ABC Costing 03

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Activity Based Costing:A Tool to Aid Decision Making



© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill

Activity Based Costing (ABC)

The objective of activity-basedcosting is tounderstand

overhead and theprofitability of

products andcustomers.

ABC is agood supplementto our traditional

cost system I agree!




Ov erhead rates maybe based on acti v ity

at capacity.

Activity Based Costing (ABC)

Acti v ity-Based Costing

Both manufacturingand nonmanufacturing

costs may beassigned toproducts.

Some manufacturingcosts may be excluded

from product

costs.

There are a number of cost pools each of

which is allocatedusing a unique

measure of acti v ity.

Allocation bases oftendiffer from

traditional costingsystems.




H ow Costs are Treated UnderActivity-Based Costing

Overhead Allocation

P lantwideOv erhead

Rate

DepartmentalOv erhead

Rates

Acti v ity BasedCosting




P lantwide Overhead Rate

C ompanies tend to use direct labor direct labor as the overhead allocation base.




A two stage process isnecessary because costs

are allocated to departmentsand then to products.

F inishing Department

Shipping Department

Painting Department

Departmental Overhead Rates




Department1

Department2

Department3

C ost poolsC ost pools

IndirectLabor

IndirectMaterials

O ther Ov erhead

Stage One:Stage One:C osts assignedC osts assignedto poolsto pools





Department1

Department2

Department3



P roducts

Stage Two:Stage Two:C osts appliedC osts appliedto productsto products


IndirectLabor

IndirectMaterials

O ther Ov erhead




Department1

Department2

Department3



P roducts

Stage Two:Stage Two:C osts appliedC osts appliedto productsto products

Direct

Labor Hours

Machine

Hours

Raw

MaterialsC ost

Departmental Allocation Bases


IndirectLabor

IndirectMaterials

O ther Ov erhead




Designing an ABC System

Cost O bjects(e.g., products

and customers)Acti v ities

Consumptionof Resources

Cost




Designing an ABC System

Steps for Implementing AB CSteps for Implementing AB C

Identify and define activities and activity pools.Where possible, trace costs to activities and costobjects.

Assign costs to activity cost pools.C alculate activity rates.

Assign costs to cost objects.Prepare management reports.




I dentifying Activity to I nclude

A part of the productionA part of the productionprocess for which managementprocess for which management

wants a separate reporting of thewants a separate reporting of thecosts of the acti v ity in v ol v ed.costs of the acti v ity in v ol v ed.

Unit-Le v elActi v ity

Batch-Le v elActi v ity

P roduct-Le v elActi v ity

Customer-Le v elActi v ityO rganization-

sustaining

Acti v ity




I dentifying Activity to I nclude

Acti v ity Cost P oolActi v ity Cost P oolis a ³bucket´ in

which costs areaccumulated thatrelate to a single

activity in the AB C system.

$

$

$ $

$$




The Mechanics of ABC

At Classic Brass, the ultimate cost objects are:P roducts,Customer orders, andCustomers.

O ne o v erhead cost - shipping - can be traceddirectly to customer orders.

The company¶s o v erhead costs are shown onthe next slide.




Produc t on Depar t en tndirec t f ac tory wages 500,000$Fac tory equipmen t deprecia tion 300,000 Fac tory u tilities 120,000 Fac tory building lease 80,000 1,000,000$

Shipping cos ts traced to cus tomer orders 40,000 General Adminis tra tive Depar tmen tAdminis tra tive wages and salaries 400,000 Off ice equipmen t deprecia tion 50,000 Adminis tra tive building lease 60,000 510,000

Marke ting Depar tmen tMarke ting wages and salaries 250,000 Selling expenses 50,000 300,000

To tal overhead cos ts 1,850,000$

Overhead Cos ts a t Classic Brass(Manu f ac turing and NonManu f ac turing )




Activity-Based Costing at Classic Brass

DirectMaterials

DirectLabor

ShippingC osts Overhead C osts

Traced $/ DLH Traced

Cost O bjects:P roducts, Customer O rders, Customers





DirectMaterials

DirectLabor

ShippingC osts

Order Size

C ustomer Orders

ProductDesign

C ustomer Relations

Other

Overhead C osts


F irst-Stage Allocation





DirectMaterials

DirectLabor

ShippingC osts


Order Size

C ustomer Orders

ProductDesign

C ustomer Relations

Other

Overhead C osts

F irst-Stage Allocation

Second-Stage Allocations

$/ MH $/ O rder $/ Design $/ Customer

Unallocated




Assigning Costs to Activity Cost P ools

Customer Orders

ProductDesign

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 traced to customer order N/AGeneral 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

Management at C lassic Brass believes overhead should bedistributed as follows:




Customer Orders

ProductDesign

Order Size


Production DepartmentIndirect factory wages 125,000$

Factory equipment depreciationFactory utilitiesFactory building lease

General Administrative DepartmentAdministrative wages and salariesOffice equipment depreciationAdministrative building lease

Marketing Department

Marketing wages and salariesSelling expenses

Total

Activity Cost Pools


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

$125,000

Using the total costs and percentage consumption of overhead, costs are assigned to activity pools.




Customer Orders

ProductDesign

Order Size


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 wages and salariesSelling expenses

Total

Activity Cost Pools


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

$ 60,000

Using the total costs and percentage consumption of overhead, costs are assigned to activity pools.




Customer Orders

ProductDesign

Order Size


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 00,000 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 wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 5,000 10,000 50,000

Total 15,000$ 257,000$ 80,000$ 67,500$ 490,500$ 1,810,000$

Activity Cost Pools

Assigning Costs to Activity Cost P oolsU

sing the total costs and percentage consumption of overhead, costs are assigned to activity pools.




Computation of Activity Rates

The AB C team has determined that C lassicBrass has the following total activities for each

activity cost pool . . .1,000 customer orders,200 new designs,20,000 machine-hours100 customers.

N ow the team can compute the individualN ow the team can compute the individualactivity rates.activity rates.








Difference Between ABC andTraditional P roduct Costs

AB C will ordinarily shiftbatch-level and

product-level

overhead costs fromhigh-volume

products produced inlarge batches to low-

volume productsproduced in small

batches.




Difference Between ABC andTraditional P roduct Costs

U nder AB C bothmanufacturing andnonmanufacturing

costs may beassigned to products.

Organization-sustaining costs and

the costs of idlecapacity are not

assigned to products.




E ase of Adjustment

Costs that adjust automatically to changes in acti v ity:Direct materials.Shipping.

Costs that could be adjusted to changes in acti v ity:Direct labor.

actory utilities.Administrati v e wages and salaries.O ffice equipment depreciation.Marketing wages and salaries.

Selling expenses.Costs that are difficult to adjust to changes in acti v ity:

actory equipment depreciation.actory building lease.

Administrati v e building lease.

Documents

ABC Costing 03