Activity-Based Costing Systems: Mcgraw-Hill/Irwin

9
Activity-Based
Costing Systems
McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.
4-2
Learning Objective 1
4-3
Traditional Costing Systems
Traditional
Traditional cost
cost systems
systems were
were created
created when
when
manufacturing
manufacturing processes
processes were
were labor
labor intensive.
intensive.
A
A single
single company-wide
company-wide overhead
overhead rate
rate
based
based on on direct
direct labor
labor hours
hours may
may be
be
used
used to to allocate
allocate overhead
overhead to
to products
products
in
in these
these labor
labor intensive
intensive processes.
processes.
4-4
In
Inthis
thisexample,
example, overhead
overheadwill
will be
beallocated
allocatedtotojobs
jobs
using
usingdirect
direct labor
laborhours.
hours. IfIf total
total overhead
overheadis is$120,
$120,
how
howmuch
muchwillwillbe
beallocated
allocatedto toeach
eachjob?
job?
4-5
Overhead Rate = $120 ÷ 8 direct labor hours

Overhead Rate = $15 per direct labor hour
Job 1 = 2 hours × $15 per hour = $30

4-6
The company introduces

automated machinery. Total
overhead rises from $120 to
$420, while the labor time
needed for Job 2 falls from
6 hours to 1 hour. Now
allocate the $420 overhead
to the two jobs.
4-7
Overhead Rate = $420 ÷ 3 direct labor hours

Overhead Rate = $140 per direct labor hour

Job 2 = 1 hour × $140 per hour = $140
4-8
Is this a reasonable costing method?

Automation benefited only Job 2, but most of the
additional overhead cost was allocated to Job 1.
Clearly, we need to look for another cost driver.
4-9
4-10
Activity-Based Costing (ABC)
AA costing
costing method
method that
that identifies
identifies the
the activities
activities
performed
performed within
within the
the organization
organization as as itit delivers
delivers
its
its goods
goods and
and services.
services.
Products Activities
Require Consume
Activities Resources
People
Manage
Activities
4-11
AA costing
costing method
method that
that assigns
assigns costs
costs toto
products,
products, based
based on
on the
the number
number of
of activities
activities the
the
organization
organization used
used inin producing
producing them.
them.
Process
Lot size Direct
setups
labor
hours
Design Machine Customer

time hours contact
4-12
Both
Both manufacturing
manufacturing
and
and nonmanufacturing
nonmanufacturing ABC
ABC isis aa good
good
costs
costs may
may be
be supplement
supplement
assigned
assigned to
to to
to our
our traditional
traditional
products.
products. cost
cost system.
system.
A
B C
Allocation
Allocation bases
bases
Used
Used in
in internal
internal
often
often differ
differ from
from
decision
decision making
making as as well
well
traditional
traditional costing
costing
as
as in
in inventory
inventory valuation
valuation
systems.
systems.
for
for external
external reporting.
reporting.
4-13
ABC Compared with Traditional Costing
Activity-Based
Activity-Based
Costing
Costing
i ty n
ex tio
pl nta
o m e its
C m e f
o f l e n
Traditional
Traditional l m B p e
Costing v e I of
Costing f
Le t o el
os ev
C L
4-14
ABC Compared with Traditional Costing

Traditional Costing Activity-Based Costing
Resource Costs Resource Costs
Directly traced Directly traced

or allocated or allocated
Cost Pools: Cost Pools:

Plants or Activities or
Departments Activity Centers
Predetermined Cost driver
overhead rates for
rate each activity
Cost Objects Cost Objects
4-15

Activity
An Activity Cost Costs
Pool is a
common way to $$
collect costs $
$ $
that are related $
to a specific
activity in the
ABC system.
4-16
Four Steps in the ABC Process

 Identify
Identify and
and classify
classify the
the activities
activities
related
related to
to the
the company’s
company’s
products
products oror services.
services.

 Estimate
Estimate the
the cost
cost of
of each
each activity
activity
identified
identified in
in .
.

 Calculate
Calculate aa cost-driver
cost-driver rate
rate for
for
each
each activity.
activity.

