA
ChemicalB
ChemicalC
DepartmentalIndirect CostPool
CostAllocationBase
ProductCostObjects
No. ofSamplesTaken
No. ofBatches
ProcessingMixing TestingActivityIndirect CostPool
21b - 12Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Chemtech Traditional Cost System Aldehyde PH
Sale price per Kg $10 $70Less: manufacturingcost per KgDirect materials 5 20Direct labour 1 10Manufacturing overhead 2 20Gross profit per Kg $ 2 $20
Traditional versus Activity-Based
Costing Systems
21b - 13Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Traditional versus Activity-Based
Costing Systems Assume that the company produced
7,000 Kg of Aldehyde and 5 Kg of PH. What is the total labour cost per
product? 7,000 Kg × $1 = $7,000 (Aldehyde) 5 Kg × $10 = $50 (PH) What is the total manufacturing
overhead allocated to each product?
21b - 14Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Chemtech assigns 140 times as much overhead to Aldehyde as to PH.
Chemtech assigns 140 times as much overhead to Aldehyde as to PH.
Traditional versus Activity-Based
Costing Systems $7,000 × 200% = $14,000 to Aldehyde $50 × 200% = $100 to PH
21b - 15Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Identify activities.
MixingProcessing
Testing
Estimate the total indirectcosts of each activity.
Labour $150,000Depreciation 200,000Other 250,000Total $600,000
Step 1 Step 2
21b - 16Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Identify the primary cost driver foreach activity’s indirect costs.
(1) (2) (3)Activity Estimated Costs Cost DriverMixing $600,000 # of batchesProcessing $300,000 # of hours (MH)Testing $600,000 # samples
Step 3
21b - 17Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Estimate the total quantity of each allocation base.
(1) (4)Activity Estimated Quantity of Cost DriverMixing 4,000 batchesProcessing 5,000 machine hours (MH)Testing 3,000 samples
Step 4
21b - 18Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Calculate the allocation rate for each activity.
(1) (5)Activity Cost Allocation RateMixing $600,000 ÷ 4,000 = $150/batchProcessing $300,000 ÷ 5,000 = $60/MHTesting $600,000 ÷ 3,000 = $200/sample
Step 5
21b - 19Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Obtain the actual quantity of each allocation base used by each product.
During the year, Chemtech produced60 batches of Aldehyde and 1 batch of PH.
The remaining batches consistof Chemtech’s other chemicals.
Step 6
21b - 20Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
Allocate the costs to each product.
Mixing Cost Allocation:Aldehyde: 60 batches × $150 per batch = $9,000
PH: 1 batch × $150 per batch = $150
Step 7
21b - 21Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Activity-Based Costing System
The ABC system allocates 29 times asmuch overhead to Aldehyde as to PH.
Activity Cost Driver Units Cost Allocated to:Used By:
Aldehyde PH Aldehyde PH Mixing 60 batches 1 batch $ 9,000 $150Processing 30.5 MH 2 MH 1,830* 120Testing 14 samples 1 sample 2,800 200Total $13,630 $470
*30.5 MH × $60 per MH = $1,830
21b - 22Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Cost/kg Traditional ABC(Overhead) System SystemAldehyde $ 2.00 $ 1.95PH $20.00 $94.00
Activity-Based Costing System
What is the overhead cost per kg? Aldehyde: $13,630 ÷ 7,000 = $1.95 PH: $470 ÷ 5 = $94
21b - 23Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Aldehyde PH Sale price per kg $10.00 $ 70.00Less: manufacturing
cost per kgDirect materials 5.00 20.00Direct labour 1.00 10.00Manufacturing overhead 1.95 94.00 Gross profit per kg $ 2.05 $(54.00)
Activity-Based Costing System
Chemtech Gross Profit per Kg.
21b - 24Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Decide when ABC is most likely
to pass the cost-benefit test.
Objective 2
21b - 25Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
The Cost-Benefit Test
ABC’s benefits are higher when...– the company produces many different
products that use different amounts of resources.
– the company has high overhead costs.– the company produces high volumes of
some products, and low volumes of other products.
21b - 26Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
The Cost-Benefit Test
The costs of adopting ABC are lower when the company has...
– accounting and information system expertise to develop the system.
– information technology (bar coding, optical scanning) to record cost driver data.
21b - 27Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Managers don’t understand costs and profits.
The cost system is outdated.
Signs That the Cost SystemMay Be Broken