4 -1

CHAPTER

Activity-Based
Costing
 4 -2

Objectives
Objectives
1. Discuss the importance
After of unit
studying this costs.
After studying this
2. Describe functional-based
chapter, you costing
should
chapter, you should
approaches. be
be able
able to:
to:
3. Explain why functional-based costing
approaches may produce distorted costs.
4. Explain how an activity-based costing system
works for product costing.
continued
continued
 4 -3

Objectives
Objectives
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.
 4 -4
Unit
Unit cost
cost isis the
the total
total cost
cost
associated
associated with
with thethe units
units
produced
produced divided
divided by by the
the
number
number ofof units
units produced.
produced.

Unit cost is used for--

Inventory valuation
Income determination
Providing input to a
variety of decisions
such as pricing, make or
buy, and accept or
reject special orders
 4 -5

Product
Product cost
cost isis often
often defined
defined asas the
the
sum
sumofof direct
direct materials,
materials, direct
direct labor,
labor,
and
and manufacturing
manufacturing overhead.
overhead. This
This
definition
definition isis required
requiredfor
for external
external
financial
financial reporting.
reporting.
 4 -6

Cost
Cost measurement
measurement consists
consists of
of
determining
determining the
the dollar
dollar amounts
amounts of of
direct
direct materials,
materials, direct
direct labor,
labor, and
and
overhead
overhead used
used inin production.
production.
 4 -7

The
The process
process of
of associating
associating
the
the costs,
costs, once
once measured,
measured,
with
with the
the units
units produced
produced isis
called
called cost
cost assignment.
assignment.
 4 -8

Measurement
Measurement Systems
Systems
Two possible measurement systems are
actual costing and normal costing.
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
Measurement Systems
Systems
AA predetermined
predetermined
overhead
overhead rate
rate isis aa rate
rate
based
based on
on estimated
estimated data. data.

Budgeted (estimated) cost

Estimated activity usage
 4 -10

Examples
Examples of
of Unit-Level
Unit-Level Drivers
Drivers

Units produced
Direct labor hours
Direct labor dollars
Machine-hours
Direct material dollars
 4 -11

Units
(of
driver) Theoretical
Practical
Expected actual

Normal

Time
 4 -12

Functional-Based
Functional-Based Costing:
Costing: Plantwide
Plantwide Rate
Rate

Overhead Costs

Assign Costs Direct Tracing

Plantwide Pool Stage One: Pool Formation

Assign Costs Unit-Level Driver

Products 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
 4 -14

Belring, Inc.
Predetermined Overhead Budgeted (estimated) cost
Rate =
Estimated activity usage
Predetermined $360,000
Overhead Rate =
100,000 DLH
Predetermined
Overhead Rate = $3.60 per DLH
 4 -15
The
The total
total overhead
overhead
assigned
assigned toto actual
actual
production
production isis called
called
applied
applied overhead.
overhead.

Overhead rate
Applied
= x
overhead
Actual activity
output
 4 -16

Belring, Inc.
Applied
= Overhead rate x Actual activity output
overhead

= $3.60 x 100,000 DLH

= $360,000
 4 -17
Per-Unit Cost
Belring, Inc.
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
 4 -18
Functional-Based
Functional-Based Costing
Costing Department
Department Rates
Rates
Overhead Costs

Allocation
Direct Tracing
Assign Costs Driver Tracing

Stage One: Pool

Department A Pool Formation Department B Pool

Assign Costs Unit-Level Drivers Assign Costs

Stage Two: Costs

Products Assigned
Products
 Departmental
Departmental Data
Data
4 -19

Belring, Inc.
Fabrication Assembly
Budgeted overhead $252,000 $108,000
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
= ($6.30 x actual mh) + ($1.35 x actual dlh)
overhead

= ($6.30 x 40,000) + ($1.35 x 80,000)

= $252,000 + $108,000

= $360,000
 4 -21

Belring, Inc.
Per-Unit
Per-Unit Cost:
Cost: Departmental
Departmental Rates
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
Symptoms ofof an
an Outdated
Outdated
Functional
Functional Cost
Cost System
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
Continued
 4 -23

Symptoms
Symptoms ofof an
an Outdated
Outdated
Functional
Functional Cost
Cost System
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
Non-unit activity
activity drivers
drivers are
are
factors
factors that
that measure
measure the
the
consumption
consumption of of non-unit
non-unit
activities
activities by
by products
products and
and other
other
cost
cost objects.
objects.
 4 -25

Product
Product diversity
diversity means
means that
that the
the
products
products consume
consume overhead
overhead activities
activities
in
in systematically
systematically different
different proportions.
proportions.
 4 -26

Belring, Inc.
Product-Costing
Product-Costing Data
Data
Cordless Regular Total
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

Activity
Activity Usage
Usage
Measures
Measures
 4 -27

Belring, Inc.
Product-Costing
Product-Costing Data
Data
Activity Activity Cost

Setups $120,000
Material handling 60,000
Machining 100,000
Testing 80,000
Total $360,000

Overhead Activities
 4 -28

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
a 20/30 (cordless) and 10/30 (regular)
 4 -29

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
b 60/90 (cordless) and 30/90 (regular)
 4 -30

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
c 5,000/50,000 (cordless) and 45,000/50,000 (regular)
 4 -31

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
d 10,000/100,000 (cordless) and 90,000/100,000 (regular)
 4 -32

Belring, Inc.
Activity
Activity Rates
Rates
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
 4 -33

Belring, Inc.
Activity
Activity Rates
Rates
Cordless
$4,000 Regular
$4,000
Prime costs $ 78,000
x
$667 $ 738,000
x
$667
Overhead costs: 20
x 10
x
$2 $2
Setups 60
x
80,000 30
x
40,000
$0.80 $0.80
Material handling 5,000
x
40,000 45,000
x
20,000
10,000 90,000
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
 4 -34

Belring, Inc.
Comparison
Comparison of
of Unit
Unit Costs
Costs
Cordless Regular
Plantwide rate $11.40 $10.62
Departmental rate 10.73 10.69
Activity rate 21.60 9.60