Activity-Based Costing: A Tool to Aid Decision Making

Activity–Based Costing (ABC)
ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect “fixed” as well as variable costs.
ABC is a good supplement to our traditional cost system

I agree!

Learning Objective 1

Understand activitybased costing and how it differs from a traditional costing system.

. Manufacturing costs Nonmanufacturing costs Traditional product costing ABC product costing  ABC assigns both types of costs to products.How Costs are Treated Under Activity–Based Costing ABC ABC differs differs from from traditional traditional cost cost accounting accounting in in three three ways. ways.

How Costs are Treated Under Activity–Based Costing ABC ABC differs differs from from traditional traditional cost cost accounting accounting in in three three ways. ways. not but all Nonmanufacturing costs Some ABC product costing Traditional product costing  ABC does not assign all manufacturing costs to products. Manufacturing costs Mo st. All .

Level of complexity Activity–Based Activity–Based Costing Costing Departmental Departmental Overhead Overhead Rates Rates Plantwide Plantwide Overhead Overhead Rate Rate Number of cost pools  ABC uses more cost pools. .How Costs are Treated Under Activity–Based Costing ABC ABC differs differs from from traditional traditional cost cost accounting accounting in in three three ways. ways.

How Costs are Treated Under Activity–Based Costing ABC ABC differs differs from from traditional traditional cost cost accounting accounting in in three three ways.  ABC uses more cost pools. . Traditional Traditional cost systems usually usually rely rely cost systems on volume measures measures such such as as direct direct labor labor on volume hours hours and/or and/or machine machine hours hours to to allocate allocate all all overhead overhead costs costs to to products. activity. ways. Each Each ABC ABC cost cost pool has has its own own unique unique measure measure of of activity. products.

Activity Cost Pool $$ $ $ $ $ .How Costs are Treated Under Activity–Based Costing Activity An event that causes the consumption of overhead resources. A “cost bucket” in which costs related to a single activity measure are accumulated.

.How Costs are Treated Under Activity–Based Costing Activity Measure An allocation base in an activity-based costing system. The term cost driver is also used to refer to an activity measure.

Duration driver A measure of the amount of time needed for an activity. .How Costs are Treated Under Activity–Based Costing Two common types of activity measures: Transaction driver Simple count of the number of times an activity occurs.

How Costs are Treated Under Activity–Based Costing ABC defines five levels of activity that largely do not relate to the volume of units produced. products. Traditional Traditional cost cost systems systems usually usually rely rely on on volume volume measures measures such such as as direct direct labor labor hours hours and/or and/or machine machine hours hours to to allocate allocate all all overhead overhead costs costs to to products. .

How Costs are Treated Under Activity–Based Costing Unit-Level Activity Batch-Level Activity Manufacturing companies typically combine their activities into five classifications. Product-Level Activity Customer-Level Activity Organizationsustaining Activity .

Characteristics of Successful ABC Implementations Strong Strong top top management support Link to evaluations and and rewards Cross-functional involvement involvement .

000 41.000.000.000.000 $ 15.Baxter Battery – An ABC Example Baxter Battery Company Income Statement Year Ended December 31.000 14. 2009 Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Gross margin Selling and administrative expenses Shipping expenses Marketing expenses General administrative expenses Net operating income loss $ 50.000.000.000 2.000.000.000) Manufacturing Manufacturing overhead overhead is is allocated allocated to to products products using using a a single single plantwide plantwide overhead overhead rate rate based based on on machine machine hours.000 9.000 6.000 3.000.000. .000 12.000 $ (2.000 11.000. hours.000.

Activity Cost Pools. Define Activities. the ABC team. Battery. and Activity Measures At Baxter Battery. selected the following activity cost pools and activity measures: Activity Cost Pools at Baxter Battery Activity Cost Pool Customer orders Design changes Order size Customer relations Other Activity Measure Number of customer orders Number of design changes Machine-hours Number of active customers Not applicable .

