04 Activity Based Costing

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Chapter 1 - 1

AGUS SISWANDI

01153056

MANAGEMENT

ACCOUNTING

Chapter 1 - 3

Learning Objectives

Discuss the importance of unit costs.

Describe functional-based costingapproaches.

Explain why functional-based costingapproaches may produce distorted costs.

Explain how an activity-based costingsystem works.

Chapter 1 - 4

Provide a detailed description of how

activities can be grouped into

homogeneous sets to reduce the number of activity rates.

Describe the role of activity-based costing

for organizations with only one product,homogeneous products, or a JIT structure.

Learning Objectives (continued)

Chapter 1 - 5

Unit Costs

The unit cost is the total cost associated with theunits produced divided by the number of unitsproduced

Although the concept is simple, the practical reality of the computation can be somewhat more complexbecause of the following issues:

– What is meant by “total cost”? – How do we measure the costs to be assigned?

– How do we assign costs to the product?

Chapter 1 - 6

Unit Costs (continued)

Unit costs are important for:

inventory valuation

income determination

providing input to a variety of decisions such as

pricing, make or buy, and accept or reject

special orders

Chapter 1 - 7

Measurement Systems

Two possible measurement systems areactual costing and normal costing.

Actual costing assigns the actual costs of direct materials, direct labor, and overheadto products.

Normal costing assigns the actual costs of direct materials and direct labor toproducts; however, overhead cots areassigned to products using predeterminedrates.

Chapter 1 - 8

Activity Capacity Measures

Units (of driver)

Theoretical

Practical

Expected actual

Normal

Chapter 1 - 9

Functional-Based Costing:

Plantwide Rate

Overhead Costs

Assign Costs

Plantwide Pool

Assign Costs

Products

Direct Tracing

Stage One: Pool Formation

Unit-Level Driver

Stage Two: Costs Assigned

Chapter 1 - 10

Belring, Inc.

Belring, Inc. produces two telephones: a cordless

and a regular model. The company has the

following actual and budgeted data:

Budgeted overhead $360,000

Expected activity (DLH) 100,000Actual activity (DLH) 100,000

Actual overhead $380,000

Chapter 1 - 11

Belring, Inc. (continued)

Cordless Regular

Units produced 10,000 100,000

Prime costs $78,000 $738,000

Direct labor hours 10,000 90,000

Chapter 1 - 12

Belring, Inc. (continued)

Predetermined

Overhead Rate =Budgeted overhead Expected activity

= $360,000 100,000 DLH

= $3.60 per DLH

B l i I U i C C i

Chapter 1 - 13

Belring, Inc. – Unit Cost Computation:

Plantwide Rate

Cordless RegularPrime costs $ 78,000 $ 738,000

Overhead costs:

$3.60 x 10,000 36,000 ---

$3.60 x 90,000 --- 324,000

Total mfg. costs $114,000 $1,062,000

Unit cost $ 11.40 $ 10.62======= ========

F i l B d C i

Chapter 1 - 14

Functional-Based Costing:

Departmental Rates

Overhead Costs

Assign Costs

Department A Pool

Assign Costs

Products

Department B Pool

Assign Costs

Products

Stage One: Pool

Formation

Unit-Level

Drivers

Stage Two: Costs

Assigned

Chapter 1 - 15

Belring, Inc. – Departmental Data

Fabrication Assembly

Budgeted OH $252,000 $108,000======= =======

Expected and actual usage (DLH):

Cordless 7,000 3,000

Regular 13,000 77,00020,000 80,000===== =====

Expected and actual usage (MH):

Cordless 4,000 1,000Regular 36,000 9,000

40,000 10,000===== =====

Chapter 1 - 16

Belring, Inc. – Departmental Rates

Overhead Rates:

Fabrication Rate = Budgeted OH / Expected MH

= $252,000/40,000

= $6.30 per MH

Assembly Rate = Budgeted OH / Expected DLH

= $108,000/80,000= $1.35 per DLH

B l i I U it C t C t ti

Chapter 1 - 17

Belring, Inc. – Unit Cost Computation:

Departmental Rate

Cordless RegularPrime costs $ 78,000 $738,000

Overhead costs:

($6.30 x 4,000) + ($1.35 x 3,000) 29,250 ---($6.30 x 36,000) + ($1.35 x 77,000) --- 330,750

Total mfg. costs $107,250 $1,068,750

Units produced

10,000

100,000Unit cost $ 10.73 $ 10.69

======= ========

S t f O td t d

Chapter 1 - 18

Symptoms of an Outdated

Functional Cost System

The outcome of bids is difficult to explain.

