a&mis 5251 introduction to accounting activity based costing: a tool to aid decision making...

A&MIS 525 1

Introduction to Accounting

Activity Based Costing:A Tool to Aid Decision Making

Session 10

February 7,2002

A&MIS 525 2

Activity Based Costing (ABC)

The objective of activity-based costing is to understand

overhead and the profitability of products and customers.

ABC is agood supplement to our traditional

cost systemI agree!

A&MIS 525 3

Overhead rates maybe based on activity

at capacity.

Overhead rates maybe based on activity

at capacity.

Activity Based Costing (ABC)

Activity-Based CostingActivity-Based Costing

Both manufacturingand nonmanufacturing

costs may be assigned toproducts.

Both manufacturingand nonmanufacturing

costs may be assigned toproducts.

Some manufacturingcosts may be excluded

from productcosts.

Some manufacturingcosts may be excluded

from productcosts.

There are a numberof cost pools each of

which is allocatedusing a unique

measure of activity.

There are a numberof cost pools each of

which is allocatedusing a unique

measure of activity.

Allocation bases oftendiffer from

traditional costingsystems.

Allocation bases oftendiffer from

traditional costingsystems.

A&MIS 525 4

How Costs are Treated Under Activity-Based Costing

Level of C

omplexity

Level of C

omplexity

Overhead Allocation

Plantwide Overhead

Rate

Plantwide Overhead

Rate

DepartmentalOverhead

Rates

DepartmentalOverhead

Rates

Activity BasedCosting

Activity BasedCosting

A&MIS 525 5

Plantwide Overhead Rate

Companies tend to use direct labordirect labor as the overhead allocation base.

6 A&MIS 525

A two stage process isnecessary because costs

are allocated to departmentsand then to products.

A two stage process isnecessary because costs

are allocated to departmentsand then to products.

Finishing Department

Shipping Department

Painting Department

Departmental Overhead Rates

A&MIS 525 7

Department1

Department2

Department3Cost poolsCost pools

IndirectLabor

IndirectLabor

IndirectMaterialsIndirect

MaterialsOther

OverheadOther

OverheadStage One:Stage One:Costs assignedCosts assignedto poolsto pools


A&MIS 525 8

Department1

Department2


Stage One:Stage One:Costs assignedCosts assignedto poolsto pools

Products Products

Stage Two:Stage Two:Costs appliedCosts appliedto productsto products


IndirectLabor

IndirectLabor


MaterialsOther

OverheadOther

Overhead

A&MIS 525 9

Department1

Department2


Stage One:Stage One:Costs assignedCosts assignedto poolsto pools

Products Products

Stage Two:Stage Two:Costs appliedCosts appliedto productsto products

Direct Labor Hours

MachineHours

RawMaterials

Cost

Departmental Allocation Bases


IndirectLabor

IndirectLabor


MaterialsOther

OverheadOther

Overhead

A&MIS 525 10

Designing an ABC System

Cost Objects(e.g., products

and customers)

Cost Objects(e.g., products

and customers)ActivitiesActivities Consumption

of Resources

Consumptionof Resources

CostCost

A&MIS 525 11

Designing an ABC System

Steps for Implementing ABCSteps for Implementing ABCIdentify 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.

A&MIS 525 12

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

A&MIS 525 13

Identifying Activity to Include

Activity Cost Activity Cost PoolPool is a “bucket” in which costs are accumulated that relate to a single

activity in the ABC system.

$

$

$ $

$$

A&MIS 525 14

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.

A&MIS 525 15

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)

A&MIS 525 16

Activity-Based Costing at Classic Brass

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ShippingCosts

ShippingCosts Overhead CostsOverhead Costs

TracedTraced $/DLH$/DLH TracedTraced

Cost Objects:Products, Customer Orders, Customers


A&MIS 525 17


DirectMaterials

DirectMaterials


ShippingCosts

ShippingCosts

OrderSize

OrderSize

CustomerOrders

CustomerOrders

ProductDesignProductDesign

CustomerRelationsCustomerRelations OtherOther

Overhead CostsOverhead Costs



First-Stage Allocation

A&MIS 525 18


DirectMaterials

DirectMaterials


ShippingCosts

ShippingCosts



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

A&MIS 525 19

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:

A&MIS 525 20

Customer Orders

Product Design

Order Size


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


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.

A&MIS 525 21

Customer Orders

Product Design

Order Size


Production DepartmentIndirect factory wages 125,000$ Factory equipment depreciation 60,000 Factory utilitiesFactory building lease



Total

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


A&MIS 525 22

Customer Orders

Product Design

Order Size


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



A&MIS 525 23

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-hours– 100 customers.

Now the team can compute the individual Now the team can compute the individual activity rates.activity rates.

