Activity Based Costing Ch05 Horngren

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Chapter 5Chapter 5

Activity-Based Costing and Management

Activity-Based Costing and Management

Traditional, Volume-Based Traditional, Volume-Based Product-Costing SystemProduct-Costing System

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• Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.

• The following information is obtained from company records:

• Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.

• The following information is obtained from company records:

Mode I Mode I I Mode I I IProduction: Units 10,000 20,000 4,000 Runs 1 run of 10,000

units 4 runs of

5,000 units 10 runs of 400 units


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Additional information includes:Mode I Mode I I Mode I I I

Direct materials 50.00$ 90.00$ 20.00$ Direct labor (hr/board) 3 4 2 Setup time (hr/run) 10 10 10 Machine time (hr/board) 1 1.25 2

Manufacturing overhead is determined as follows


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Budgeted manufacturing overhead Budgeted manufacturing overhead $3,894,000 $3,894,000 Budgeted direct-labor hours 118,000Budgeted direct-labor hours 118,000 = $33 per hour= $33 per hour


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With these product costs, Aerotech established target selling prices (Cost × 125%).

209.00 x 1.25

Activity Based Costing System Activity Based Costing System (ABC)(ABC)

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ABC systems follow a two-stage two-stage procedure to assign overhead costs to products.

Stage OneIdentify significant activities and assign overhead costs to each activity in proportion to resources used.

Stage TwoIdentify cost drivers appropriate to each activity and allocate overhead to the products.

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Overhead CostsOverhead CostsTotal budgeted cost = $3,894,000Total budgeted cost = $3,894,000

ActivityActivityCostCostPoolsPools

MachineryMachinerycost poolcost pool

$1,212,600$1,212,600

SetupSetupcost poolcost pool$3,000$3,000

EngineeringEngineeringcost poolcost pool$700,000$700,000

FacilityFacilitycost poolcost pool$507,400$507,400

UnitLevel

BatchLevel

Product-Sustaining

Level

FacilityLevel

Identificationof ActivityCost Pools

Identificationof ActivityCost Pools

ActivityActivitymust bemust bedone ondone oneach uniteach unitproduced.produced.

ActivityActivityperformedperformedon eachon eachbatchbatch

produced.produced.

Activities needed to supportActivities needed to supportan entire product linean entire product line

Activity required in orderActivity required in orderfor the productionfor the productionprocess to occur.process to occur.

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Receiving/InspectionReceiving/Inspectioncost pool cost pool $200,000$200,000

Material-HandlingMaterial-Handlingcost pool cost pool $600,000$600,000

Quality-AssuranceQuality-Assurancecost pool cost pool $421,000$421,000

Packaging/ShippingPackaging/Shippingcost pool cost pool $250,000$250,000

MachineryMachinerycost poolcost pool

$1,212,600$1,212,600

SetupSetupcost poolcost pool$3,000$3,000

EngineeringEngineeringcost poolcost pool$700,000$700,000

FacilityFacilitycost poolcost pool$507,400$507,400

UnitLevel

BatchLevel

Product-Sustaining

LevelFacilityLevel

STAGE ONESTAGE ONE

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Machinery Cost PoolMachinery Cost PoolTotal budgeted cost = $1,212,600

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

ActivityActivitycostcostpoolpool

Various overheadVarious overheadcosts relatedcosts relatedto to machinerymachinery

STAGE TWOSTAGE TWO

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CalculateCalculatethe poolthe pool

raterate

Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour$28.20/hour

CostCostAssignmentAssignment

=

=

STAGE ONESTAGE ONE

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Calculation ofCalculation oftotal total setup costsetup cost

Setup Cost PoolSetup Cost PoolTotal budgeted cost = $3,000


STAGE TWOSTAGE TWO

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CalculateCalculatethe poolthe pool

raterate

Budgeted Setup Costs $3,000Planned Production Runs 15 runs $200 per run$200 per run


=

=

STAGE ONESTAGE ONE

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Various overheadVarious overheadcosts relatedcosts related

to to engineeringengineering

Engineering salaries

Engineering supplies

Engineering software

Depreciation

Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000


STAGE TWOSTAGE TWO

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Allocate basedAllocate basedon on engineeringengineering

transactionstransactions


Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000

STAGE ONESTAGE ONE

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Various overheadVarious overheadcosts relatedcosts related

to to generalgeneraloperationsoperations

Plant depr.