  Order Order Size Size .assigned assigned all all costs costs of of resources resources that that are are consumed consumed by by taking taking and and processing processing customer customer orders. and Activity Measures Customer Customer Orders Orders .assigned assigned all all costs costs of of resources resources consumed consumed as as a a consequence consequence of of the the number number of of units units produced. customers.assigned assigned all all costs costs of of resources resources consumed consumed by by customer customer requested requested design design changes. Define Activities.   Design Design Changes Changes .   Customer Customer Relations Relations – – assigned assigned all all costs costs associated associated with with maintaining maintaining relations relations with with customers. produced. orders.   Other Other – – assigned assigned all all organization-sustaining organization-sustaining costs costs and and unused unused capacity capacity costs costs   . Activity Cost Pools. changes.

.Learning Objective 2 Assign costs to cost pools using a firststage allocation.

000.000.000.500. Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6.000 Marketing Department Marketing wages and salaries 1.000 $ General Administrative Department Administrative wages and salaries 4.000 Factory building lease 2.000 Factory utilities 2.000 2.000.000 Total overhead costs $ 14.000 22.000 .000 6.500.100.000.000 Administrative building lease 1.500.000.000 Factory equipment depreciation 3.000 Selling expenses 500.000 Office equipment depreciation 900.000.

000 Administrative building lease 1.000.000.000 General Administrative Department Administrative wages and salaries 4. Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6.000 Factory utilities 2.000.000 Factory equipment depreciation 3.000are excluded 2.000 Office equipment depreciation 900. .000 $ 14.000 6. and shipping Selling expenses 500.000.000 Factory building lease 2. direct labor.100.000 Marketing Department Marketing wages and salaries 1.500.000 because Baxter Battery’s existing cost system$can directly Total overhead costs 22.000.000 Direct materials.000 trace these costs to products or customer orders.000.500.500.000.

Activity Cost Pools Customer Design Orders Changes Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses 30% 20% 0% 0% 30% 30% 0% 30% 20% 30% 10% 10% 0% 10% 10% 0% 10% 0% Order Size 20% 60% 60% 0% 10% 0% 0% 0% 0% Customer Relations 10% 0% 0% 0% 30% 20% 0% 50% 70% Other 10% 10% 30% 100% 20% 40% 100% 10% 10% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% . Assign Overhead Costs to Activity Cost Pools At Baxter Battery the following distribution of resource consumption across activity cost pools is determined.

500.000 Marketing Department Marketing wages and salaries 1.000 General Administrative Department Administrative wages and salaries 4.000 Selling expenses 500.000 $1.000.000 Office equipment depreciation 900.000.100.000.000 $ 1.500.000 Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total 6.800.000 Total overhead costs $ Total 14.000 22.000 Administrative building lease 1.000 Indirect $6.000.000 2.000.000.800.000 Percent 30% Percent consumed consumed by by customer customer orders orders 30% $1.000 Customer Design Customer Factory utilities 2.000.800.000 Activity Cost Pools Factory equipment depreciation 3.000 Orders changes Order Size Relations Other $ Factory building lease 2.000.500.000.000 . Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6.000 Indirect factory factory wages wages $6.

000 Administrative building lease 1.000 Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total 6.000.500.500.000 Factory $3.000 General Administrative Department Administrative wages and salaries 4.000.000.000 Percent 20% Percent consumed consumed by by customer customer orders orders 20% $ $ 700.500.000 700.000 .000. Assign Overhead Costs to Activity Cost Pools Overhead Costs at Baxter Battery (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 6.500.000.000 Customer Design Customer Factory utilities 2.000 700.000 Activity Cost Pools Factory equipment depreciation 3.500.000 Office equipment depreciation 900.000 22.000 Total overhead costs $ Total 14.100.000 Selling expenses 500.800.000 Orders changes Order Size Relations Other $ Factory building lease 2.000.000.000 $ 1.000 Factory equipment equipment depreciation depreciation $3.000 2.000 Marketing Department Marketing wages and salaries 1.

