management accounting - hansen mowen ch04

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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.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

continuedcontinuedcontinuedcontinued

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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.

ObjectivesObjectivesObjectivesObjectives

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

number of units produced.

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

number of units produced.

Inventory valuation

Income determination

Providing 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.

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.

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.

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 SystemsMeasurement 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 SystemsMeasurement SystemsMeasurement Systems

A predetermined overhead rate is a rate

based on estimated data.

A predetermined overhead rate is a rate

based on estimated data.

Budgeted (estimated) cost

Estimated activity usage

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Examples of Unit-Level DriversExamples of Unit-Level DriversExamples 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 RateFunctional-Based Costing: Plantwide Rate

Overhead CostsOverhead Costs

Assign CostsAssign Costs

Plantwide PoolPlantwide Pool

Assign CostsAssign Costs

ProductsProducts

Direct Tracing

Stage One: Pool Formation

Unit-Level Driver

Stage Two: Costs Assigned

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

.

Budgeted overhead$360,000Expected 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 usage

Predetermined Overhead Rate =

$360,000

100,000 DLHPredetermined Overhead Rate = $3.60 per DLH

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The total overhead assigned to actual

production is called applied overhead.

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 RatesFunctional-Based Costing Department Rates

Department A PoolDepartment A Pool Department B PoolDepartment B Pool

AllocationDirect Tracing

Driver Tracing

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Budgeted overhead $252,000$108,000

Departmental DataDepartmental DataDepartmental DataDepartmental Data

Belring, Inc.FabricationFabrication Assembly Assembly

Expected and actual usage (dlh):

Cordless 7,0003,000

Regular 13,000 77,000

20,00080,000

Expected and actual usage (mh.):

Cordless 4,0001,000

Regular 36,0009,000

40,00010,000

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Belring, Inc.Applied overhead

= ($6.30 x actual mh) + ($1.35 x actual dlh)

= ($6.30 x 40,000) + ($1.35 x 80,000)

= $360,000

= $252,000 + $108,000

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Belring, Inc.

Per-Unit Cost: Departmental RatesPer-Unit Cost: Departmental RatesPer-Unit Cost: Departmental RatesPer-Unit Cost: Departmental Rates

CordlessRegular

Prime 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 manufacturing costs $107,250$1,068,750

Units produced 10,000 100,000

Unit cost $ 10.73$ 10.69

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

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.

ContinuedContinuedContinuedContinued

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

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.

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.

Product diversity means that the products consume overhead activities

in systematically different proportions.

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

Prime costs $78,000 $738,000 $816,000

Direct labor hours 10,000 90,000 100,000

Machine hours 5,000 45,000 50,000

Production runs 20 10 30

Number of moves 60 30 90

Belring, Inc.

Activity Usage Measures

Activity Usage Measures

Product-Costing DataProduct-Costing Data

Cordless Regular Total

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Activity Activity Cost

Belring, Inc.

Setups $120,000

Material handling 60,000

Machining 100,000

Testing 80,000

Total $360,000

Overhead Activities

Product-Costing DataProduct-Costing Data

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Belring, Inc.Product Diversity: Consumption RatiosProduct Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular Activity

Activity Phone Phone Driver a a

b b

c c

d d

20/30 (cordless) and 10/30 (regular)a

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Belring, Inc.Product Diversity: Consumption RatiosProduct Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular Activity

Activity Phone Phone Driver a a

b b

c c

d d

60/90 (cordless) and 30/90 (regular)b

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Belring, Inc.Product Diversity: Consumption RatiosProduct Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular Activity

Activity Phone Phone Driver a a

b b

c c

d d

5,000/50,000 (cordless) and 45,000/50,000 (regular)c

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Belring, Inc.Product Diversity: Consumption RatiosProduct Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular Activity

Activity Phone Phone Driver a a

b b

c c

d d

10,000/100,000 (cordless) and 90,000/100,000 (regular)d

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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

Belring, Inc.Activity RatesActivity Rates

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Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

Setups 80,000 40,000

Material handling 40,000 20,000

Machining 10,000 90,000

Testing 8,000 72,000

Total manufacturing costs $216,000 $ 960,000

Units produced 10,000 100,000

Unit cost (total costs/units) $ 21.60 $ 9.60

Belring, Inc.Activity RatesActivity Rates

$4,000x

20

$4,000x

10$667

x60

$667x

30$2x

5,000

$2x

45,000$0.80

x10,000

$0.80x

90,000

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Plantwide rate $11.40 $10.62

Departmental rate 10.73 10.69

Activity rate 21.60 9.60

Comparison of Unit CostsComparison of Unit CostsComparison of Unit CostsComparison of Unit Costs

Cordless Regular

Belring, Inc.

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ABC: Two-Stage Assignment

Cost of ResourcesCost of Resources

Assign CostsAssign Costs

ActivitiesActivities

Assign CostsAssign Costs

ProductsProducts

Driver Tracing

Driver Tracing

Driver Tracing

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

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.

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.

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.

Examples: 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 ActivitiesClassification of ActivitiesClassification of Activities

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

Examples: Setups, inspections, production scheduling, and material handling.

Classification of ActivitiesClassification of ActivitiesClassification 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: Engineering changes, process engineering, and expediting.

Classification of ActivitiesClassification of ActivitiesClassification 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 ActivitiesClassification 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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Customer Costing versus

Product Costing

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Large Customer Ten Smaller Customers (50% of sales) (50% of sales)

Units purchased 500,000 500,000

Orders placed 2 200

Number of sales calls 10 210

Manufacturing cost $3,000,000 $3,000,000

Order-filling costsallocated $202,000 $202,000

Sales-force costsallocated $110,000 $110,000

ExampleExampleExampleExample

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The purchasing manager uses two suppliers, Murray Inc. and Plata Associates, as the source of

two machine parts: Part A1 and Part B2.

ExampleExampleExampleExample

Activity CostsRepairing products $800,000

Expending products 200,000

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ExampleExampleExampleExample

Murray Inc. Plata Associates

Part A 1 Part B2 Part A 1 Part B2Unit purchase price $20 $52 $24 $56

Units purchased 80,000 40,000 10,000 10,000

Failed units 1,600 380 10 10

Late shipments 60 40 0 0

Repair rate = $800,000 ÷ 2,000 = $400 per failed part

Expediting rate = $200,000 ÷ 100 = $2,000 per late delivery

60 + 40

(1,600 + 380 + 10 + 10)

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ExampleExampleExampleExample

Murray Inc. Plata Associates

Part A 1 Part B2 Part A 1 Part B2 Purchase cost $1,600,000 $2,080,000 $240,000 $560,000

Repairing products 640,000 152,000 4,000 4,000

Expediting products 120,000 80,000

Total costs $2,360,000 $2,312,000 $244,000 $564,000Units ÷ 80,000 ÷ 40,000 ÷ 10,000 ÷ 10,000

Total unit cost $ 29.50 $ 57.80 $ 24.40 $ 56.40

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The EndThe EndThe EndThe End

Chapter FourChapter Four

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