Job-Order Costing System

Activity Based Costing: A Tool to Aid Decision Making

UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

Chapter

DirectMaterials

DirectLabor

Mfg.Overhead

Work-in-Process

FinishedGoods

Cost-ofGoods Sold

Cost Measurement

Cost Accumulation

Cost Assignment

Goal: Accurately costed products.

Actual Costing System

Normal Costing System

Standard Costing System

Measuring Costs

Actual DMActual DL

Actual MOH

Actual DMActual DL

Estimated MOH

Standard DMStandard DL

Standard MOH

Cost Accounting SystemsProduct Costs

Job-Order Costing Process Costing

Total/Unit Cost

Assigning Manufacturing Costs

Functional Based Costing

Activity Based Costing

Activity Based Costing (ABC)

ABC is designed to ABC is designed to provide managers provide managers

with cost information with cost information for strategic and for strategic and

other decisions that other decisions that potentially affect potentially affect

capacity and capacity and therefore “fixed” therefore “fixed”

costs.costs.

ABC is agood supplement to our traditional

cost systemI agree!

Overhead rates maybe based on activity

at capacity.

Activity Based Costing (ABC)

Both manufacturingand nonmanufacturing

costs may be assigned toproducts.

Some manufacturingcosts may be excluded

from productcosts.

A numberof cost pools each

allocated to a productor cost object.

Allocation bases oftendiffer from

traditional costingsystems.

How Costs are Treated Under Activity-Based Costing

Level of C

omplexity

Overhead Allocation

Plantwide Overhead

Rate

DepartmentalOverhead

Rates

Activity BasedCosting

Functional Based (Traditional) Costing

Department1

Department2

Department3Cost poolsCost pools

IndirectLabor

IndirectMaterials

OtherOverhead

Stage One:Stage One:Costs assignedCosts assignedto poolsto pools

Departmental Overhead Rates

Products Products

Stage Two:Stage Two:Costs appliedCosts appliedto productsto products

Departmental Allocation BasesDepartmental Allocation Bases

Direct Labor Hours

MachineHours

RawMaterials

Cost

Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.

Resources

Functions

Products

EfficiencyAnalysis

Performance Analysis

Functional-Based Management Model

Cost View

Operational View

The problem with this approach is that individual products, services, etc., may use those resources in a nonuniform way.

The end result is that some products will be overcosted while others will be undercosted.

Refining a Cost System

Reclassify indirect costs as direct costs.

Define more cost pools.

Identify cost drivers.

Use Activity-Based Costing.

Resources

Activities

Products & Customers

Driver Analysis

Performance Analysis

Activity-Based Management Model

Cost View

Operational View

Designing an ABC System

Cost ObjectsCost Objects(e.g., products(e.g., productsand customers)and customers)

ActivitiesActivities

ConsumptionConsumptionof Resourcesof Resources

CostCost

Designing an ABC System

1. Identify and define activities and activity cost pools.

2. Whenever possible, directly trace costs to activities and cost objects.

3. Assign costs to activity cost pools.

4. Calculate activity rates.

Designing an ABC System

5. Assign costs to cost objects using the activity rates and activity measures.

6. Prepare management reports.

Identify and Define Activities and Activity Cost Pools

Step #1:Identify and Define Activities and Activity Cost Pools

An Activity Cost Activity Cost PoolPool is a “bucket” in

which costs are accumulated that relate to a single

activity measure in the ABC system.

$

$$ $

$$

Activity Levels (Step #1)

Activity Levels

Product Level

Customer Level

UnitLevel

BatchLevel

Organization-Sustaining Level

At Classic Brass, the ABC team, selected the following activity cost pools and activity

measures:

Activity Cost Pool Activity MeasureCustomer orders Number of customer ordersProduct design Number of product designsOrder size Machine-hoursCustomer relations Number of active customersOther Not applicable

Activity Cost Pools at Classic Brass

Step #1: Identify and Define Activities and Activity Cost PoolsStep #1 For Classic Brass

Step #1:Identify and Define Activities and Activity Cost Pools

Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders.

Product Designs - assigned all costs of resources consumed by designing products.

Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.

Step #1:Identify and Define Activities and Activity Cost Pools

Customer Relations – assigned all costs associated with maintaining relations with customers.

Other – assigned all overhead costs that are not associated with the other cost pools.

Whenever Possible, Directly Trace Overhead Costs to Activities and Cost Objects.

The overhead costs at Classic Brass

Exhibit 8-2

Assign Costs to Activity Cost Pools

The overhead costs at Classic Brass

Exhibit 8-2

Assign Costs to Activity Cost Pools

Customer Orders

Product Design

Order Size

Customer Relations Other Total

Production DepartmentIndirect factory wages 25% 40% 20% 10% 5% 100%Factory equipment depreciation 20% 0% 60% 0% 20% 100%Factory utilities 0% 10% 50% 0% 40% 100%Factory building lease 0% 0% 0% 0% 100% 100%

Shipping costs **General Administrative Department

Administrative wages and salaries 15% 5% 10% 30% 40% 100%Office equipment depreciation 30% 0% 0% 25% 45% 100%Administrative building lease 0% 0% 0% 0% 100% 100%

Marketing DepartmentMarketing wages and salaries 20% 10% 0% 60% 10% 100%Selling expenses 10% 0% 0% 70% 20% 100%

Activity Cost Pools

At Classic Brass the following distribution of resource consumption across activity cost pools is determined.

