copyright © 2006, the mcgraw-hill companies, inc.mcgraw-hill/irwin activity-based costing: a tool...
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Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Activity-Based Costing: A Tool to Aid Decision Making
Chapter Eight
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Activity Based Costing (ABC)
ABC is designed to provide more accurate
ways of assigning indirect and support
service costs to activities, processes, products, customers
ABC is agood supplement to our traditional
cost systemI agree!
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ABC differs from traditional costing
• Both manufacturing and non manufacturing costs are allocated
• Use of several cost pools• Different kinds of allocation base• Allocation through capacity vs activity
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Designing an ABC System
Cost ObjectsCost Objects(e.g., products(e.g., productsand customers)and customers)
Cost ObjectsCost Objects(e.g., products(e.g., productsand customers)and customers)
ActivitiesActivitiesActivitiesActivities
ConsumptionConsumptionof Resourcesof ResourcesConsumptionConsumptionof Resourcesof Resources
CostCostCostCost
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Designing an ABC System
Steps for Implementing ABCIdentify and define activities and activity cost
pools.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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Identify and Define Activitiesand Activity Cost Pools
ManufacturingManufacturingcompanies typically combinecompanies typically combine
their activities into fivetheir activities into fiveclassifications.classifications.
Unit-LevelUnit-LevelActivityActivity
Batch-Level Batch-Level ActivityActivity
Product-LevelProduct-LevelActivityActivity
Customer-LevelCustomer-LevelActivityActivityOrganization-Organization-
sustainingsustainingActivityActivity
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Identify and Define Activitiesand Activity Cost Pools
Activities should only be
combined within a levelif they are highly
correlated.
When combiningactivities, they should be grouped together only at
the appropriatelevel.
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Identify and Define Activitiesand Activity Cost Pools
An Activity Cost Activity Cost PoolPool is a “bucket” in
which costs are accumulated that relate to a single
activity measure in the ABC system.
$
$
$ $
$$
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Identify and Define Activitiesand Activity Cost Pools
Simple countof the number oftimes an activity
occurs.
Transactiondriver
A measureof the amountof time neededfor an activity.
Durationdriver
Two types of activity measures:
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Identify and Define Activitiesand Activity Cost Pools
At Classic Brass, the ABC team, selected the followingactivity cost pools and activity measures:
At Classic Brass, the ABC team, selected the followingactivity cost pools and activity measures:
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Identify and Define Activitiesand Activity Cost Pools
• Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders.
• Product Designs - assigned all costs of resources consumed by designing products.
• Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.
• Customer Relations – assigned all costs associated with maintaining relations with customers.
• Other – assigned all overhead costs that are not associated with the other cost pools.
• Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders.
• Product Designs - assigned all costs of resources consumed by designing products.
• Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.
• Customer Relations – assigned all costs associated with maintaining relations with customers.
• Other – assigned all overhead costs that are not associated with the other cost pools.
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When Possible, Directly Trace OverheadCosts to Activities and Cost Objects
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Assign Costs to Activity Cost Pools
At Classic Brass the following distribution of resource consumption across activity cost pools is determined.
**Not included because they are directly traced to customer orders.
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Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%
$125,000$125,000
Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%
$125,000$125,000
Assign Costs to Activity Cost Pools
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Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%
$ 60,000$ 60,000
Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%
$ 60,000$ 60,000
Assign Costs to Activity Cost Pools
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Assign Costs to Activity Cost Pools
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Calculate Activity Rates
The ABC team determines that Classic Brass will have these total activities for each activity cost
pool . . . 1,000 customer orders,1,000 customer orders, 200 new designs,200 new designs, 20,000 machine-hours,20,000 machine-hours, 100 customer relations activities.100 customer relations activities.
Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
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Calculate Activity Rates
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TracedTraced TracedTraced TracedTraced
Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts Overhead CostsOverhead Costs
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
OrderOrderSizeSize
OrderOrderSizeSize
CustomerCustomerOrdersOrders
CustomerCustomerOrdersOrders
ProductProductDesignDesignProductProductDesignDesign
CustomerCustomerRelationsRelationsCustomerCustomerRelationsRelations OtherOtherOtherOther
Overhead CostsOverhead Costs
First-Stage Allocation
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Activity-Based Costing at Classic Brass
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ShippingCosts
ShippingCosts
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers
OrderOrderSizeSize
OrderOrderSizeSize
CustomerCustomerOrdersOrders
CustomerCustomerOrdersOrders
ProductProductDesignDesignProductProductDesignDesign
CustomerCustomerRelationsRelationsCustomerCustomerRelationsRelations OtherOtherOtherOther
Overhead CostsOverhead Costs
First-Stage Allocation
Second-Stage AllocationsSecond-Stage AllocationsSecond-Stage AllocationsSecond-Stage Allocations
$/MH$/MH $/Order$/Order $/Design$/Design $/Customer$/Customer
UnallocatedUnallocated
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Assigning Costs to Cost Objects
Let’s take a look at how our system worksfor just one customer – Windward Yachts.
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.
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 $25.
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Assigning Costs to Cost Objects
The customer-level cost is assigned to customers directly; it is not assigned to
products.
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Prepare Management Reports
Standard StanchionsSales 13,600$ 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$
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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Prepare Management Reports
Customer Profitability Analysis
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Product Margins
Traditional Cost Accounting System
Predetermined manufacturingoverhead rate
$1,000,000 20,000 MH
= $50/MH=
400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000
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Differences Between ABC and Traditional Product Costs
Product margins are different for four reasons:
Traditional costing assigns design costs to both products based on machine hours. ABC assigns product design costs to a product only if product design work is required.
Traditional costing assigns customer order costs, a batch- level cost, using a unit-level allocation base, machine hours. ABC assigns these batch-level costs using a batch-level activity measure.
Traditional costing assigns only manufacturing costs to products. ABC also assigns nonmanufacturing costs to products.
Traditional costing assigns all manufacturing costs to products. The ABC system does not assign organization- sustaining manufacturing costs to the products.
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Differences Between ABC and Traditional Product Costs
When batch-level andproduct-level costs are present,
ABC will usually shift costs from highvolume products, produced in large batches,
to low volume products produced in small batches.
This cost shifting will usually have itsgreatest impact on the per
unit cost of the lowvolume products.
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So What????
• Diverse product line various models and variants
• The difference will be felt for specialty and customized products
Cum
ulative products
+ profitability -
WHALE CURVE-After assigning service and Support departments by ABC
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Activity Based Management
• Upon analysis of product costs thru ABC Re-price products Substitute products Redesign products Improve processes and operations strategy Technology investment Eliminate products
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Customer Profitability Analysis
• High Cost to Serve Order custom products Small order quantity Unpredictable orders Customized delivery Large amount of pre-sales
efforts Large amount of post-
sales efforts Pay slow
• High Cost to Serve Order std. products High order quantity Predictable orders Std. delivery No pre-sales efforts No post-sales efforts Pay on time
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highpassiveproduct is crucialgood supplier match
price sensitive agrressivefew special demands low price
lots of customizationlow
low cost to serve high
costly to serve butpay premium
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End of Chapter 8End of Chapter 8