 Assign Overhead Costs to Activity Cost Pools
Activity Cost Pools Design changes Order Size 1,800,000 $ 350,000 250,000 400,000 90,000 150,000 3,040,000 $ 1,200,000 $ 2,100,000 1,500,000 400,000 5,200,000 $

Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $

Customer Relations 600,000 $ 1,200,000 180,000 750,000 350,000 3,080,000 $

Other 600,000 $ 350,000 750,000 2,000,000 800,000 360,000 1,100,000 150,000 50,000 6,160,000 $

Total 6,000,000 3,500,000 2,500,000 2,000,000 4,000,000 900,000 1,100,000 1,500,000 500,000 22,000,000

1,800,000 $ 700,000 1,200,000 270,000 450,000 100,000 4,520,000 $

$

Learning Objective 3

Compute activity rates for cost pools.

 Calculate Activity Rates
The ABC team determines that Baxter Battery will have these total activities for each activity cost pool . . .
   

10,000 customer orders, 4,000 design changes, 800,000 machine-hours, 2,000 customers served.

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

200.000 (b) Total Activity 10.000 changes 800.000 MHs 2.000.160.000 5.50 per MH $1.540 per customer Not applicable .000 6.040.520.000 $ 22.000 orders 4.000 3.000 3.080.000 customers Not applicable (a) ÷ (b) Activity Rate $452 per order $760 per change $6. Calculate Activity Rates Computation of Activity Rates Activity Cost Pools Customer orders Design changes Order size Customer relations Other Total (a) Total Cost $ 4.

Customer Orders. Customers .Activity–Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs Traced Traced Traced Cost Objects: Products.

Activity–Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs First-Stage Allocation Customer Orders Design Changes Order Size Customer Relations Other Cost Objects: Products. Customers . Customer Orders.

Customers Unallocated .Activity–Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs First-Stage Allocation Customer Orders Design Changes Order Size Customer Relations Other Second-Stage Allocations $/Order $/Change $/MH $/Customer Cost Objects: Products. Customer Orders.

Learning Objective 4 Assign costs to a cost object using a secondstage allocation. .

1. resources. Requires Requires no no new new design design resources. resources. Each Each LongLife LongLife requires requires 48 48 minutes minutes of of machine machine time time for for a a total total of of 320. 1. 3. machine-hours.000 4.000 machine-hours. 3. 2.000 480.000 custom custom designs designs prepared. . 4. 4.000 machine-hours. Assigning Overhead to Products Baxter Battery Information SureStart SureStart 1. 2. 2.000 separate separate orders.000 6. 800. 4.000 400. 400. machine-hours. 3. prepared. orders. Requires Requires new new design design resources. Each Each SureStart SureStart requires requires 36 36 minutes minutes of of machine machine time time for for a a total total of of 480. orders.000 batteries batteries ordered ordered with with 4.000 800. LongLife LongLife 1.000 4. 3.000 separate separate orders.000 320.000 batteries batteries ordered ordered with with 6. 2.

080.000 $ Overhead Cost for the LongLife Activity Cost Pools Customer orders Design changes Order size Total (a) Activity Rate $ 452.000 7.000 3.808.000 $ (a) × (b) ABC Cost 1.50 (b) Activity 6.000 4.000 2.000 $ (a) × (b) ABC Cost 2. Assigning Overhead to Products Overhead Cost for the SureStart Activity Cost Pools Customer orders Design changes Order size Total (a) Activity Rate $ 452.50 (b) Activity 4.000 4.120.712.000 3.00 760.000 $ .000 480.928.832.040.00 6.00 6.00 760.000 320.

order. Machine-hours Machine-hours 1. 2. order. 1.000 customers – Acme Auto Parts who placed a total of twelve orders.Assigning Overhead to Customers Let’s take a look at how Baxter Battery’s system works for just one of the 2. The The 200 200 LongLifes LongLifes required required 160 160 machine machine hours. 1. Eight Eight orders orders for for 60 60 SureStarts SureStarts per per order. Note that the four orders for LongLifes required a design change. machine-hours. Orders Orders 1. Four Four orders orders for for 50 50 LongLifes LongLifes per per order. hours. 2. 2. The The 480 480 SureStarts SureStarts required required 288 288 machine-hours. 2. .