**Not included because they are directly traced to customer orders.

Customer Orders

Product Design

Order Size

Customer Relations Other Total

Production DepartmentIndirect factory wages 125,000$ Factory equipment depreciationFactory utilitiesFactory building lease

General Administrative DepartmentAdministrative wages and salariesOffice equipment depreciationAdministrative building lease

Marketing DepartmentMarketing wages and salariesSelling expenses

Total

Activity Cost Pools

Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%

$125,000$125,000

Production DepartmentIndirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

Shipping costs traced to customer orders 40,000 General Administrative Department

Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000

Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000

Total overhead costs 1,850,000$

Overhead Costs at Classic Brass(Manufacturing and NonManufacturing)

Assign Costs to Activity Cost Pools

Customer Orders

Product Design

Order Size

Customer Relations Other Total

Production DepartmentIndirect factory wages 125,000$ Factory equipment depreciation 60,000 Factory utilitiesFactory building lease

General Administrative DepartmentAdministrative wages and salariesOffice equipment depreciationAdministrative building lease

Marketing DepartmentMarketing wages and salariesSelling expenses

Total

Activity Cost PoolsProduction Department

Indirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

Shipping costs traced to customer orders 40,000 General Administrative Department

Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000

Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000

Total overhead costs 1,850,000$

Overhead Costs at Classic Brass(Manufacturing and NonManufacturing)

Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%

$ 60,000$ 60,000

Assign Costs to Activity Cost Pools

Customer Orders

Product Design

Order Size

Customer Relations Other Total

Production DepartmentIndirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$ Factory equipment depreciation 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000 Factory building lease - - - - 80,000 80,000

General Administrative DepartmentAdministrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment depreciation 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000

Marketing DepartmentMarketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000

Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$

Activity Cost Pools

Assign Costs to Activity Cost Pools

Calculate the Activity Rates

At Classic Brass, the ABC team, selected the following activity cost pools and activity

measures:

Activity Cost Pool Activity MeasureCustomer orders Number of customer ordersProduct design Number of product designsOrder size Machine-hoursCustomer relations Number of active customersOther Not applicable

Activity Cost Pools at Classic Brass

Step #1: Identify and Define Activities and Activity Cost Pools

Activity Cost Pools For Classic Brass

Calculate Activity Rates

The ABC team determines that Classic Brass will have these total activities for each activity cost pool

. . . 1,000 customer orders1,000 customer orders 200 new designs200 new designs 20,000 machine-hours20,000 machine-hours 100 customer relations activities100 customer relations activities

Now the team can compute the individual activity rates by dividing the total cost for

each activity by the total activity levels.

Calculate Activity Rates

(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable

Computation of Activity Rates÷

Traced Traced Traced

DirectMaterials

DirectLabor

ShippingCosts Overhead Costs

Cost Objects:Products, Customer Orders, Customers

Activity-Based Costing at Classic Brass

DirectMaterials

DirectLabor

ShippingCosts Overhead Costs

Cost Objects:Products, Customer Orders, Customers

Activity-Based Costing at Classic Brass

OrderOrderSizeSize

CustomerCustomerOrdersOrders

ProductProductDesignDesign

CustomerCustomerRelationsRelations OtherOther

First-Stage Allocation

Activity-Based Costing at Classic Brass

DirectMaterials

DirectLabor

ShippingCosts Overhead Costs

Cost Objects:Products, Customer Orders, Customers

Activity-Based Costing at Classic Brass

OrderOrderSizeSize

CustomerCustomerOrdersOrders

ProductProductDesignDesign

CustomerCustomerRelationsRelations OtherOther

First-Stage Allocation

Second-Stage Allocations

$/MH $/Order $/Design $/Customer

Unallocated

Assign Costs to Cost Objects

Assigning Costs to Cost Objects

Let’s take a look at how our system works for just one customer – Windward Yachts.

Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.3. Selling price is $34 each.4. Direct materials total $2,110.4. Direct materials total $2,110.5. Direct labor totals $1,850.5. Direct labor totals $1,850.6. Shipping costs total $180.6. Shipping costs total $180.

Custom Compass Housing (requires new design)1. One order during the year.1. One order during the year.2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .3. Selling price is $650 each.3. Selling price is $650 each.4. Direct materials total $13.4. Direct materials total $13.5. Direct labor totals $50.5. Direct labor totals $50.6. Shipping costs total $25.6. Shipping costs total $25.

Standard Stanchions (no design required)1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .3. Selling price is $34 each.3. Selling price is $34 each.4. Direct materials total $2,110.4. Direct materials total $2,110.5. Direct labor totals $1,850.5. Direct labor totals $1,850.6. Shipping costs total $180.6. Shipping costs total $180.

(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable

Computation of Activity Rates

(a) (b) (a) (b)Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 315,000$ 1,000 orders $315 per orderProduct design 257,000 200 designs $1,285 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 100 customer $3,675 per customerOther 490,500 Not applicable Not applicable

Computation of Activity Rates

Custom Compass Housing (requires new design)1. One order during the year.1. One order during the year.2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .3. Selling price is $650 each.3. Selling price is $650 each.4. Direct materials total $13.4. Direct materials total $13.5. Direct labor totals $50.5. Direct labor totals $50.6. Shipping costs total $25.6. Shipping costs total $25.

Prepare Management Reports

Product MarginsStandard

StanchionsCompass Housing

Sales 13,600$ 650$ Costs

Direct materials (2,110) (13) Direct labor (1,850) (50) Manufacturing overhead (10,000) (200)

Product margin (360)$ 387$

Traditional Traditional Cost Accounting SystemCost Accounting System

Predetermined manufacturingoverhead rate

$1,000,000 20,000 MH = $50/MH=

400 units x 0.5 MH/unit x $50/MH = $10,000400 units x 0.5 MH/unit x $50/MH = $10,000