 Assign
Assign activity
activity costs
costs to
to products
products
using
using the
the cost-driver
cost-driver rate.
rate.
4-17
4-18
 Identify and Classify Activities

UNIT-LEVEL ACTIVITIES
Resources acquired and activities performed for individual units of product.
BATCH-LEVEL ACTIVITIES
Resources acquired and activities performed for a group or batch of
similar products or services.
PRODUCT-LEVEL ACTIVITIES
Resources acquired and activities performed to produce and sell a
specific product or service.
CUSTOMER-LEVEL ACTIVITIES
Resources acquired and activities performed to serve specific customers.
FACILITY-LEVEL ACTIVITIES
Resources acquired and activities performed to provide general capacity to
produce goods or services.
4-19
 Identify and Classify Activities
TOP
TOP DOWN
DOWN APPROACH
APPROACH
ABC
ABCteams
teamsofofpeople
peoplefrom
from
top
toplevels
levelsof
of management
management
generate
generate the
theactivity
activity
dictionary.
dictionary.
INTERVIEW
INTERVIEW OR
OR
RECYCLING
RECYCLING PARTICIPATIVE
PARTICIPATIVE
APPROACH
APPROACH APPROACH
APPROACH
Reuses
Reuses documentation
documentation ABC
ABCteams
teamsinclude
includeor
or
of
of processes
processesused
usedfor
for interview
interviewoperating
operating
other
other purposes.
purposes. employees.
employees.
4-20
4-21
 Estimate the Cost of Activities
The
TheABC
ABCteams
teams should
should gather
gather data
dataononthe
the costs
costsof
ofall
all
the
theactivities
activitiesidentified
identified in
inStep
Step1.1.
Examine
Examine Ask
Askemployees
employees
accounting
accounting to
toindicate
indicatehow
how
records
recordsfor
for much
muchtimetime
recorded
recordedcost
cost they
theywork
workonon
information.
information. various
various
activities.
activities.
4-22
 Calculate Cost-Driver Rates for

Activities
Two
Twopieces
piecesofof
information
informationare are
required
required toto compute
compute
the
thecost-driver
cost-driverrate:
rate:
••Activity
ActivityCost
Cost
••Activity
Activity Volume
Volume
May
MayCompany
Companyhashas44employees
employeesin inits
itsQuality
QualityControl
Control
Department.
Department.Salaries
Salariesand
andcosts
costsfor
forthe
thedepartment
departmenttotal
total
$360,000
$360,000per
peryear.
year. May
Mayproduces
produces500,000
500,000units
unitsof
of
product
productaayear.
year. What
What is
isthe
thecost-driver
cost-driverrate
rateper
perunit?
unit?
$360,000
$360,000 ÷÷500,000
500,000 units
units== $.72
$.72per
perunit
unit
4-23

Activities
MAY
MAYhashasaacustomer
customerservice
servicecenter
center
where
wherecustomers
customers can
can call
call to
to ask
ask
questions.
questions. Customers
Customerspay payaafixed
fixed fee
fee for
for
each
eachcall
call they
theymake
maketotothe
theservice
servicecenter.
center.
ItItcosts
costsMAY
MAY$1,260,000
$1,260,000aayear
yeartotooperate
operate
the
thecenter.
center. The
Thecenter
centerreceives
receives120,000
120,000
calls
callsper
peryear.
year. The
Thecenter
centerhandles
handles
1,000,000
1,000,000minutes
minutesof of calls.
calls.
What
Whatis
isthe
theappropriate
appropriatecost
cost driver:
driver: total
total
minutes
minutesfor
forall
all calls
callsor
ornumber
numberof ofcalls?
calls?
What
Whatis isthe
thecost-driver
cost-driver rate?
rate?
4-24

Activities
Since
Sincecustomers
customersarearecharged
charged“per
“percall”,
call”,the
the
proper
properactivity
activityin
inthis
thiscase
caseis
isthe
thenumber
numberof of
calls
callshandled
handledby bythe
thecenter.
center.
The
Thecost-driver
cost-driverrate
ratewould
wouldbe:
be:
$1,260,000
$1,260,000÷÷120,000
120,000units
units==$10.50
$10.50per
per call
call
4-25

