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Copyright

2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 5

Activity-BasedCosting and

Management

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Copyright


LearningObjective

1

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Traditional, Volume-BasedProduct-Costing System

1-3

Aerotech produces three complex printed circuitboards referred to as Mode I, Mode II, and ModeIII.

The following information is obtained fromcompany records:

Mode I Mode II Mode II I

Production:

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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1-4

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 2Setup time (hr/run) 10 10 10

Machine time (hr/board) 1 1.25 2

Mode I Mode I I Mode I I I

Direct materials 50.00$ 90.00$ 20.00$Direct labor 60.00 80.00 40.00

Manufacturing overhead 99.00 132.00 66.00Total 209.00$ 302.00$ 126.00$

Manufacturing overhead is determined as follows

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1-5

Mode I Mode II Mode I II

Units produced 10,000 20,000 4,000

Direct labor (hr/unit) 3 4 2

Total hours 30,000 80,000 8,000

Total hours required 118,000

Budgeted manufacturing overhead $3,894,000

Budgeted direct-labor hours 118,000

= $33 per hour

Mode I Mode I I Mode I II

Direct labor (hr/unit) 3 4 2

Overhead rate per hour 33$ 33$ 33$

Overhead per unit 99$ 132$ 66$

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1-6

With these product costs, Aerotech establishedtarget selling prices (Cost125%).

Mode I Mode I I Mode I I I


Direct labor 60.00 80.00 40.00

Manufacturing overhead 99.00 132.00 66.00

Total 209.00$ 302.00$ 126.00$

Mode I Mode II Mode II I

Cost per unit 209.00$ 302.00$ 126.00$

Target selling price 261.25 377.50 157.50

209.00 x 1.25

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LearningObjective

2

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Activity Based Costing System(ABC)

1-8

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

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

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

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LearningObjective

3

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Overhead CostsTotal budgeted cost = $3,894,000

ActivityCostPools

Machinerycost pool

$1,212,600

Setupcost pool$3,000

Engineeringcost pool$700,000

Facilitycost pool$507,400

Unit

Level

Batch

Level

Product-

Sustaining

Level

Facility

Level

Identificationof Activity

Cost Pools

Activitymust be

done oneach unitproduced.

Activityperformedon each

batchproduced.

Activities needed to supportan entire product line

Activity required in orderfor the productionprocess to occur.

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Receiving/Inspectioncost pool $200,000

Material-Handlingcost pool $600,000

Quality-Assurancecost pool $421,000

Packaging/Shippingcost pool $250,000

Machinery

cost pool$1,212,600

Setup

cost pool$3,000

Engineering

cost pool$700,000

Facility

cost pool$507,400

Unit

Level

Batch

Level

Product-

Sustaining

Level

Facility

Level

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LearningObjectives

3 & 4

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STAGE ONE

1-13

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

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

Activitycostpool

Various overheadcosts relatedto machinery

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STAGE TWO

1-14

Calculatethe pool

rate

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

$28.20/hour

CostAssignment

==

Mode I:

$28.20 per hr.

1 hr. per unit

$28.20 per unit

Mode II:

$28.20 per hr.

1.25 hr. per unit

$35.25 per unit

Mode III:

$28.20 per hr.

2 hr. per unit

$56.40 per unit

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STAGE ONE

1-15

Calculation oftotal setup cost

Setup Cost PoolTotal budgeted cost = $3,000

Activitycostpool

Total budgeted setup cost

$20 per hour

10 hr. per setup

$200 cost per setup

15 production runs3,000$ Total

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STAGE TWO

1-16

Calculatethe pool

rate

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

$200 per run

CostAssignment

=

=

Mode I: (1 Run)

= $.02 per unit

$200 per run

10,000 units per run

Mode II: (4 Runs)

= $.04 per unit

$200 per run

5,000 units per run

Mode III: (10 Runs)

= $.50 per unit

$200 per run

400 units per run

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STAGE ONE

1-17

Various overheadcosts related

to engineering

Engineering salaries

Engineering supplies

Engineering software

Depreciation

Engineering Cost PoolTotal budgeted cost = $700,000

Activitycostpool

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STAGE TWO

1-18

Allocate basedon engineering

transactions

CostAssignment

Engineering Cost PoolTotal budgeted cost = $700,000

Mode I:

= $17.50 per unit

25% $700,000

10,000 units

Mode II:

= $15.75 per unit

45% $700,000

20,000 units

Mode III:

= $52.50 per unit

30% $700,000

4,000 units

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STAGE ONE

1-19

Various overheadcosts related

to generaloperations

Plant depr.