540.540 $ 12.50 1.424 3.00 760.912 1.040 2.916 .00 (b) Activity 12 4 448 1 (a) × (b) ABC Cost $ 5.00 6.Assigning Overhead to Customers Overhead Cost for Acme Auto Parts Activity Cost Pools Customer orders Design changes Order size Customer relations Total (a) Activity Rate $ 452.

Learning Objective 5 Use activity-based costing to compute product and customer margins. .

000.000 5.000 Total $ 50.000 7.000 2.000.000 15.000. Prepare Management Reports Product Margin Calculations The first step in computing product margins is to gather each product’s sales and direct cost data.000. Sales Direct costs Direct material Direct labor Shipping SureStarts $ 31.000 9.700.000 1.000.000.000 LongLifes $ 18.000.000.000 3.000.000.000 6.000 .300.000 12.

000.000.000 12.040.000 6.000 2. Prepare Management Reports Product Margin Calculations The second step in computing product margins is to incorporate the previously computed activity-based cost assignments pertaining to each product.000.000.000 3.080.000 7.000.000 Total $ 50.000 2.000 1.000 5.000 3.040.000 4.000.520.700.300.712.000.000 1.808.200.000 3.000.000. Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Design changes Order size SureStarts $ 31.000 .000 15.000 5.000 9.000 3.000 2.000.120.000 LongLifes $ 18.

040.000 $ (1.000.000 5.300.000 $ 9.712.000 1.000 19.372.000.000) .000 $ 8.120.808.000 3.080.000 1.000 22.700.000 3.000.000 LongLifes $ 18.832.928.000 2.000.000 $ 6.000.000 7.000.000 2.000 2.132. Sales Costs Direct material Direct labor Shipping Customer orders Design changes Order size Total cost Product margin SureStarts $ 31. Prepare Management Reports Product Margin Calculations The third step in computing product margins is to deduct each product’s direct and indirect costs from sales.

000 $ (1.000 22.000) .000 $ 7.372.000 $ (2.240.000) Total $ 50.832.000 19.160.300.000 3.000 42.000.700.080.000 9.000.928.000 6. Prepare Management Reports Product Margin Calculations The product margins can be reconciled with the company’s net operating income as follows: Sales Total costs Product margins Less costs not assigned to products: Customer relations Other Total Net t operating income loss SureStarts $ 31.132.240.000 $ 8.760.000 LongLifes $ 18.

200 7.700 1. Prepare Management Reports Customer Margin Analysis The first step in computing Acme Auto Parts’ customer margin is to gather its sales and direct cost data. Acme Auto Parts $ 29.700 Sales Direct costs Direct material Direct labor Shipping .500 6.

040 2. Prepare Management Reports Customer Margin Analysis The second step is to incorporate Acme Auto Parts’ previously computed activity-based cost assignments.500 6. Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Product design Order size Customer relations Acme Auto Parts $ 29.424 3.200 7.540 .912 1.700 1.700 5.

912 1. Prepare Management Reports Customer Margin Analysis The third step is to compute Acme Auto Parts’ customer margin of $384 by deducting all its direct and indirect costs from its sales.040 2.424 3.700 1. Sales Direct costs Direct material Direct labor Shipping Customer orders Product design Order size Customer relations Customer margin Acme Auto Parts $ 29.540 28.816 $ 384 .700 5.200 $ 7.500 6.

000.000 7.000 12.000 LongLifes $ 18.000 .000.000 5.000. Sales Direct costs Direct material Direct labor SureStarts $ 31.000.Product Margins Computed Using the Traditional Cost System The first step in computing product margins is to gather each product’s sales and direct cost data.000 Total $ 50.300.700.000 6.000.000 9.000 15.000.000.

000.000 320.000.000 @ 0.80 hours) Total machine-hours Machine-hours 480.000.500.000 $ 14.000 2.000 .000 MH = $17.Product Margins Computed Using the Traditional Cost System The second step in computing product margins is to compute the plantwide overhead rate.60 hours) LongLifes (400. Manufacturing Overhead Costs at Baxter Battery Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Total manufacturing overhead $ 6.50 per machine-hour SureStarts (800.000 Plantwide manufacturing overhead rate = $14.000 800.000.000 @ 0.000 3.000 800.000 2.500.

