activity based costing: a tool to aid decision making chapter 8
TRANSCRIPT
Activity Based Costing:A Tool to Aid Decision Making
Chapter
8
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ABC Costing
Used by management for internal decision making, such as…Identify activities that would benefit from
process improvementReduce fixed costsEliminate wasteReduce processing time
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Traditional Cost System
Direct labor and direct material are traced to products.
A single pool of overhead costs.
Overhead Allocation: actual usage of the cost driver (DLH or MH) times the predetermined rate.
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Traditional Cost System
Inaccuracies arise when products do not use similar amounts of resources.
Solution: Activity based cost (ABC) systems.
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Link ABC Cost System to Compensation
Requires people to change behavior.
Should be linked to evaluation and pay
Should be a cooperative venture
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Designing an ABC System
Steps for Implementing ABCSteps for Implementing ABC Identify and define activities and activity pools. Where possible, trace costs to activities and cost
objects.Assign costs to activity cost pools. Calculate activity rates. Assign costs to cost objects.Prepare management reports.
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ABC Terminology
Activity: Any event that causes overhead to be consumed.
Activity cost pool: Buckets (categories) in which costs of an activity are accumulated.
Activity measure: Allocation base (also referred to as cost driver.
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Identifying Activity to Include
A part of the productionA part of the productionprocess for which managementprocess for which management
wants a separate reporting of thewants a separate reporting of thecosts of the activity involved.costs of the activity involved.
Unit-LevelActivity
Batch-Level Activity
Product-LevelActivity
Customer-LevelActivityOrganization-
sustainingActivity
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Types of Activities
Unit level: activity performed each time a unit is produced.
Batch level: cost incurred each time a batch is handled, regardless of the number of units in the batch.Example: Cost of setting up machines to
produce a particular product.
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Types of Activities
Product level: costs related to a specific product that are unrelated to the number of batches or units produced.
Cost of designing the product
Cost of advertising a particular product.
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Types of Activities
Customer level activities: costs that arise from interactions with specific customers.Cost of sales calls Cost of customer support that does not
arise from specific products.
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Types of Activities
Organization sustaining activities: cost incurred regardless of which customers are served.Heating factory buildingChief executive officeCompany wide services
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The Mechanics of ABC
At Classic Brass, the ultimate cost objects are:Products,Customer orders, andCustomers.
One overhead cost - shipping - can be traced directly to customer orders.
The company’s overhead costs are shown on the next slide.
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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)
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts Overhead CostsOverhead Costs
TracedTraced $/DLH$/DLH TracedTraced
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts
OrderSize
OrderSize
CustomerOrders
CustomerOrders
ProductDesignProductDesign
CustomerRelationsCustomerRelations OtherOther
Overhead CostsOverhead Costs
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
First-Stage Allocation
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts
Cost Objects:Products, Customer Orders, Customers
Cost Objects:Products, Customer Orders, Customers
OrderSize
OrderSize
CustomerOrders
CustomerOrders
ProductDesignProductDesign
CustomerRelationsCustomerRelations OtherOther
Overhead CostsOverhead Costs
First-Stage Allocation
Second-Stage Allocations
$/MH$/MH $/Order$/Order $/Design$/Design $/Customer$/Customer
UnallocatedUnallocated
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Assigning 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 traced to customer order N/AGeneral 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
Management at Classic Brass believes overhead should be distributed as follows:
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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
Assigning Costs to Activity Cost Pools
Indirect factory wages $500,000Percent consumed by customer orders 25%
$125,000
Indirect factory wages $500,000Percent consumed by customer orders 25%
$125,000
Using the total costs and percentage consumption of overhead, costs are assigned to activity pools.
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wages 125,000$ 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 Pools
Assigning Costs to Activity Cost Pools
Factory equipment depreciation $300,000Percent consumed by customer orders 20%
$ 60,000
Factory equipment depreciation $300,000Percent consumed by customer orders 20%
$ 60,000
Using the total costs and percentage consumption of overhead, costs are assigned to activity pools.
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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
Assigning Costs to Activity Cost Pools
Using the total costs and percentage consumption of overhead, costs are assigned to activity pools.
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Exercise 1: Assigning Costs to Activity Pools
Use the Production Department costs on the next slide (23).
Assume the same percentage allocation of costs to the activity pools as shown in slide 18.
Calculate the Indirect Labor cost that will be assigned to the 5 activity cost pools.
Record your answer on slide 24.
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Production DepartmentIndirect factory wages 400,000$ Factory equipment depreciation 100,000 Factory utilities 200,000 Factory building lease 80,000 780,000$
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 1,630,000$
Exercise 1 Overhead Costs (Manufacturing and NonManufacturing)
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Customer Orders
Product Design
Order Size
Customer Relations Other Total
Production DepartmentIndirect factory wagesFactory 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
Exercise 1Assigning Costs to Activity Cost Pools
Indirect factory wages $400000Percent consumed by customer orders 25%
Indirect factory wages $400000Percent consumed by customer orders 25%
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Computation of Activity Rates
The ABC team has determined that Classic Brass has the following total activities for each
activity cost pool . . .1,000 customer orders,200 new designs,20,000 machine-hours100 customers.
