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Activity-Based Activity-Based CostingCosting

CHAPTERCHAPTER

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1. Discuss the importance of unit costs.2. Describe functional-based costing

approaches.3. Explain why functional-based costing

approaches may produce distorted costs.4. Explain how an activity-based costing system

works for product costing.

ObjectivesObjectives

continuedcontinued

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5. Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates.

6. Describe activity-based customer and supplier costing.

ObjectivesObjectives

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Unit cost is the total cost associated with the units produced divided by the

number of units produced.

Inventory valuationIncome determinationProviding input to a variety of decisions such as pricing, make or buy, and accept or reject special orders

Unit cost is used for--

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Product cost is often defined as the sum of direct materials, direct

labor, and manufacturing overhead. This definition is required for external financial reporting.

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Cost measurement consists of determining the dollar amounts of direct materials, direct labor, and

overhead used in production.

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The process of associating the costs, once measured, with the units produced is

called cost assignment.

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Two possible measurement systems are actual costing and normal costing.

Measurement SystemsMeasurement Systems

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

Normal costing assigns the actual costs of direct materials and direct labor to products; however, overhead cots are assigned to products using predetermined rates.

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Measurement SystemsMeasurement Systems

A predetermined overhead rate is a rate

based on estimated data.

Budgeted (estimated) costEstimated activity usage

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Examples of Unit-Level DriversExamples of Unit-Level Drivers

Units produced

Direct labor hours

Direct labor dollars

Machine-hours

Direct material dollars

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Units (of

driver)

Time

Theoretical

Practical

Normal

Expected actual

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Functional-Based Costing: Plantwide Rate (overhead rate total)

Overhead CostsOverhead Costs

Assign CostsAssign Costs

Plantwide PoolPlantwide Pool

Assign CostsAssign Costs

ProductsProducts

Direct Tracing (single rate)

Stage One: Pool Formation

Unit-Level Driver

(multiple rate)

Stage Two: Costs Assigned

Distribution (company), Allocation (dept.), Assignment (product)

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Belring, Inc.Belring, Inc. produces two telephones: a cordless (nircable) and a regular model (cable). The company has the following actual and budgeted data:

.

Budgeted overhead$360,000Expected activity (DLH)100,000Actual activity (DLH)100,000Actual overhead$380,000

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Predetermined Overhead Rate =

Belring, Inc.Budgeted (estimated) cost

Estimated activity usagePredetermined Overhead Rate =

$360,000

100,000 DLHPredetermined Overhead Rate = $3.60 per DLH

4 -16 The total overhead assigned to actual

production is called applied overhead.

Applied overhead =

Overhead rate x

Actual activity output

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Belring, Inc.Applied overhead = Overhead rate x Actual activity output

= $3.60 x 100,000 DLH

= $360,000

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Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

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

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

Total manufacturing costs $114,000 $1,062,000

Units produced 10,000 100,000

Unit cost $ 11.40 $ 10.62

Belring, Inc.Per-Unit CostPer-Unit Cost

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Overhead CostsOverhead Costs

Assign CostsAssign Costs

Assign CostsAssign Costs Assign CostsAssign Costs

ProductsProducts ProductsProducts

Stage One: Pool Formation

Unit-Level Drivers

Stage Two: CostsAssigned

Functional-Based Costing Department Rates

Department A PoolDepartment A Pool Department B PoolDepartment B Pool

AllocationDirect Tracing

Driver Tracing

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Symptoms of an Outdated Symptoms of an Outdated Functional Cost SystemFunctional Cost System

1. The outcome of bids is difficult to explain.

2. Competitors’ prices appear unrealistically low.

3. Products that are difficult to produce show high profits.

4. Operational managers want to drop products that appear profitable.

5. Profit margins are difficult to explain.

ContinuedContinued

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Symptoms of an Outdated Symptoms of an Outdated Functional Cost SystemFunctional Cost System

6. The company has a highly profitable niche all to itself.

7. Customers do not complain about price increases.8. The accounting department spends a lot of time

supplying cost data for special projects.9. Some departments are using their own accounting

system.10. Product costs change because of changes in

financial reporting regulations.

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Non-unit activity drivers are factors that measure the consumption of non-unit activities by products and

other cost objects.

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Product diversity means that the products consume overhead activities

in systematically different proportions.

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A primary activity is one that is consumed by a product or customer.

A secondary activity is one that is consumed by

other primary and secondary activities.

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Resource drivers are factors that measure the

consumption of resources by activities.

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Unit-level activities are those that are performed each time a unit is produced. Order 40 chairs & 4 cupboards

Examples: : a unit of product : Power and machine hours are used each time a unit is produced. Direct materials and direct labor activities are also unit-level activities, even though they are not overhead costs.

Classification of ActivitiesClassification of Activities

Imagine in order costing method

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Batch-level activities are those that are performed each time a batch of products is produced.

Examples: for 40 chairs and 4 cupboards : Setups, inspections, production scheduling, and material handling.

Classification of ActivitiesClassification of Activities

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Product-level (sustaining) activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold.

Examples: for 40 chairs different to 4 cupboards : Engineering changes, process engineering, and expediting.

Classification of ActivitiesClassification of Activities

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Facility-level activities are those that sustain a factory's general manufacturing processes.

Examples: Plant management, landscaping, maintenance, security, propertytaxes, and plant depreciation.

Classification of ActivitiesClassification of Activities

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DriverDriverFilterFilter

DriverDriverFilterFilter

DriverDriverFilterFilter

Unit Level Batch Level Product Level Facility Level

AA11 AA AA AA AA22 33 44 55

Set 1Set 1 Set 2Set 2 Set 3Set 3 Set 4Set 4 Set 5Set 5 Set 6Set 6 Set 7Set 7

Activity Level Filter

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AN EXAMPE SEE EXCEL ABC

4 -32 Just in Time (JIT)

• Demand pull system

• Objectives: eliminate waste by producing only when it is needed and in the quantity demanded by customers

• Benefits: better quality, increased productivity, reduced lead times, major reduction in inventory, reduced setup times, lower manufacturing costs.

4 -33 Comparison of JIT with Traditional Approach

JIT TRADITIONAL

1.Pull through system

2.Insignificant inventories

3.Long term supplier contract

4.Cellular structure

5.Multiskilled labor

6.Decentralized services

7.High employee involvement

8.TQM

1.Push through system

2.Significant inventories

3.Sort term supplier contract

4.Departmental structure

5.Specialized labor

6.Centralized services

7.Low employee involvement

8.Acceptable quality level

4 -34 Companies implement JIT

Wall mart General Motors Toys R Us

Ford General Electric Black & Decker

Chrysler Hewlett-Packard Harley Davidson

Motorola AT & T Xerox

Intel Borg Warner Westinghouse

John Deere Mercury Marine

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The EndThe End

Chapter FourChapter Four

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