Cost Accounting chapter 5 ABC

Activity-Based Costing andActivity-Based Management

Chapter 5

Learning Objective 1

Explain undercosting

and overcosting ofproducts and services.

Undercosting andOvercosting Example

Jose, Roberta, and Nancy orderseparate items for lunch.

Jose’s order amounts to $14Roberta consumed 30Nancy’s order is 16Total $60

What is the average cost per lunch?

Undercosting andOvercosting Example

$60 ÷ 3 = $20

Jose and Nancyare overcosted.

Roberta isundercosted.


Present three guidelines for

refining a costing system.

Existing Single Indirect-Cost Pool System Example

Kole Corporation manufactures a normal lens(NL) and a complex lens (CL).

Kole currently uses a single indirect-cost ratejob costing system.

Cost objects: 80,000 (NL) and 20,000 (CL).


Normal Lenses (NL)Direct materials $1,520,000Direct mfg. labor 800,000Total direct costs $2,320,000

Direct cost per unit: $2,320,000 ÷ 80,000 = $29


Complex Lenses (CL)Direct materials $ 920,000Direct mfg. labor 260,000Total direct costs $1,180,000

Direct cost per unit: $1,180,000 ÷ 20,000 = $59


All Indirect Costs$2,900,000

All Indirect Costs$2,900,000

50,000 DirectManufacturingLabor-Hours

50,000 DirectManufacturingLabor-Hours

INDIRECT-COSTPOLL

INDIRECTCOST-ALLOCATIONBASE

$58 per DirectManufacturing

Labor-Hour


Indirect Costs

Direct Costs

Indirect Costs

Direct Costs

COST OBJECT:NL AND CLLENSES

DIRECTCOSTS

DirectMaterials

DirectMaterials

DirectManufacturing

Labor

DirectManufacturing

Labor


Kole uses 36,000 direct manufacturinglabor-hours to make NL and 14,000 directmanufacturing labor-hours to make CL.

How much indirect costs are allocatedto each product?


NL: 36,000 × $58 = $2,088,000

CL: 14,000 × $58 = $812,000

What is the total cost of normal lenses?

Direct costs $2,320,000 +Allocated costs $2,088,000 = $4,408,000

What is the cost per unit?

$4,408,000 ÷ 80,000 = $55.10


What is the total cost of complex lenses?

Direct costs $1,180,000 + Allocated costs $812,000 = $1,992,000

What is the cost per unit?

$1,992,000 ÷ 20,000 = $99.60


Normal lenses sell for $60 each andcomplex lenses for $142 each.

Normal Complex Revenue $60.00 $142.00 Cost 55.10 99.60 Income $ 4.90 $ 42.40 Margin 8.2% 29.9%

Refining a Costing System

Direct-cost tracing

Indirect-cost pools

Cost-allocation basis


1. Design of Products and Process

The Design Department designs the moldsand defines processes needed (details of

the manufacturing operations).


2. Manufacturing Operations

Lenses are molded, finished,cleaned, and inspected.

3. Shipping and Distribution

Finished lenses are packed andsent to the various customers.


Distinguish between the

traditional and the activity-based costing

approaches to designing

a costing system.

Activity-Based Costing System

FundamentalCost Objects

Activities

Costs of Activities

Assignment to OtherCost Objects

Cost of:• Product• Service• Customer


A cross-functional team at KoleCorporation identified key activities:

Design products and processes.

Set up molding machine.

Operate machines to manufacture lenses.

Maintain and clean the molds.


Set up batches of finished lenses for shipment.

Distribute lenses to customers.

Administer and manage all processes.


No. ofSetupHours

LensesNL

LensesCL

LensesOther

CostAllocationBase

ProductCostObjects

No. ofShipments

Parts-Square

feet

SetupDesign ShippingActivityIndirect CostPool


NL CL Quantity produced 80,000 20,000 No. produced/batch 250 50 Number of batches 320 400 Setup time per batch 2 hours 5 hours Total setup-hours 640 2,000

Total setup costs are $409,200.


What is the setup cost per setup-hour?

$409,200 ÷ 2,640 hours = $155

What is the setup cost perdirect manufacturing labor-hour?

$409,200 ÷ 50,000 = $8.184


Allocation using direct labor-hours:NL: $8.184 × 36,000 = $294,624CL: $8.184 × 14,000 = $114,576

Total $409,200

Allocation using setup-hours:NL: $155 × 640 = $ 99,200CL: $155 × 2,000 = $310,000

Total $409,200


Describe a four-part

cost hierarchy.

Cost Hierarchies

A cost hierarchy is a categorizationof costs into different cost pools.

Cost drivers bases (cost-allocation bases)

Degrees of difficulty in determiningcause-and-effect relationships

Cost Hierarchies

ABC systems commonly use afour-part cost hierarchy to

identify cost-allocation bases:

1. Output unit-level costs

2. Batch-level costs

3. Product-sustaining costs

4. Facility-sustaining costs

Output Unit-Level Costs

These are resources sacrificedon activities performed on each

individual unit of product or service.

Energy

Machine depreciation

Repairs

Batch-Level Costs

These are resources sacrificed onactivities that are related to a groupof units of product(s) or service(s)rather than to each individual unit

of product or service.

Setup-hours

Procurement costs

Product-Sustaining Costs

These are often called service-sustainingcosts and are resources sacrificed on

activities undertaken to supportindividual products or services.

Design costs

Engineering costs

Facility-Sustaining Costs

These are resources sacrificed onactivities that cannot be traced to

individual products or services butsupport the organization as a whole.

General administration

– rent – building security


Cost products or services using

activity-based costing.

ImplementingActivity-Based Costing

Identify cost objects.

NLCL

Identify the direct costsof the products.

Direct materialDirect labor

Mold cleaning and maintenance

Step 1 Step 2


Cleaning and maintenance costs of$360,000 are direct batch-level costs.

Why?

Because these costs consist of workers’wages for cleaning molds after each

batch of lenses is run.


Normal Lenses (NL)

Cost HierarchyDescription Category

Direct materials Unit-level$1,520,000

Direct mfg. labor Unit-level 800,000

Cleaning and maint. Batch-level 160,000

Total direct costs$2,480,000


Complex Lenses (CL)

Cost HierarchyDescription Category

Direct materials Unit-level $ 920,000

Direct mfg. labor Unit-level 260,000

Cleaning and maint. Batch-level 200,000

Total direct costs$1,380,000


Select the cost-allocation bases to use forallocating indirect costs to the products.

(1) (2) (3)Activity Cost Hierarchy Total CostsDesign Product-sustaining $450,000Setups Batch-level $409,200Operations Unit-level $637,500

Step 3


Identify the indirect costs associatedwith each cost-allocation base.

Overhead costs incurred are assignedto activities, to the extent possible, on

the basis of a cause-and-effect relationship.

Step 4


Compute the rate per unit.

(1) (5)NL CL Total

Setup-hours: 640 2,000 2,640

Step 5

$409,200 ÷ 2,640 = $155


Compute the indirect costs allocatedto the products.

NL: $155 × 640 = $ 99,200CL: $155 × 2,000 = 310,000

Total $409,200

Step 6


Compute the costs of the products.

NL and CL would show threedirect cost categories.

Step 7

1. Direct materials

2. Direct manufacturing labor

3. Cleaning and maintenance


NL and CL would show six indirect cost pools.

1. Design

2. Molding machine setups

3. Manufacturing operations

4. Shipment setup

5. Distribution

6. Administration

End of Chapter 5

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Cost Accounting chapter 5 ABC