© the mcgraw-hill companies, inc., 2002 mcgraw-hill/irwin 5-1 activity-based costing and cost...
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© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
5-5-11
Activity-Based Costing Activity-Based Costing and Cost Management and Cost Management SystemsSystems
5Chapter FiveChapter Five
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Traditional, Volume-Based Product-Costing System
Aerotech produces three complex printed Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, circuit boards referred to as Mode I, Mode II, and Mode III.and Mode III.
The following information is obtained from The following information is obtained from company records:company records:
Aerotech produces three complex printed Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, circuit boards referred to as Mode I, Mode II, and Mode III.and Mode III.
The following information is obtained from The following information is obtained from company records:company records:
Mode I Mode II Mode IIIProduction: Units 10,000 20,000 4,000 Runs 1 of 10,000 4 of 5,000 10 of 400
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Traditional, Volume-Based Product-Costing System
Additional information includes:Additional information includes:
Mode I Mode II Mode IIIDirect 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
Manufacturing overhead is determined as follows
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Traditional, Volume-Based Product-Costing System
Budgeted manufacturing overhead Budgeted manufacturing overhead $3,894,000 $3,894,000 Budgeted direct-labor hours 118,000Budgeted direct-labor hours 118,000 = $33 per hour= $33 per hour
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Traditional, Volume-Based Product-Costing System
With these product costs, Aerotech established With these product costs, Aerotech established target selling prices (Cost × 125%).target selling prices (Cost × 125%).
209.00 x 1.25
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Traditional, Volume-Based Product-Costing System
Aerotech wishes to see what target selling prices would be suggested when using
activity-based costing.
Aerotech wishes to see what target selling prices would be suggested when using
activity-based costing.
Let’s see how ABC works.Let’s see how ABC works.
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Activity Based Costing System (ABC)
ABC systems follow ABC systems follow a a two-stagetwo-stage procedure to procedure to
assign overhead assign overhead costs to products.costs to products.
Assigningoverhead to
products is adifficult process.
I agree!
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Activity Based Costing System (ABC)
ABC systems follow ABC systems follow a a two-stagetwo-stage procedure to procedure to
assign overhead assign overhead costs to products.costs to products.
Let’s beginby identifying
our major activities.
Stage OneIdentify significant
activities and assign overheadcosts to each activity in
proportion to resources used.
Stage OneIdentify significant
activities and assign overheadcosts to each activity in
proportion to resources used.
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Activity Based Costing System (ABC)
ABC systems follow ABC systems follow a a two-stagetwo-stage procedure to procedure to
assign overhead assign overhead costs to products.costs to products.
Overhead assigned to activities are called
“activity cost pools.”
Stage TwoIdentify cost drivers
appropriate to each activityand allocate overhead to
the products.
Stage TwoIdentify cost drivers
appropriate to each activityand allocate overhead to
the products.
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5-5-1010Overhead CostsOverhead Costs
Total budgeted cost = $3,894,000Total budgeted cost = $3,894,000
ActivityActivityCostCostPoolsPools
MachineryMachinerycost poolcost pool
$1,212,600$1,212,600
SetupSetupcost poolcost pool$3,000$3,000
EngineeringEngineeringcost poolcost pool$700,000$700,000
FacilityFacilitycost poolcost pool$507,400$507,400
UnitLevel
BatchLevel
Product-Sustaining
LevelFacilityLevel
Identificationof ActivityCost Pools
Identificationof ActivityCost Pools
ActivityActivitymust bemust bedone ondone oneach uniteach unitproduced.produced.
ActivityActivityperformedperformedon eachon eachbatchbatch
produced.produced.
Activities needed to supportActivities needed to supportan entire product linean entire product line
Activity required in orderActivity required in orderfor the productionfor the productionprocess to occur.process to occur.