Activities
Cause and effect
relationship between Measurable
activity and costs
Appropriate
cost-driver
base
Based on resource’s Predict or explain
practical capacity to an activity’s use
support activities of resources
4-26
Practical Capacity Note
When
Whenestimating
estimatingthe the
cost EXAMPLE
EXAMPLE
cost of
of an
anactivity,
activity,
only
onlythe
thecosts
costs Suppose
Supposewe werent
rentaa1,000
1,000
associated
associatedwithwiththe
the square
squarefoot
foot warehouse
warehousefor for
product
productshould
shouldbe be $1,000
$1,000per
permonth.
month. Only
Only800800
used
used(practical
(practical sq.
sq.ft.
ft.are
areused
usedtotostore
store
capacity).
capacity). The
Thecost
cost Product
ProductA. A. The
The rest
restof
ofthe
the
of
of“unused
“unusedcapacity”
capacity” warehouse
warehouseis is“unused”.
“unused”.
should
shouldnot not be
be How
Howmuch
muchrent
rentcost
costshould
shouldbe be
applied
appliedto to products.
products. allocated
allocatedtotoProduct
Product A?A?
4-27
Practical Capacity Note
80%, or $800 20%, or $200 should

should be assigned be assigned to
to Product A “unused capacity”
4-28
4-29
 Assign Activity Costs to Products
1.
1.Identify
Identify all
all 2.
2.Determine
Determine 3.
3.Assign
Assigncosts
costs
the
theactivities
activities how
howmany
many to
toproducts
products
related
relatedtotoaa units
unitsof
of each
each using
using the
thecost-
cost-
given
given product
product activity
activityare
are driver
driverrates
ratesfor
for
or
or service.
service. used
usedperperunit
unit each
eachactivity.
activity.
of
of product.
product.
4-30
Example: Yazz, Inc. produces 130,000 units of Product A

and 400,000 units for Product B. Using the following
cost information, how much overhead should be
allocated to Product A?
4-31
4-32
Activity-Based Costing Example
Let’s look at an
example from the
Bilson Company.
4-33
 Bilson,
Bilson, Inc.
Inc.manufactures
manufacturesandandsells
sells5,000
5,000units
unitsof
of
Product
Product AA(deluxe
(deluxe model),
model),and
and25,000
25,000units
unitsof
of Product
ProductBB
(standard
(standard model)
model)each
eachyear.
year.
 Product
Product AArequires
requires3.0
3.0direct
direct labor
labor hours
hours(DLH)
(DLH) and
and
Product
Product BBrequires
requires2.5
2.5DLH
DLHto toproduce.
produce.
 Employing
Employingaatraditional
traditional costing
costingsystem,
system,Bilson
Bilsonassigns
assigns
overhead
overheadcostcostto
toproducts
productsusing
usingdirect
directlabor
labor hours.
hours.
 The
Thepredetermined
predeterminedoverhead
overheadrate
rateis:
is:
Mfg. overhead cost $1,550,000
= = $20/DLH
Direct labor hours 77,500
4-34
Bilson’s unit product costs using

traditional costing are:
Product A Product B
Direct material $ 40.00 $ 29.00
Direct labor 30.00 25.00
Manufacturing overhead
3.0 DLH × $20/DLH 60.00
2.5 DLH × $20/DLH 50.00
Total unit product cost $ 130.00 $ 104.00
Bilson marks its products up by 50 percent and allocates

its $500,000 customer service costs based on revenue.
4-35
$130.00 × 1.50
Traditional Costing
Product A Product B
Volume 5,000 25,000
Sales Price $ 195.00 $ 156.00
Sales Revenue $ 975,000 $ 3,900,000

Direct Material $ 40.00 200,000 $ 29.00 725,000
Direct Labor 30.00 150,000 25.00 625,000
Overhead 60.00 300,000 50.00 1,250,000
Gross Margin $ 65.00 $ 325,000 $ 52.00 $ 1,300,000
Customer Service Costs 100,000 400,000
Product operating income $ 225,000 $ 900,000
$975,000 ÷ ($975,000 +$3,900,000) × $500,000