Plant mgmt.

Plant maint.

Property taxes

Insurance

Security

Facility Cost PoolTotal budgeted cost = $507,400

Activitycostpool

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STAGE TWO

1-20

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

$4.30/hour

CostAssignment

=

=

Mode I:

$4.30 per hr.

3 hr. per unit

$12.90 per unit

Mode II:

$4.30 per hr.

4 hr. per unit

$17.20 per unit

Mode III:

$4.30 per hr.

2 hr. per unit

$8.60 per unit

Calculatethe pool

rate

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Other Overhead Costs

1-21

Board Ove rh e ad % Un its = Cos t/Un it

Mode 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 Inspect ion Cost Pool


Mode I 600,000$ 7% 10,000 = 4.20$

Mode II 600,000 30% 20,000 = 9.00

Mode III 600,000 63% 4,000 = 94.50

Material-Handling Cos t P ool


Mode I 421,000$ 20% 10,000 = 8.42$

Mode II 421,000 40% 20,000 = 8.42Mode III 421,000 40% 4,000 = 42.10

Quality-Assu rance Cost P ool


Mode I 250,000$ 4% 10,000 = 1.00$

Mode II 250,000 30% 20,000 = 3.75

Mode III 250,000 66% 4,000 = 41.25

Packaging and Sh ipping Cost Pool

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Other Overhead Costs

1-22


Mode I 250,000$ 4% 10,000 = 1.00$

Mode II 250,000 30% 20,000 = 3.75

Mode III 250,000 66% 4,000 = 41.25

Packaging and Sh ipping Cost Pool


Mode I 421,000$ 20% 10,000 = 8.42$

Mode II 421,000 40% 20,000 = 8.42Mode III 421,000 40% 4,000 = 42.10

Quality-Assu rance Cost P ool


Mode 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 Inspect ion Cost Pool


Mode I 600,000$ 7% 10,000 = 4.20$

Mode II 600,000 30% 20,000 = 9.00

Mode III 600,000 63% 4,000 = 94.50

Material-Handling Cos t P ool

$14.82

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Product Cost from ABC

1-23

These are the new product costs when Aerotechuses ABC.Mode I Mode II Mode III


Direct labor 60.00 80.00 40.00

Machinery 28.20 35.25 56.40

Setup 0.02 0.04 0.50

Engineering 17.50 15.75 52.50Facilities 12.90 17.20 8.60

Other 14.82 23.57 212.85

Total 183.44$ 261.81$ 390.85$

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Copyright


Learning

Objective5

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Distorted Product Costs

1-25

Both original and ABC target selling prices are basedon (Cost125%).

Mode I Mode II Mode III

Tradition al cos tin g 209.00$ 302.00$ 126.00$

ABC cos tin g 183.44 261.81 390.85

Origin al targe t s e llin g price 261.25 377.50 157.50

ABC targe t s e llin g price 229.30 327.26 488.56

[$209.001.25] [$183.44 1.25]

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

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Distorted Product Costs

1-26

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

Mode I Mode II Mode III

Tradition al cos tin g 209.00$ 302.00$ 126.00$ABC cos tin g 183.44 261.81 390.85

Cos t dis tortion pe r u n it 25.56 40.19 (264.85)

Un its produ ce d 10,000 20,000 4,000

Total cos t dis tortion 255,600 803,800 (1,059,400)

Traditional costing understates the costof complex, low volume products.

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Two Key Points

1-27

A large propor t ion of non -

un it- level activ i t ies

A unit-level cost driver,

such as direct labor,machine hours, orthroughput, will not beable to assign the costsof non-unit-level activities

accurately.

Product d ivers i ty

When the

consumption ratiosdiffer widely betweenactivities, no singlecost driver will

accurately assign theresulting overheadcosts.

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Learning

Objective6

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Cost Drivers

1-29

A characteristic of an event or activity that resultsin the incurrence of costs. In selecting a cost

driver, we must consider . . .