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5-5-1111Overhead CostsOverhead Costs
Total budgeted cost = $3,894,000Total budgeted cost = $3,894,000
ActivityActivityCostCostPoolsPools
MachineryMachinerycost poolcost pool
$1,212,600$1,212,600
SetupSetupcost poolcost pool$3,000$3,000
EngineeringEngineeringcost poolcost pool$700,000$700,000
FacilityFacilitycost poolcost pool$507,400$507,400
MoreCostPools
UnitLevel
BatchLevel
Product-Sustaining
LevelFacilityLevel
Identificationof ActivityCost Pools
Identificationof ActivityCost Pools
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Receiving/InspectionReceiving/Inspectioncost pool cost pool $200,000$200,000
Material-HandlingMaterial-Handlingcost pool cost pool $600,000$600,000
Quality-AssuranceQuality-Assurancecost pool cost pool $421,000$421,000
Packaging/ShippingPackaging/Shippingcost pool cost pool $250,000$250,000
MachineryMachinerycost poolcost pool
$1,212,600$1,212,600
SetupSetupcost poolcost pool$3,000$3,000
EngineeringEngineeringcost poolcost pool$700,000$700,000
FacilityFacilitycost poolcost pool$507,400$507,400
UnitLevel
BatchLevel
Product-Sustaining
LevelFacilityLevel
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Various overheadVarious overheadcosts relatedcosts relatedto to machinerymachinery
Maintenance
Depreciation
Computer Support
Lubrication
Electricity
Calibration
Machinery Cost PoolMachinery Cost PoolTotal budgeted cost = $1,212,600
ActivityActivitycostcostpoolpool
STAGE ONESTAGE ONE
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CalculateCalculatethe poolthe pool
raterate
Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour$28.20/hour
CostCostAssignmentAssignment
STAGE TWOSTAGE TWO
=
=
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Calculation ofCalculation oftotal total setup costsetup cost
Setup Cost PoolSetup Cost PoolTotal budgeted cost = $3,000
ActivityActivitycostcostpoolpool
STAGE ONESTAGE ONE
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CalculateCalculatethe poolthe pool
raterate
Budgeted Setup Costs $3,000Planned Production Runs 15 runs $200 per run$200 per run
CostCostAssignmentAssignment
STAGE TWOSTAGE TWO
=
=
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Various overheadVarious overheadcosts relatedcosts related
to to engineeringengineering
Engineering salaries
Engineering supplies
Engineering software
Depreciation
Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000
ActivityActivitycostcostpoolpool
STAGE ONESTAGE ONE
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Allocate basedAllocate basedon on engineeringengineering
transactionstransactions
CostCostAssignmentAssignment
STAGE TWOSTAGE TWO
Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000
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Various overheadVarious overheadcosts relatedcosts related
to to generalgeneraloperationsoperations
Plant depr.
Plant mgmt.
Plant maint.
Property taxes
Insurance
Security
Facility Cost PoolFacility Cost PoolTotal budgeted cost = $507,400
ActivityActivitycostcostpoolpool
STAGE ONESTAGE ONE
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CalculateCalculatethe poolthe pool
raterate
Budgeted Facilities Cost $507,400Budgeted Direct-Labor Hours 118,000 $4.30/hour$4.30/hour
CostCostAssignmentAssignment
STAGE TWOSTAGE TWO
=
=
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Product Cost from ABC
Here are the new product costs so far . . .Here are the new product costs so far . . .
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Other Overhead CostsBoard Overhead × % ÷ Units = Cost/UnitMode I 200,000$ × 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
Board Overhead × % ÷ Units = Cost/UnitMode I 421,000$ × 20% ÷ 10,000 = 8.42$ Mode II 421,000 × 40% ÷ 20,000 = 8.42 Mode III 421,000 × 40% ÷ 4,000 = 42.10
Quality-Assurance Cost Pool
Board Overhead × % ÷ Units = Cost/UnitMode I 250,000$ × 4% ÷ 10,000 = 1.00$ Mode II 250,000 × 30% ÷ 20,000 = 3.75 Mode III 250,000 × 66% ÷ 4,000 = 41.25
Packaging and Shipping Cost Pool
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Board Overhead × % ÷ Units = Cost/UnitMode I 250,000$ × 4% ÷ 10,000 = 1.00$ Mode II 250,000 × 30% ÷ 20,000 = 3.75 Mode III 250,000 × 66% ÷ 4,000 = 41.25
Packaging and Shipping Cost Pool
Board Overhead × % ÷ Units = Cost/UnitMode I 421,000$ × 20% ÷ 10,000 = 8.42$ Mode II 421,000 × 40% ÷ 20,000 = 8.42 Mode III 421,000 × 40% ÷ 4,000 = 42.10
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
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
$14.82$14.82
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Product Cost from ABCThese are the new product costs when Aerotech These are the new product costs when Aerotech
uses ABC.uses ABC.
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Product Diversity
Both original and ABC target selling prices are Both original and ABC target selling prices are based on (Cost × 125%).based on (Cost × 125%).
[$209.00 × 1.25] [$183.44 × 1.25]
The selling price of Mode I and II are reducedThe selling price of Mode I and II are reducedand the selling price for Mode III is increased.and the selling price for Mode III is increased.
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Product Diversity
Can you identify any problems Aerotech is likely to Can you identify any problems Aerotech is likely to face as a result of this distortion?face as a result of this distortion?
Traditional costing understates the costTraditional costing understates the costof complex, low volume products.of complex, low volume products.
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ABC: Some Key Issues
The Past Small number of
products which did not differ much in required manufacturing support.
Labor was the dominant element in the cost structure.
The Past Small number of
products which did not differ much in required manufacturing support.
Labor was the dominant element in the cost structure.
The Present Numerous products
with more and complicated production requirements.
Labor is becoming an ever smaller part component of total production costs.
The Present Numerous products
with more and complicated production requirements.
Labor is becoming an ever smaller part component of total production costs.
