21b - 1 horngren ♦ harrison ♦ bamber ♦ best ♦ fraser ♦ willett, accounting 4e copyright ©...

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


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


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


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


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


Describe and developactivity-based costs

(ABC).

Objective 1


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


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.



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.



Costing SystemsChemical Manufacturing Department Overhead

DirectLabour

Cost

ChemicalA

ChemicalB

ChemicalC

DepartmentalIndirect CostPool

CostAllocationBase

ProductCostObjects



Costing SystemsChemical Manufacturing Department Overhead

No. ofMachine

Hours

ChemicalA

ChemicalB

ChemicalC

DepartmentalIndirect CostPool

CostAllocationBase

ProductCostObjects

No. ofSamplesTaken

No. ofBatches

ProcessingMixing TestingActivityIndirect CostPool


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


Costing Systems



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?


Chemtech assigns 140 times as much overhead to Aldehyde as to PH.

Chemtech assigns 140 times as much overhead to Aldehyde as to PH.


Costing Systems $7,000 × 200% = $14,000 to Aldehyde $50 × 200% = $100 to PH


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



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



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



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



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



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



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


Cost/kg Traditional ABC(Overhead) System SystemAldehyde $ 2.00 $ 1.95PH $20.00 $94.00


What is the overhead cost per kg? Aldehyde: $13,630 ÷ 7,000 = $1.95 PH: $470 ÷ 5 = $94


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)


Chemtech Gross Profit per Kg.


Decide when ABC is most likely

to pass the cost-benefit test.

Objective 2


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.


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.


Managers don’t understand costs and profits.

The cost system is outdated.

Signs That the Cost SystemMay Be Broken


End of Chapter 21B

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