A&MIS 525 24

1,000 Orders

200 Designs

20,000 machine-

hours 100

Customers Other

Production DepartmentIndirect factory wages 125$ Factory equipment depreciationFactory utilitiesFactory building lease



Total

Activity Cost Pools


A&MIS 525 25


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

A&MIS 525 26

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 customer 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.

A&MIS 525 27


Let’s take a look at how our system works for just one customer - Windward Yachts.

– Windward ordered two products - Stanchions and customer 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.

A&MIS 525 28

2 Orders No new design

200 machine

hours N/A Total




Total

Activity Cost Pools


$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.

A&MIS 525 29


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.

A&MIS 525 30

1 Order 1 new design

4 machine hours N/A Total




Total

Activity Cost Pools


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

A&MIS 525 31


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.

A&MIS 525 32

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


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)$



A&MIS 525 33





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


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


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$

A&MIS 525 34

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=

A&MIS 525 35

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

A&MIS 525 36

Difference Between ABC and Traditional Product Costs

ABC will ordinarily shift batch-level and product-level

overhead costs from high-volume

products produced in large batches to

low-volume products produced in small

batches.

A&MIS 525 37

Difference Between ABC and Traditional Product Costs

Under ABC both manufacturing and

nonmanufacturing costs may be assigned to

products. Organization-sustaining costs and the

costs of idle capacity are not assigned to

products.

A&MIS 525 38

Ease of Adjustment

Costs that adjust automatically to changes in activity:– Direct materials.– Shipping.

Costs that could be adjusted to changes in activity:– Direct labor.– Factory utilities.– Administrative wages and salaries.– Office equipment depreciation.– Marketing wages and salaries.– Selling expenses.

Costs that are difficult to adjust to changes in activity:– Factory equipment depreciation.– Factory building lease.– Administrative building lease.

A&MIS 525 39

A&MIS 525 40

Simplified Approach to ABC

After the first-stage allocation is complete, computation of activity rates for each activity cost pool can be simplified

as follows:

Computation of the Activity Rates Customer

Orders Product Design Order Size

Customer Relations Other

Costs from first- stage allocation 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ Total activity 1,000 200 20,000 100 N/ACost per unit of activity 315$ 1,285$ 19$ 3,675$

Computation of the Activity Rates Customer

Orders Product Design Order Size

Customer Relations Other

Costs from first- stage allocation 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ Total activity 1,000 200 20,000 100 N/ACost per unit of activity 315$ 1,285$ 19$ 3,675$

÷ ÷ ÷ ÷

A&MIS 525 41


Standard Stanchions: Sales 13,600$ Costs: Direct materials 2,110$ Direct labor 1,850 Shipping costs 180 Customer orders (2) 630 Product design - Order size (200) 3,800 8,570 Product margin 5,030$

2 orders @ $315 per order2 orders @ $315 per order

A&MIS 525 42


Custom Compass Housing Sales 650$ Costs: Direct materials 13$ Direct labor 50 Shipping costs 25 Customer orders (1) 315 Product design 1,285 Order size 76 1,764 Product margin (1,114)$

1 design @ $1,285 per design1 design @ $1,285 per design

A&MIS 525 43


Customer margin for Windward Yachts is shown below:Customer Profitability AnalysisProduct margins: Standard stanchion $ 5,030 Custom compass housing (1,114) Total product margins 3,916 Less: Customer relations (3,675) Customer margin 241

A&MIS 525 44

End of Chapter 8End of Chapter 8I call thisI call thisquality quality

time!time!

A&MIS 525 45

Puzzle

A shipping company had trouble determining how much it should cost to ship materials from Ohio to a point near the Atlantic ocean. In spite of numerous trips within the Great Lakes area, the company still found it difficult to predict costs. What do you suppose was making cost estimation difficult?

A&MIS 525 46

Agenda Today

• Clarify our views of the activity paradigm

• Discuss efficiency & effectiveness

• Summarize the basics about the relationship of standards to the costs incurred

• Review some problems

47 A&MIS 525

OutputsInputs

Basic Activity View

A&MIS 525 48

Activities

• Activities are about actions, doing something, effort, work done, not the consequences of the work or effort.

• Metrics or measures are the ways we are going to quantify the volume of activity during a time period. Different activities require different metrics.

A&MIS 525 49

Activity Terminology

• Statistics represent the numeric values assigned to the metrics for a period.

• Data sources are the primary or secondary sources of the statistics.

A&MIS 525 50

Thinking About Activities

Inputs Activities Outputs

1. Labor Assembling Products

2. Materials Processing Intermediate

products

3. Parts Assembling Assembly

4. Equipment Stamping Steel part

5. Services Insurance Risk reduction 6. Warehouse Storing Availability

A&MIS 525 51

An Observation

• Defining activities can be difficult, particularly in service and creative work.