Degree ofCorrelation

Cost ofMeasurement

BehavioralEffects

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Learning

Objective7

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COLLECTING ABC DATA

1-31

INTERVIEWS AND PAPER TRAILS - The informationfor ABC systems initially comes from interviews withemployees in the support departments and a review of eachdepartments records.

STORYBOARDING -A procedure used to develop adetailed process flow chart, which visually represents activitiesand the relationships among activities.

MULTIDISCIPLINARY ABC PROJECT TEAMSTo

gather information from all facets of an organizationsoperations, it is essential to involve personnel from a variety offunctional areas. A typical ABC project team includesACCOUNTING, FINANCE, PRODUCTION, OPERATIONS,ENGINEERS, MARKETINGetc.

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Learning

Objective8

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Activity-Based Management

1-33

The use ofABC costing

informationto help

managementmake decisions

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Activity-Based Management

1-34

Activity-based costingestablishes relationshipsbetween overhead costs and activities so that

we can better allocate overhead costs.

Activity-based managementfocuseson managing activities to reduce costs.

T Di i l ABC d

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Two-Dimensional ABC andActivity-Based Management

1-35

Activities

T Di i l ABC d

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1-36

Cost Objects

Activities

Resource costs

Cost Assignment View

T Di i l ABC d

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1-37

Activity

Triggers

Cost Objects

Activities

Root

Causes

Process ViewActivity Analysis

Resource costs

Cost Assignment View

Performance

Measures

Activity Evaluation

Eli i ti f N V l Add d

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Elimination of Non-Value-AddedCosts

1-38

Nonvalue-added

activities

NecessaryUnnecessary

Activities

Reduce orEliminate

Continually Evaluateand Improve

U i ABM t Eli i t N

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Using ABM to Eliminate Non-Value-Added Activities and Costs

1-39

1. Identify Activities.

2. Identify Non-Value-Added Activities.

3. Understand Activity Linkages, Root Causes,

and Triggers.

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

Specifyparts

Selectvendor

Receiveparts

Producegoods

Inspectfinishedgoods

Reworkdefectiveproducts

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Using ABM to Eliminate Non-Value-Added Activities and Costs

1-40

Inspection time

Process time

Storage time

Move time Waiting time

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Learning

Objective9

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1-42

Customer Profitability Analysis

Customer profitability analysis usesactivity-based costing to determine

the activities, costs, and profit associated

with serving particular customers.

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1-43


Orderssmall

quantities.

Orders

frequently.

Oftenchanges

orders.

Requiredspecial

packaging.

Demandfast

service.

costly customer

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1-44


Customer-Related Activities Cost Driver Base

Cost Drive

Rate

Order processing Purchase orders 150$

Sales contacts (phone calls, faxes, etc.) Contacts 100

Sales visits Visits 1,000

Shipment processing Shipments 200

Billing and collection Invoices 160Design/engineering change orders Design changes 4,000

Special packaging Units packaged 40

Special handling Units handled 60

A company may use these customerrelated costs to help determine the

profitability of each customer.

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1-45


Customer Profitability

0.0%

25.0%

50.0%

75.0%

100.0%

125.0%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20CumulativeOperatingIncome

asa%ofTotal

OperatingIncome

75% of actual operating income



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Learning

Objective10

Acti it Based Management in the

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1-47

Activity-Based Management in theService Industry

ActivityAnalysis

CustomerProfitability

Analysis

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Learning

Objective11

Just in Time Inventory and

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Just-in-Time Inventory andProduction Management

1-49

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

The primary goal of aJIT production system is

to reduce or eliminate

inventories at everystage of production.

Key Features of the JIT

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Key Features of the JITApproach

1-50

Smooth, uniform production rate

Pull method of production

Purchase is small lot sizes

Quick, inexpensive setups

High quality materials

Effective preventive maintenanceTeamwork

Multiskilled workers

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JIT Purchasing

1-51

Long-termcontracts with

suppliers.

Only a fewsuppliers.

Parts deliveredin small lots.

Minimalinspection of

materials.

Groupedpayments to

vendor.

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End of Chapter 5This is

my kind of costpool!

chapter 05 n

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