50 5.000 hours × $17.000.Product Margins Computed Using the Traditional Cost System The third step in computing product margins is allocate manufacturing overhead to each product.000 SureStarts LongLifes Total overhead allocated to products 480.000 .400.000 $ 17.400.50 $ 8. Machine Overhead Overhead Hours Rate Allocated 480.600.000 17.50 per hour = $8.000 $ 14.000 320.

000.000 $ 16.000.000 6.000.000 9.000.400.000 LongLifes $ 18.000 12.000.000 5.000 6.000 $ $ 24.000.000.000 2.000.000 11.000 5. SureStarts $ 31.000.000 (2.000 8.000.000 Total $ 15.000 2.Product Margins Computed Using the Traditional Cost System The fourth step is to actually compute the product margins.000 14.000 $ 9.600.000.900.300.000.000 6.000.000 .000 $ 41.600.000.000) Shipping expenses Marketing expenses General administrative expenses $ 3.000 Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Product margin Selling and administrative Nett operating operating income loss 50.000 $ 11.400.700.000.000.000 7.100.

000 LongLifes $ 2.132. .000 (1.372.000) $ (3.232.472.900.000 8.000) Product margins – traditional Product margins – ABC Change in reported margins The traditional cost system overcosts the SureStarts and reports a lower product margin for this product.100. The traditional cost system undercosts the LongLifes and reports a higher product margin for this product.000 $ 1.Differences Between ABC and Traditional Product Costs SureStarts $ 6.

Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another. ABC costing only assigns manufacturing overhead costs consumed by products to those products. Traditional costing allocates all manufacturing overhead to products. .

Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another.  Traditional costing allocates all manufacturing overhead costs using a volume-related allocation base. ABC costing also uses non-volume related allocation bases. .

Differences Between ABC and Traditional Product Costs There are three reasons why the reported product margins for the two costing systems differ from one another.  Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products. .

activity rates can also provide valuable clues on where to focus improvement efforts. . Benchmarking Benchmarking can can be be used used to to compare compare activity activity cost cost information information with with world-class world-class standards standards of of performance performance achieved achieved by by other other organizations. While the theory of constraints approach discussed in Chapter 1 is a powerful tool for targeting improvement efforts.Targeting Process Improvement Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements. organizations.

3. . External External reports reports are are less less detailed detailed than than internal internal reports. 2. 4. 1. GAAP. 4. 1. 3. 2. employees.Activity-Based Costing and External Reporting Most companies do not use ABC for external reporting because . ABC ABC does does not not conform conform to to GAAP. It It may may be be difficult difficult to to make make changes changes to to the the company’s company’s accounting accounting system. Auditors Auditors may may be be suspect suspect of of the the subjective subjective allocation allocation process process based based on on interviews interviews with with employees. . reports. system. .

Potential misinterpretation of unfamiliar numbers. Two costing systems may be needed. Does not conform to GAAP. .ABC Limitations Substantial resources required to implement and maintain. Resistance to unfamiliar numbers and reports. Desire to fully allocate all costs to products.

ABC Action Analysis Appendix 8A .

Learning Objective 6 (Appendix 8A) Prepare an action analysis report using activity-based costing data and interpret the report. .

Appendix 8A: ABC Action Analysis Conventional ABC analysis does not identify potentially relevant costs. • Indicates how difficult it would be to adjust those costs in response to changes in the level of activity. . An action analysis report helps because it: • Shows what costs have been assigned to a cost object.

Let’s revisit the stage-one allocations from the Baxter Battery Company example that we discussed earlier. an activity rate is computed for each type of overhead cost that is consumed supporting a given activity. In addition to computing an overall activity rate for each activity cost pool. .Appendix 8A: ABC Action Analysis Constructing an action analysis report begins with the first-stage allocation process.