• Even when we can define an activity, it can be difficult to separate measures of activity level from measures of output. It is simpler to focus on outputs, which is what the text tends to do in places.

• But properly defining activities is crucial

A&MIS 525 52

Related Terminology

• What does it mean to be efficient?

• What does it mean to be effective?

A&MIS 525 53

Efficiency

• Measures of efficiency nearly always compare the inputs to an activity or process with its outputs. The greater the output per unit of input, the more efficient. The fewer the units of input required to make one unit of output, the greater the efficiency.

• Efficiency is a general concept that relates to entities ranging from individuals performing a single task to entire economies.

A&MIS 525 54

Efficiency

• Since the productivity of labor has been so key to the wealth of a society, we continue to focus on the productivity of people. Sales per person, gross margin per person, and physical output per person, are measures of efficiency as well as measures of productivity.

• Cost per sales dollar, or cost per unit of output are the most common measures of efficiency used in managerial accounting.

A&MIS 525 55

Efficiency in Accounting

• In accounting we use cost standards, flexible budgets and profitability measures to evaluate efficiency. These standards relate the work done to the cost incurred to achieve that work. Physical measures are useful, but the ultimate measures include profitability.

• We may measure other operating variables because we believe they relate to profitability in the longer run.

56 A&MIS 525

Just in

time

Basic Activity View

INPUTS

Outputs

Input/Output

A&MIS 525 57

Input/Output Relationships

INPUTS OUTPUTS

Yield or Productivity

Efficiency

58 A&MIS 525

Basic Activity View

Outputs

INPUTS

Input/Output

Utilization

Rates

Productivity

A&MIS 525 59

Effectiveness

• Effectiveness is concerned with the achievement of objectives. Making a sales goal, achieving a target market share, completing a project on schedule, satisfying customers, and retaining employees--which may or may not change productivity. So effectiveness is a separate issue:

Did we achieve the goal?

A&MIS 525 60

Effectiveness Measures

• Percent of the goal achieved.

• Percent variance from goal.

• Improvement from past experience

• Percent of the goal achieved compared with last period.

• Percent variance from goal compared with last period.

• Examples from your experience?

A&MIS 525 61

Effectiveness Measures

• Headcount, cycle time, customer satisfaction, and other measures are believed to lead to greater profitability. But they are not measures of efficiency per se.

A&MIS 525 62

Operational (Technical) Control

Provides feedback to employees and their managers about the efficiency of activities being performed. Measures of effectiveness might include cycle times, spoilage rates, lost units, late shipments, etc.

A&MIS 525 63

• Break for it!

A&MIS 525 64

Standard Costing

• A management system that makes sense in a technical planning and control context

• Concerned with economic efficiency, not effectiveness beyond this one isssue.

A&MIS 525 65

Roots

• Originated as part of the scientific management movement of the early to mid 20th century.

• Represents a move away from arbitrary management methods to those based on observable “scientific” information. This movement followed the successes of medicine and agriculture earlier in the 20th century.

A&MIS 525 66

Substance

• Standards represent the output that should be achieved at a specified level of perfection based on the operating capacities of people, equipment, management, process design, etc.

A&MIS 525 67

Relationship Overview

Standard cost

+ Unfavorable variances

- Favorable variances

= (Actual) cost incurred (GAAP)

A&MIS 525 68

Relationship Overview (dr/cr)

Standard cost (dr)

+ Unfavorable variances (dr)

- Favorable variances (cr)

= (Actual) cost incurred (dr)

A&MIS 525 69

Formulae

• Output achieved x unit standard = total input at standard

• Materials, labor and driver activity:

AQO (output) x sq (unit standard) = SQ (total material, labor or driver activity “allowed” at standard)

• Standard cost per unit = Σ(sq x sp)

A&MIS 525 70

Formulae

• Standard cost of production =

AQO x Σ(sq x sp)

• When the price variance is isolated and recorded at usage,

aq•ap = sp•sq + (ap–sp)aq + (aq-sq)sp

aq•ap = sp•sq + ap•aq – sp•aq + aq•sp -sq•sp

A&MIS 525 71

• Nothing in the world can take the place of PERSISTENCE.

• Talent will not; nothing is more common than unsuccessful men with talent.

• Genius will not; unrewarded it's almost a proverb.• Education will not; the world is filled with educated

derelicts.• PERSISTENCE and DETERMINATION alone are

omnipotent.

_Calvin Coolidge

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a&mis 5251 introduction to accounting activity based costing: a tool to aid decision making...

Documents

overhead slide

overhead stage

costing activity

activity cost pools

activity pools

activity rates

costing slide

cost pools stage