Baxter Battery – An ABC Example

Baxter Battery Company Income Statement Year Ended December 31, 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 $ 15,000,000 12,000,000 14,000,000

41,000,000 9,000,000

3,000,000 2,000,000 6,000,000

11,000,000 $ (2,000,000)

Manufacturing overhead is allocated to products using a single plantwide overhead rate based on machine hours.
McGraw-Hill/Irwin
Slide 14

Define Activities, Activity Cost Pools, and Activity Measures
At Baxter Battery, the ABC team, selected the following activity cost pools and activity measures:

McGraw-Hill/Irwin

Slide 15

Define Activities, Activity Cost Pools, and Activity Measures
Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. Design Changes - assigned all costs of resources consumed by customer requested design changes. Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. Customer Relations – assigned all costs associated with maintaining relations with customers. Other – assigned all organization-sustaining costs and unused capacity costs
McGraw-Hill/Irwin
Slide 16

Learning Objective 2 Assign costs to cost pools using a firstfirst-stage allocation. McGraw-Hill/Irwin Slide 17 .

Assign Overhead Costs to Activity Cost Pools McGraw-Hill/Irwin Slide 18 .

Assign Overhead Costs to Activity Cost Pools Direct materials. direct labor. McGraw-Hill/Irwin Slide 19 . and shipping are excluded because Baxter Battery’s existing cost system can directly trace these costs to products or customer orders.

McGraw-Hill/Irwin Slide 20 .Assign Overhead Costs to Activity Cost Pools At Baxter Battery the following distribution of resource consumption across activity cost pools is determined.

000 Percent consumed by customer orders 30% $1.000.000 McGraw-Hill/Irwin Slide 21 .800.Assign Overhead Costs to Activity Cost Pools Indirect factory wages $6.

000 McGraw-Hill/Irwin Slide 22 .Assign Overhead Costs to Activity Cost Pools Factory equipment depreciation $3.000 Percent consumed by customer orders 20% $ 700.500.

Assign Overhead Costs to Activity Cost Pools McGraw-Hill/Irwin Slide 23 .

Learning Objective 3 Compute activity rates for cost pools. McGraw-Hill/Irwin Slide 24 .

000 customers served. 2.000 machinemachine-hours. Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.000 customer orders. . McGraw-Hill/Irwin Slide 25 . 10.000 design changes. 4. .Calculate Activity Rates The ABC team determines that Baxter Battery will have these total activities for each activity cost pool . 800.

Calculate Activity Rates McGraw-Hill/Irwin Slide 26 .

Customers McGraw-Hill/Irwin Slide 27 .Activity–Based Costing at Baxter Battery Direct Materials Direct Labor Shipping Costs Overhead Costs Traced Traced Traced Cost Objects: Products. Customer Orders.

Customers McGraw-Hill/Irwin Slide 28 .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. Customer Orders.

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 SecondSecond -Stage Allocations $/Order $/Change $/MH $/Customer Cost Objects: Products. Customer Orders. Customers McGraw-Hill/Irwin Unallocated Slide 29 .

Learning Objective 4 Assign costs to a cost object using a secondsecond-stage allocation. McGraw-Hill/Irwin Slide 30 .

4.000 separate orders. Each SureStart requires 36 minutes of machine time for a total of 480.Assigning Overhead to Products Baxter Battery Information SureStart 1.000 separate orders. 3.000 machinemachine-hours. 2.000 custom designs prepared.000 machinemachine-hours. 400. McGraw-Hill/Irwin Slide 31 .000 batteries ordered with 6. LongLife 1. 2.000 batteries ordered with 4. 800. Requires new design resources. 3. 4. Each LongLife requires 48 minutes of machine time for a total of 320. Requires no new design resources.

Assigning Overhead to Products McGraw-Hill/Irwin Slide 32 .

The 480 SureStarts required 288 machine machine-hours.Assigning Overhead to Customers Let’s take a look at how Baxter Battery’s system works for just one of the 2. The 200 LongLifes required 160 machine hours. Machine-hours 1. Four orders for 50 LongLifes per order.000 customers – Acme Auto Parts who placed a total of twelve orders. 2. 2. Orders 1. Note that the four orders for LongLifes required a design change. McGraw-Hill/Irwin Slide 33 . Eight orders for 60 SureStarts per order.

Assigning Overhead to Customers McGraw-Hill/Irwin Slide 34 .

Learning Objective 5 Use activityactivity-based costing to compute product and customer margins. McGraw-Hill/Irwin Slide 35 .

000.000 Total $ 50.000.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 6.000 7.000.000 McGraw-Hill/Irwin Slide 36 .700.000 3. Sales Direct costs Direct material Direct labor Shipping SureStarts $ 31.000.000.000 15.000 2.000 12.000.000.000 LongLifes $ 18.000 1.000 9.300.000.000.000.000 5.