000 800.000 800.000 orders = $180 per order Other entries in the table are computed similarly.100.000 150.000 400.000 1.200.000 2.000 1.50 6.000 $ 1.100.000 22.000 900.000 $ 350.000 ÷ 10.800.000 $ 1.000 250.000 400.200.000.50 760.080.520.500.000.00 $ 87.000 350.000 5.000 2.63 1.500.500.000 3.000 1.000 50.100.000 750.000 3.000 2.000 $ Total 6.Customer Orders Total Activity 10.000 1.200.000 270.000 $ $ $1.000 6.00 22.00 $ Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ Activity Cost Pools Design changes Order Size 1.000 360.000 Activity Cost Pools Design Customer Changes Order Size Relations 4.000 4.88 0.000 1.000.000 3.160.50 62.000 100.000 450.000 $ Other 600.000.000 4.50 37.800.500.000 90.000 $ Customer Relations 600.800.200.040.000 1.000 $ 2.000 180.50 $ 2.000 300 600 90 375 175 1.000.000 $ 700.50 100. .000 1.000 750.000 500.000 150.000 $ 350.540 Other N/A Appendix 8A: ABC Action Analysis Production Department Indirect factory wages $ Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 180 $ 70 120 27 45 10 452 $ 450.50 $ 2.

000 N/A $ 1.000 Total $ $180 per order × 4.260.000 480.000 900.000 $ 1.000 240. .000 900.928.000 $ 280.000 40.000 720.540.000 $ Design Customer Changes Order Size Relations $ 480.000 orders = $720.000 Other entries in the table are computed similarly.000 1.440.Action Analysis Cost Matrix for SureStart Batteries Activity Cost Pools Customer Orders Total activity for batteries Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 4.000 108.000 40.000 180.120.000 1.000 4.000 720.000 108.808.000 $ 3.000 720.000 180.

000 orders = $1.080.000 350.000 162.000 250.360.000 7.000 Other entries in the table are computed similarly.000 $ 1.000 $ 3.000 $ 480.000 720.000 150.000 90.000 $ $180 per order × 6.000 60.712.000 1.000 850.000 400.000 420.000 160.040.Action Analysis Cost Matrix for LongLife Batteries Activity Cost Pools Customer Orders Total activity for battery housing Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total 6.610. .000 $ 2.000 Total $ 1.080.000 $ 2.000 N/A $ 3.000 Design Changes 4.000 270.000 60.000 600.000 Customer Order Size Relations 320.080.000 1.800.280.832.000 840.000 420.000 252.

label each cost using an ease of adjustment code: • Green costs adjust more or less automatically to changes in activity level without any action by managers. .Appendix 8A: ABC Action Analysis Next. but it would require management action to realize the change in cost. • Red costs can be adjusted to changes in activity level only with a great deal of difficulty and with management intervention. • Yellow costs can be adjusted to changes in activity level.

000 850.000 $ 1.000 1.000 $ 5.222.000.000 60.000 11.000.610.000 1.610.132.700.000 $ $ 18.000 478.000.000 420.000.000 1.700.000 11.000 (1.000 3.000 7.280.000) .360.000 252.Appendix 8A: ABC Action Analysis Action Analysis of LongLife Batteries Sales Green costs Direct materials Shipping costs Green margin Yellow costs Direct labor Indirect factory wages Factory utilities Administrative wages and salaries Office equipment depreciation Marketing wages and salaries Selling expenses Yellow margin Red costs Factory equipment depreciation Factory building lease Administrative building lease Red margin $ 6.

Using a Modified Form of Activity-Based Costing to Determine Product Costs for External Reports Appendix 8B .

.Learning Objective 7 (Appendix 8B) Use activity-based costing techniques to compute unit product costs for external reports.

products. costs.Appendix 8B A A modified modified form form of of activity-based activity-based costing costing can can be be used used to develop product product costs for for external external financial financial reports. . reports. • • Exclude Exclude nonmanufacturing nonmanufacturing costs costs even even if if they they are are caused caused by by the the products. ABC ABC product product costs: costs: • • Include Include organization-sustaining organization-sustaining costs costs and and unused unused capacity capacity costs.

