4 -1

Activity-Based

Costing

CHAPTER

4 -2

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.

Objectives

After studying this

chapter, you should

be able to:

continued

4 -3

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.

Objectives

4 -4

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--

4 -5

Product cost is often defined as the

sum of direct materials, direct labor,

and manufacturing overhead. This

definition is required for external

financial reporting.

4 -6

Cost measurement consists of

determining the dollar amounts of

direct materials, direct labor, and

overhead used in production.

4 -7

The process of associating

the costs, once measured,

with the units produced is

called cost assignment.

4 -8

Two possible measurement systems are

actual costing and normal costing.

Measurement 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.

4 -9

Measurement Systems

A predetermined

overhead rate is a rate

based on estimated data.

Budgeted (estimated) cost

Estimated activity usage

4 -10

Examples of Unit-Level Drivers

Units produced

Direct labor hours

Direct labor dollars

Machine-hours

Direct material dollars

4 -11

Units

(of

driver)

Time

Theoretical

Practical

Normal

Expected actual

4 -12

Functional-Based Costing: Plantwide Rate

Overhead Costs

Assign Costs

Plantwide Pool

Assign Costs

Products

Direct Tracing

Stage One: Pool Formation

Unit-Level Driver

Stage Two: Costs Assigned

4 -13

Belring, Inc.

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

.

Budgeted overhead $360,000

Expected activity (DLH) 100,000

Actual activity (DLH) 100,000

Actual 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 DLH

Predetermined Overhead Rate = $3.60 per DLH

4 -15

The total overhead assigned

to actual production is

called applied overhead.

Applied

overhead=

Overhead rate

x

Actual activity

output

4 -16

Belring, Inc.

Applied

overhead= Overhead rate x Actual activity output

= $3.60 x 100,000 DLH

= $360,000

4 -17

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 Cost

4 -18

Overhead Costs

Assign Costs

Assign Costs Assign Costs

Products Products

Stage One: Pool

Formation

Unit-Level Drivers

Stage Two: Costs

Assigned

Functional-Based Costing Department Rates

Department A Pool Department B Pool

Allocation

Direct TracingDriver Tracing

4 -19

Budgeted overhead $252,000 $108,000

Departmental Data

Belring, Inc.

Fabrication Assembly

Expected and actual usage (dlh):

Cordless 7,000 3,000

Regular 13,000 77,000

20,000 80,000

Expected and actual usage (mh.):

Cordless 4,000 1,000

Regular 36,000 9,000

40,000 10,000

4 -20

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

4 -21

Belring, Inc.

Per-Unit Cost: Departmental Rates

Cordless Regular

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

4 -22

Symptoms of an Outdated

Functional 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.

Continued

4 -23

Symptoms of an Outdated

Functional 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.

4 -24

Non-unit activity drivers are

factors that measure the

consumption of non-unit

activities by products and other

cost objects.

4 -25

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

Product-Costing Data

Cordless Regular Total

4 -27

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 Data

4 -28

Belring, Inc.

Product 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 Drivera a

b b

c c

d d

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

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Belring, Inc.

Product 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 Drivera a

b b

c c

d d

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

4 -30

Belring, Inc.

Product 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 Drivera a

b b

c c

d d

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

4 -31

Belring, Inc.

Product 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 Drivera a

b b

c c

d d

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

4 -32

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 Rates

4 -33

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 Rates

$4,000

x

20

$4,000

x

10$667

x

60

$667

x

30$2

x

5,000

$2

x

45,000$0.80

x

10,000

$0.80

x

90,000

4 -34

Plantwide rate $11.40 $10.62

Departmental rate 10.73 10.69

Activity rate 21.60 9.60

Comparison of Unit Costs

Cordless Regular

Belring, Inc.

4 -35

ABC: Two-Stage Assignment

Cost of Resources

Assign Costs

Activities

Assign Costs

Products

Driver

Tracing

Driver

Tracing

Driver

Tracing

4 -36

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.

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 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 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 Activities

4 -41

Facility-level activities are those that sustain a

factory's general manufacturing processes.

Examples: Plant management, landscaping,

maintenance, security, property

taxes, and plant depreciation.

Classification of Activities

4 -42

Driver

Filter

Driver

Filter

Driver

Filter

Unit Level Batch Level Product Level Facility Level

A1 A A A A2 3 4 5

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

Activit

y Level

Filter

4 -43

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 costs

allocated $202,000 $202,000

Sales-force costs

allocated $110,000 $110,000

Example

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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.

Example

Activity Costs

Repairing products $800,000

Expending products 200,000

4 -46

Example

Murray Inc. Plata Associates

Part A 1 Part B2 Part A 1 Part B2

Unit 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)

4 -47

Example

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 $564,000

Units ÷ 80,000 ÷ 40,000 ÷ 10,000 ÷ 10,000

Total unit cost $ 29.50 $ 57.80 $ 24.40 $ 56.40

4 -48

The End

Chapter Four

4 -49