000 1.080.000.040.000.000 2.000.300.000 5.000.000 LongLifes $ 18.712.000.000 15.000 1.120.000 4.000 3.000 3.700.000.000 2.000 9.000 7.040.000.520.000 3.808.000. Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Design changes Order size SureStarts $ 31.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 2.000 5.000 McGraw-Hill/Irwin Slide 37 .200.000 Total $ 50.000 3.000.000.000 6.000 12.

000.040.000 1.000) Slide 38 .000 1. Sales Costs Direct material Direct labor Shipping Customer orders Design changes Order size Total cost Product margin McGraw-Hill/Irwin SureStarts $ 31.000 2.700.000 2.000 $ 6.120.928.000 $ (1.832.000.000 7.080.000 22.000 $ 9.000.300.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.000.000 19.000 $ 8.132.000.000 2.000 LongLifes $ 18.712.372.000 5.000 3.808.000.000 3.

000.700.000 $ 8.000 19.000 3.160.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 $ 31.832.300.760.000.132.240.928.000 6.372.000 $ 7.000 9.000 LongLifes $ 18.000) Total $ 50.000) McGraw-Hill/Irwin Slide 39 .080.000 22.000 $ (1.240.000 $ (2.000 42.

200 7.500 6.700 Sales Direct costs Direct material Direct labor Shipping McGraw-Hill/Irwin Slide 40 .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.

Prepare Management Reports Customer Margin Analysis The second step is to incorporate Acme Auto Parts’ previously computed activity-based cost assignments. Acme Auto Parts $ 29.700 5.500 6.040 2.424 3.540 Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Product design Order size Customer relations McGraw-Hill/Irwin Slide 41 .700 1.912 1.200 7.

Sales Direct costs Direct material Direct labor Shipping Customer orders Product design Order size Customer relations Customer margin Acme Auto Parts $ 29.540 28.424 3.816 $ 384 McGraw-Hill/Irwin Slide 42 .040 2.912 1.200 $ 7.500 6.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.700 1.700 5.

000. Sales Direct costs Direct material Direct labor SureStarts $ 31.000 5.000 12.000 Total $ 50.000.000 9.000 7.000 McGraw-Hill/Irwin Slide 43 .700.000.000.300.000.000.000 6.000 15.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 LongLifes $ 18.000.

000 Slide 44 .000 2.500.000 @ 0.Product Margins Computed Using the Traditional Cost System The second step in computing product margins is to compute the plantwide overhead rate.000.000 2.000.000 MH = $17.000.000 3.80 hours) Total machine-hours McGraw-Hill/Irwin Machine-hours 480.000 @ 0.000. Manufacturing Overhead Costs at Baxter Battery Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Total manufacturing overhead $ 6.000 320.000 800.60 hours) LongLifes (400.000 $ 14.000 800.500.50 per machine-hour SureStarts (800.000 Plantwide manufacturing overhead rate = $14.

000 17.000 $ 17.400.50 $ 8. Machine Overhead Overhead Hours Rate Allocated 480.000 hours × $17.Product Margins Computed Using the Traditional Cost System The third step in computing product margins is allocate manufacturing overhead to each product.000 McGraw-Hill/Irwin Slide 45 .000.400.000 320.000 $ 14.50 per hour = $8.50 5.600.000 SureStarts LongLifes Total overhead allocated to products 480.

400.000 $ 9.000.000.000.900.000.000 7.000 12.000 $ 16.000.000.000.000 9.000 $ 11.100.000.000.000 11.000.000 5.000.000 Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Product margin Selling and administrative Nett operating operating income loss 50.000 2.000 6.000 8.000) Shipping expenses Marketing expenses General administrative expenses $ 3.000 14.000 2.000 $ 41.000 Total $ 15.Product Margins Computed Using the Traditional Cost System The fourth step is to actually compute the product margins.000 $ $ 24.400.000.300.000.000.700.000 LongLifes $ 18.600.000.000 McGraw-Hill/Irwin Slide 46 .600.000 5.000 (2.000 6.000. SureStarts $ 31.000 6.

McGraw-Hill/Irwin The traditional cost system undercosts the LongLifes and reports a higher product margin for this product.900.100.132.232. Slide 47 .000 LongLifes $ 2.000 (1.000) The traditional cost system overcosts the SureStarts and reports a lower product margin for this product.000 $ 1.372.000) $ (3.472.Differences Between ABC and Traditional Product Costs Product margins – traditional Product margins – ABC Change in reported margins SureStarts $ 6.000 8.

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