000 .00 2.00 $ 24. Total estimated manufacturing overhead Total estimated direct labor hours $ 1.00 $ 12.Appendix 8B Simmons’ Industries provides the following information for the company as a whole and for its only two products—deluxe and standard hedge trimmers.000 Direct materials cost per unit Direct labor cost per unit Direct labor hours per unit Units produced Deluxe Standard $ 38.800.000 400.000 200.0 1.0 100.00 $ 28.

000 = overhead rate 400.Appendix 8B Assuming that Simmons’ traditional cost system relies on one predetermined plantwide overhead rate with direct labor-hours (DLHs) as the allocation base.000 DLHs = $4.50 per DLH .800. then its plantwide overhead rate is computed as follows: Predetermined $1.

00 $ 28.00 12.0 DLH × $4.Appendix 8B Simmons’ traditional cost system would report unit product costs as follows: Deluxe Standard $ 38.00 9.00 4.50 Direct materials cost per unit Direct labor cost per unit Manufacturing overhead per unit Unit product cost 2.0 DLH × $4.00 $ 44.50 $ 71.00 24.50 per DLH 1.50 per DLH .

Appendix 8B The ABC project team at Simmons has developed the following basic information.000 500 300 . Estimated Overhead Cost Activity and Activity Measures Direct labor support (DLHs) $ 900.800.000 Total manufacturing overhead $ 1.000 Machine setups (setups) 600.000 Parts administration (part types) 300.000 Expected Activity Deluxe Standard 200.000 400 100 200 100 Total 400.000 200.

000 ÷ 300 = $ 1.000 per part type $ 1.25 per DLH 600. let’s assign overhead to the two products based upon expected activity.200 per setup 300.Appendix 8B We can calculate the following activity rates: Estimated Total Overhead Expected Cost Activity Activity Rate $ 900.800.000 Activity and Activity Measures Direct labor support (DLHs) Machine setups (setups) Parts administration (part types) Total manufacturing overhead Using the new activity rates.000 = $ 2.000 ÷ 500 = $ 1. .000 ÷ 400.

000 Machine setups (setups) 400 × $ 1.000 670.000 .000 Total overhead cost assigned $ 1.000 = 200.200 = 480.130.000 × $ 2.000 × $ 2.000 120.25 = $ Machine setups (setups) 100 × $ 1.000 Standard Product Expected Activity Activity and Activity Measures Activity Rate Direct labor support (DLHs) 200.25 = $ 450.000 Parts administration (part types) 200 × $ 1.Appendix 8B Deluxe Product Expected Activity Activity and Activity Measures Activity Rate Amount Direct labor support (DLHs) 200.000 = Total overhead cost assigned $ Amount 450.200 = Parts administration (part types) 100 × $ 1.000 100.

Appendix 8B Activity-based Activity-based unit unit product product costs costs for for both both product product lines lines Premium Standard $ 38.30 3.35 Direct materials cost per unit Direct labor cost per unit Manufacturing overhead per unit Unit product cost .30 $ 43.00 11.35 $ 73.00 12.00 24.00 $ 28.

00 11.00 12.30 3.000 ÷ 100.00 $ 28.00 24.Appendix 8B Activity-based Activity-based unit unit product product costs costs for for both both product product lines lines Premium Standard $ 38.35 Direct materials cost per unit Direct labor cost per unit Manufacturing overhead per unit Unit product cost $1.000 ÷ 200.000 units $670.30 $ 43.000 units .35 $ 73.130.

00 12.00 4.30. . .00 $ 28.35 .00 Manufacturing overhead 11.50 to $43. while the unit cost of a Deluxe unit increased from $71. . .00 9. .00 to $73.00 24.Appendix 8B Comparing the two approaches Activity-Based Costing Deluxe Standard Direct material $ 38. .50 Note that the unit product cost of a Standard unit decreased from $44. .30 $ 43. .35 Traditional Costing Deluxe Standard $ 38.00 $ 28.50 $ 71.00 12.30 3. .00 $ 44.35 Unit product cost $ 73. .00 Direct labor 24.

End of Chapter 8 .

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