Activity Based Costing

Acct 310Proffessor Rick S. Hayes, Ph.D., CPA

MicroMash CPE Course Example

• Make sure that costing done correctly, reduce costs

• Direct labor and materials costs [prime costs]– easy to trace to product

• Manufacturing overhead is indirect costs – hard to trace, control – estimate, calculate cost per unit

Traditional Unit Based Cost (UBC) Accounting

• Standard costing is about assigning overhead costs based upon one predetermined rate based on volume• Easier, less accurate; Works best with one product;• Could be misleading

• Standard costing – steps1. Accumulate total overhead costs2. Identify activity that best applies overhead costs

to the product (base), e.g. labor hours3. Calculate application base rate

(total overhead/total amount of the activity) $20,000 total oh/ 500 labor hrs = $40 base rate per hour worked

4. Apply overhead rate - Multiply base rate by total base activity used for each product. A product that takes 2 hours at $40 base rate would be allocated $80 of overhead (2 x $40)

Standard Costing Method

Total manufacturing overhead $10,000,000Direct labor hours 500,000

10,000,000/50,000 = $20/labor hour application base rate$20 * 2 hours per product to mfg. = $40 overhead cost per unitProduct A = manufacturing overhead cost/unit - $40Product B = manufacturing overhead cost/unit - $40Product A = total manufacturing cost/unit - $150Product B = total manufacturing cost/unit - $110

Standard Costing Method

• Direct Costs A B• Direct Materials $90 $50• Direct Labor @ $10/hr $20 $20• Manufacturing OH $40 $40• Total per unit cost $150 $110

Standards costing example total cost per unit

The organization is viewed as a pool of activities. Many of these activities will cut across deparments with departments often

participating in many different activities

• ABC costing – steps1. Re-categorize overhead costs into activity pools2. Calculate total costs and total physical base for each

activity3. Calculate application base rate for each category (total

overhead/total physical base)4. Calculate proportion of physical base for each category5. Multiply rate by base for each product6. Calculate total overhead for each product7. Divide total cost for each product by product

manufactured = overhead cost per unit8. Add overhead cost per unit to direct labor cost per unit

and direct material cost per unit = total cost per unit

Activity Based Costing• Two stage allocation process

– Assign costs to pools, then assign to products using cost drivers

• I.e. Sell 50,000 units – Product A, 200,000 units – Product B = 250,000 units total– Both require two direct labor hours to complete =

500,000 direct labor-hours– Total manufacturing overhead = $10,000,000

ABC Costing

Table 1 Expected activity Activity Center and Costs Costs Total Product A Product B Labor related (labor hours) $800,000 500,000 100,000 400,000 Machine related (machine hours) $2,100,000 1,000,000 300,000 700,000 Machine setups (# of setups) $1,600,000 4,000 3,000 1,000 Production orders (# orders) $450,000 1,200 400 800 Material receipts (# of receipts) $1,000,000 5,000 1,800 3,200 Parts administration ( part types) $350,000 700 400 300 Product testing (# of tests) $1,700,000 20,000 16,000 4,000 General overhead (machine hours) $2,000,000 1,000,000 300,000 700,000 Total $10,000,000

Table 2 Estimated Total Expected Overhead

Overhead Costs Activity Rate

Labor related $800,000 500,000 $1.60 Machine related $2,100,000 1,000,000 $2.10 Machine setups $1,600,000 4,000 $400.00 Production orders $450,000 1,200 $375.00 Material receipts $1,000,000 5,000 $200.00 Parts administration $350,000 700 $500.00 Product testing $1,700,000 20,000 $85.00 General Factory $2,000,000 1,000,000 $2.00

Table 3 Product A Product B Labor related Rate * activity $160,000 $640,000 Machine related $630,000 $1,470,000 Machine setups $1,200,000 $400,000 Production orders $150,000 $300,000 Material receipts $360,000 $640,000 Parts administration $200,000 $150,000 Product testing $1,360,000 $340,000 General Factory $600,000 $1,400,000 Total $4,660,000 $5,340,000 Units produced 50,000 200,000 Overhead per unit $93.20 $26.70

Product A - manufacturing overhead costs = $93.20Product B - manufacturing overhead costs = $26.70

• Direct Costs A B• Direct Materials $90 $50• Direct Labor @ $10/hr $20 $20• Manufacturing OH $93.20 26.70• Total per unit cost $203.20$96.70

QUESTIONS?

ABC Hierarchical Production Model

Facility Support Activities not ABC