Now the team can compute the individual Now the team can compute the individual activity rates.activity rates.
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1,000 Orders
200 Designs
20,000 machine-
hours 100
Customers Other
Production DepartmentIndirect factory wages 125$ 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
Computation of Activity Rates, Slide 21 data
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Computation of Activity Rates
1,000 Orders
200 Designs
20,000 machine-
hours 100
Customers Other
Production DepartmentIndirect factory wages 125$ 1,000$ 5$ 500$ N/AFactory equipment depreciation 60 - 9 - Factory utilities - 60 3 - Factory building lease - - - -
General Administrative DepartmentAdministrative wages and salaries 60 100 2 1,200 Office equipment depreciation 15 - - 125 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 50 125 - 1,500 Selling expenses 5 - - 350
Total 315$ 1,285$ 19$ 3,675$
Activity Cost Pools
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Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one customer - Windward Yachts.
Windward ordered two products - Stanchions and Custom Compass housings. Here are the details:
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.
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.
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Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one customer - Windward Yachts.
Windward ordered two products - Stanchions and Custom Compass housings. Here are the details:
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.
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 $25.
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2 Orders No new design
200 machine
hours N/A Total
Production DepartmentIndirect factory wages 250$ 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
Assigning Costs to Cost Objects
$125 per order × 2 orders = $250$125 per order × 2 orders = $250
Overhead cost of two orders for standard stanchions.Overhead cost of two orders for standard stanchions.
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Assigning Costs to Cost Objects
2 Orders No new design
200 machine
hours N/A Total
Production DepartmentIndirect factory wages 250$ -$ 1,000$ -$ 1,250$ Factory equipment depreciation 120 - 1,800 - 1,920 Factory utilities - - 600 - 600 Factory building lease - - - -
General Administrative DepartmentAdministrative wages and salaries 120 - 400 - 520 Office equipment depreciation 30 - - - 30 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 100 - - - 100 Selling expenses 10 - - - 10
Total 630$ -$ 3,800$ -$ 4,430$
Activity Cost Pools
Overhead cost of two orders for standard stanchions.Overhead cost of two orders for standard stanchions.
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1 Order 1 new design
4 machine hours N/A Total
Production DepartmentIndirect factory wages 125$ 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
Assigning Costs to Cost Objects
Overhead cost of one order for custom compass housing.Overhead cost of one order for custom compass housing.
$125 per order × 1 order = $125$125 per order × 1 order = $125
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Assigning Costs to Cost Objects
1 Order 1 new design
4 machine hours N/A Total
Production DepartmentIndirect factory wages 125$ 1,000$ 20$ -$ 1,145$ Factory equipment depreciation 60 - 36 - 96 Factory utilities - 60 12 - 72 Factory building lease - - - -
General Administrative DepartmentAdministrative wages and salaries 60 100 8 - 168 Office equipment depreciation 15 - - - 15 Administrative building lease - - - -
Marketing DepartmentMarketing wages and salaries 50 125 - - 175 Selling expenses 5 - - - 5
Total 315$ 1,285$ 76$ -$ 1,676$
Activity Cost Pools
Overhead cost of one order for custom compass housing.Overhead cost of one order for custom compass housing.
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Product MarginsStandard Stanchions
Sales 13,600$ Cost: Direct materials 2,110$ Direct labor 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Standard StanchionsSales 13,600$ Cost: Direct materials 2,110$ Direct labor 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labor 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labor 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
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Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labor 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Custom Compass HousingSales 650$ Cost: Direct materials 13$ Direct labor 50 Shipping costs 25 Customer orders 315 Product design 1,285 Order size 76 1,764
Product margin (1,114)$
Product MarginsStandard Stanchions
Sales 13,600$ Cost: Direct materials 2,110$ Direct labor 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Standard StanchionsSales 13,600$ Cost: Direct materials 2,110$ Direct labor 1,850 Shipping costs 180 Customer orders 630 Product design - Order size 3,800 8,570
Product margin 5,030$
Windward YachtsProduct margins: Standard stanchion 5,030$ Custom compass housing (1,114) Total product margin 3,916 Less: Customer relations 3,675 Customer margin 241$
Windward YachtsProduct margins: Standard stanchion 5,030$ Custom compass housing (1,114) Total product margin 3,916 Less: Customer relations 3,675 Customer margin 241$
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Product Margins
Standard Stanchions
Compass 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 Cost Accounting System
Predetermined manufacturingoverhead rate
$1,000,000 20,000 MH
= $50/MH=
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Product Margins
Standard Stanchions
Compass Housing
Sales 13,600$ 650$ Costs
Direct materials (2,110) (13) Direct labor (1,850) (50) Manufacturing overhead (10,000) (200)
Product margin (360)$ 387$
Traditional Cost Accounting System
400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000