Plant mgmt.

Plant maint.

Property taxes

Insurance

Security

Facility Cost PoolFacility Cost PoolTotal budgeted cost = $507,400


STAGE TWOSTAGE TWO

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Budgeted Facilities Cost $507,400Budgeted Direct-Labor Hours 118,000 $4.30/hour$4.30/hour


=

=CalculateCalculatethe poolthe pool

raterate

Other Overhead CostsOther Overhead Costs

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Board Overhead × % ÷ Units = Cost/UnitMode I 200,000$ × 6% ÷ 10,000 = 1.20$ Mode II 200,000 × 24% ÷ 20,000 = 2.40 Mode III 200,000 × 70% ÷ 4,000 = 35.00

Receiving and Inspection Cost Pool


Material-Handling Cost Pool


Quality-Assurance Cost Pool


Packaging and Shipping Cost Pool

Other Overhead CostsOther Overhead Costs

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Packaging and Shipping Cost Pool


Quality-Assurance Cost Pool


Receiving and Inspection Cost Pool


Material-Handling Cost Pool

$14.82$14.82

Product Cost from ABCProduct Cost from ABC

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These are the new product costs when Aerotech uses ABC.

Distorted Product CostsDistorted Product Costs

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Both original and ABC target selling prices are based on (Cost × 125%).

[$209.00 × 1.25] [$183.44 × 1.25]

The selling price of Mode I and II are reducedThe selling price of Mode I and II are reducedand the selling price for Mode III is increased.and the selling price for Mode III is increased.

Distorted Product CostsDistorted Product Costs

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Can you identify any problems Aerotech is likely to face as a result of this distortion?

Traditional costing understates the costof complex, low volume products.

Two Key PointsTwo Key Points

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A large proportion of non-unit-level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately.

A large proportion of non-unit-level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately.

Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs.

Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs.

Activity-Based ManagementActivity-Based Management

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The use ofABC costing information

to helpmanagement

make decisions

Activity-Based ManagementActivity-Based Management

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Activity-based costing establishes relationshipsbetween overhead costs and activities so that

we can better allocate overhead costs.

Activity-based management focuses on managing activities to reduce costs.

Two-Dimensional ABC and Two-Dimensional ABC and Activity-Based ManagementActivity-Based Management

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ActivitiesActivities


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Cost ObjectsCost ObjectsCost ObjectsCost Objects


Resource costsResource costsResource costsResource costs

Cost Assignment ViewCost Assignment View


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ActivityActivityTriggersTriggersActivityActivityTriggersTriggers

Cost ObjectsCost ObjectsCost ObjectsCost Objects

ActivitiesActivitiesRootRoot

CausesCausesRootRoot

CausesCauses

Process ViewProcess ViewActivity AnalysisActivity Analysis

Resource costsResource costsResource costsResource costs

Cost Assignment ViewCost Assignment View

PerformancePerformanceMeasuresMeasures

PerformancePerformanceMeasuresMeasures

Activity EvaluationActivity Evaluation

Elimination of Non-Value-Added Elimination of Non-Value-Added CostsCosts

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Nonvalue-added

activities

NecessaryNecessaryUnnecessaryUnnecessary


Reduce orReduce orEliminateEliminate

Continually Evaluate Continually Evaluate

and Improveand Improve

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Customer Profitability AnalysisCustomer Profitability Analysis

Customer profitability analysis usesactivity-based costing to determine

the activities, costs, and profit associated with serving particular customers.

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Customer Profitability AnalysisCustomer Profitability Analysis

Orderssmall

quantities.

Ordersfrequently.

Oftenchangesorders.

Requiredspecial

packaging.

Demandfast

service.

A costly customer

Just-in-Time Inventory and Just-in-Time Inventory and Production ManagementProduction Management

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No materials are purchased and no products are manufactured until they are needed.

The primary goal of aThe primary goal of aJIT production system isJIT production system is

to reduce or eliminateto reduce or eliminateinventories at everyinventories at everystage of production.stage of production.

The primary goal of aThe primary goal of aJIT production system isJIT production system is

to reduce or eliminateto reduce or eliminateinventories at everyinventories at everystage of production.stage of production.

End of Chapter 5End of Chapter 5

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This ismy kind of cost

pool!

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Activity Based Costing Ch05 Horngren