Competitors’ prices appear unrealistically low.

Products that are difficult to produce show high

profits.

Operational managers want to drop products that

appear profitable.

Profit margins are difficult to explain.

S t f O td t d F ti l

Chapter 1 - 19

Symptoms of an Outdated Functional

Cost System (continued)

The company has a highly profitable niche all toitself.

Customers do not complain about price increases.

The accounting department spends a lot of timesupplying cost data for special projects.

Some departments are using their own accountingsystem.

Product costs change because of changes infinancial reporting regulations.

Chapter 1 - 20

Belring, Inc. – Activity Usage

Cordless Regular Total

Units produced per year 10,000 100,000 110,000

Prime costs $78,000 $738,000 $816,000Direct labor hours 10,000 90,000 100,000

Machine hours 5,000 45,000 50,000

Production runs 20 10 30Number of moves 60 30 90

B l i I Additi l OH C t

Chapter 1 - 21

Belring, Inc. – Additional OH Cost

Activity Activity Cost

Setups $120,000

Material handling 60,000Machining 100,000

Testing 80,000

Total $360,000=======

Chapter 1 - 22

ABC: Two-Stage Assignment

Cost Of Resources

Assign Costs

Activities

Assign Costs

Products

Direct Tracing Driver tracing

Driver Tracing

Chapter 1 - 23

Belring, Inc. – Activity Rates

Activity rates are computed below:

Setup rate: $120,000/30 =$4,000 per run

Material-handling rate: $60,000/90 = $666.67 per move

Machining rate: $100,000/50,000 = $2 per MH

Testing rate: $80,000/100,000 = $0.80 per DLH

B l i I A ti it B d C ti

Chapter 1 - 24

Belring, Inc. – Activity-Based Costing

Unit Cost Computation

Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

Setups 80,000 40,000Material handling 40,000 20,000

Machining 10,000 90,000

Testing 8,000 72,000

Total mfg. costs $216,000 $ 960,000

Unit cost $ 21.60 $ 9.60===== =====

Chapter 1 - 25

Comparison of Unit Costs

Cordless Regular

Plantwide rate $11.40 $10.62

Departmental rate 10.73 10.69

Activity rate 21.60 9.60

Chapter 1 - 26

Activity Categories

Unit-level Activities are those that are performed

each time a unit is produced.

Examples: Power and machine hours are used each

time a unit is produced. Direct materials and

direct labor activities are also unit-levelactivities, even though they are not overhead

costs.

Chapter 1 - 27

Activity Categories (continued)

Batch-level Activities are those that are performed

each time a batch of products is produced.

Examples: Setups, inspections, production scheduling,

and material handling.

Chapter 1 - 28

Product-level (Sustaining) Activities are those that

are performed as needed to support the various

products produced by a company. These activitiesconsume inputs that develop products or allow

products to be produced and sold.

Examples: Engineering changes, and expediting.

Chapter 1 - 29

Facility-level Activities are those

that sustain a factory's generalmanufacturing processes.

Examples: Plant management,

landscaping, maintenance,security, property taxes,and plant depreciation.

Chapter 1 - 30

When To Use An ABC System

Low High

Optimal Cost Level

Measurement Cost

Error Costs

Comparison of JIT with

Chapter 1 - 31

Comparison of JIT withTraditional Manufacturing

JIT Traditional

1. Pull-through system 1. Push-through system

2. Insignificant inventories 2. Significant inventories

3. Small supplier base 3. Large supplier base

4. Long-term supplier contracts 4. Short-term supplier contracts

5. Cellular structure 5. Departmental structure

6. Multiskilled labor 6. Specialized labor

7. Decentralized services 7. Centralized services

8. High employee involvement 8. Low employee involvement

9. Facilitating management style 9. Supervisory management style

10. Total quality control 10. Acceptable quality level

Chapter 1 - 32

End of Chapter 4

04 Activity Based Costing

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