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Cost Drivers
A characteristic of an event or activity that A characteristic of an event or activity that results in the incurrence of costs. In selecting results in the incurrence of costs. In selecting
a cost driver, we must consider . . .a cost driver, we must consider . . .
Degree ofDegree ofCorrelationCorrelation
Cost ofCost ofMeasurementMeasurement
BehavioralBehavioralEffectsEffects
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Homogeneous Activity Cost Pools
A homogeneous cost pool is a grouping of A homogeneous cost pool is a grouping of overhead costs in which each cost component is overhead costs in which each cost component is
consumed in roughly the same proportion by consumed in roughly the same proportion by each product line.each product line.
A homogeneous cost poolA homogeneous cost pooluses a single cost driver.uses a single cost driver.
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Transaction Costing
ActivitiesActivities PaperworkPaperwork
UsuallyUsually
Result InResult In
TransactionTransactionprocessingprocessingprovides aprovides a
readilyreadilymeasurablemeasurable
gauge ofgauge ofdepartmentaldepartmental
activity.activity.
TransactionTransactionprocessingprocessingprovides aprovides a
readilyreadilymeasurablemeasurable
gauge ofgauge ofdepartmentaldepartmental
activity.activity.
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Storyboarding
A procedure used to develop a detailed A procedure used to develop a detailed process flow chart, which visually process flow chart, which visually
represents activities and the relationships represents activities and the relationships among activities.among activities.
Step1
Step1
Step2
Step2
Step3
Step3
Step4
Step4
These are the steps wefollow to build amemory board.
These are the steps wefollow to build amemory board.
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Direct versus Indirect Costs
Volume-Based CostingVolume-Based Costing
All production costs All production costs except direct materials except direct materials
and direct labor are and direct labor are lumped together in lumped together in one overhead cost one overhead cost
pool.pool.
Volume-Based CostingVolume-Based Costing
All production costs All production costs except direct materials except direct materials
and direct labor are and direct labor are lumped together in lumped together in one overhead cost one overhead cost
pool.pool.
Activity-Based CostingActivity-Based Costing
An effort is made to An effort is made to account for as many account for as many costs as possible as costs as possible as
direct costs of direct costs of production.production.
Activity-Based CostingActivity-Based Costing
An effort is made to An effort is made to account for as many account for as many costs as possible as costs as possible as
direct costs of direct costs of production.production.
IndirectIndirectCostsCosts
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Indicators of Need for ABC
Line managers do notbelieve the product
costs reports
Line managers do notbelieve the product
costs reports
Marketing does notuse costs reports for
pricing decisions
Marketing does notuse costs reports for
pricing decisions
Product-line profitmargins are hard
to explain
Product-line profitmargins are hard
to explain
Sales are increasing,but profits are declining.Sales are increasing,
but profits are declining.
Some products thathave reported high
profit margins are notsold by competitors
Some products thathave reported high
profit margins are notsold by competitors
Direct labor is asmall percentage
of total costs
Direct labor is asmall percentage
of total costs
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Optimal Product-Costing System
HighHigh
HighHigh
LowLow
LowLow
CostCost
InformationInformationSystemSystemAccuracyAccuracyOptimalOptimal
systemsystem
Total CostTotal Cost
Design, implementationDesign, implementationand maintenance costsand maintenance costs
Cost ofCost ofinferiorinferior
decisionsdecisionsresultingresulting
fromfrominaccurateinaccurate
information.information.
Exh.5-13
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Cost Management Systems
Measure the cost of resources consumed.Measure the cost of resources consumed. Identify and eliminate non-value-added costs.Identify and eliminate non-value-added costs. Determine the efficiency and effectiveness of Determine the efficiency and effectiveness of
all major activities.all major activities. Identify and evaluate new activities that can Identify and evaluate new activities that can
improve future performance.improve future performance.
ObjectivesObjectives
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Non-Value-Added Costs
Suppose our production process looks like this:
StorageStorageTimeTime
WaitingWaitingTimeTime
ProcessProcessTimeTime
MoveMoveTimeTime
InspectionInspectionTimeTime
VAVA NVANVANVANVANVANVANVANVA
VA VA = Valued-added activity= Valued-added activityNVA NVA = Non-value-added activity= Non-value-added activity
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Non-Value-Added Costs
VA VA = Valued-added activity= Valued-added activityNVA NVA = Non-value-added activity= Non-value-added activity
Our goal is to reduce or eliminate the non-value-added activities.
StorageStorageTimeTime
WaitingWaitingTimeTime
ProcessProcessTimeTime
MoveMoveTimeTime
InspectionInspectionTimeTime
VAVA NVANVANVANVANVANVANVANVA
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ABC in the Service Industry
ImplementationImplementationProblemsProblems
ImplementationImplementationProblemsProblems
High proportion offacility-level costs
Activities tend tobe nonrepetitive
human tasks.
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End of Chapter 5End of Chapter 5This is
real value-addedtime!