4-36

Sales
Salesof
ofProduct
ProductAAhave
haveincreased
increasedsteadily
steadilysince
sinceintroduction,
introduction,
but
butcompany
companyincome
incomehashasdeclined.
declined.Management
Management at atBilson
Bilsonisis
unhappy
unhappywith
withthe
thetraditional
traditionalcosting
costingsystem
systemand
andthey
theyhave
have
decided
decidedto totry
tryactivity-based
activity-based costing.
costing.
In
Inaddition,
addition,management
managementhas has
observed
observedthat thatthe
thecost
cost of
ofdirect
direct
labor
labor isisrelatively
relativelystable.
stable.
Since
Sincelabor
labor does
doesnot
notbehave
behave
like
likeaaunit-level
unit-levelcost,
cost,labor
labor will
will
be
becombined
combinedwith withoverhead
overheadand and
the
thetotal
totalconversion
conversion cost
cost
will
willbe
beassigned
assignedusing
usingABC.
ABC.
4-37

The
Thetotal
totalconversion
conversioncost
costis:
is:
Traditional
Traditionaloverhead
overhead $1,550,000
$1,550,000
Labor
Labor(77,500
(77,500hours
hours@ @ $10)
$10) 775,000
775,000
Total
Total $2,325,000
$2,325,000
In
Inaddition,
addition,management
managementhas has
observed
observedthat thatthe
thecost
cost of
ofdirect
direct
labor
labor isisrelatively
relativelystable.
stable.
Since
Sincelabor
labor does
doesnot
notbehave
behave
like
likeaaunit-level
unit-levelcost,
cost,labor
labor will
will
be
becombined
combinedwith withoverhead
overheadand and
the
thetotal
totalconversion
conversion cost
cost
will
willbe
beassigned
assignedusing
usingABC.
ABC.
4-38
Management has identified the following five activities

and costs in the production of its two products:
Activity Cost
Machine setups $ 800,000
Quality inspections 450,000
Production orders 225,000
Machine-hours worked 650,000
Material receipts 200,000
Total $ 2,325,000
Total conversion cost

4-39
The following transaction data has been

complied by management of Bilson:
Activity Total Product A Product B

Machine setups 5,000 3,000 2,000
Quality inspections 9,000 6,000 3,000
Production orders 600 200 400
Machine-hours worked 50,000 15,000 35,000
Material receipts 800 150 650
4-40
These data can be used to develop predetermined

cost-driver rates for each of the five activities:
Total Rate per

Activity Costs Transactions Transaction
Machine setups $ 800,000 5,000 $ 160.00 per setup
Quality inspections 450,000 9,000 50.00 per inspection
Production orders 225,000 600 375.00 per order
Machine-hours worked 650,000 50,000 13.00 per hour
Material receipts 200,000 800 250.00 per receipt
Total $ 2,325,000
$ 800,000 ÷ 5,000 Machine setups = $160.00 per setup

4-41
The activity-based overhead rates we just calculated

can be used to assign conversion costs to Bilson’s
two products.
Product A
Activity ABC Rate Transactions Amount
Machine setups $ 160.00 3,000 $ 480,000
Quality inspections 50.00 6,000 300,000
Production orders 375.00 200 75,000
Machine-hours worked 13.00 15,000 195,000
Material receipts 250.00 150 37,500
Total overhead assigned $ 1,087,500
Number of units produced ÷ 5,000
Conversion per unit $217.50
4-42

two products.
Product B
Machine setups $160.00 2,000 $ 320,000
Number of units produced ÷ 25,000
Conversion per unit $ 49.50
4-43

two products.
Product B
Machine setups $160.00 2,000 $ 320,000
Total conversion
Number assigned
of units to Product A
produced $ 1,087,500 ÷ 25,000
Total conversionper
Overhead assigned
unit to Product B 1,237,500 $ 49.50
Total overhead $ 2,325,000
4-44
Let’s compute the product cost for A and B

using our ABC overhead rates:
Activity Based Costing Product A Product B

Direct materials $ 40.00 $ 29.00
Conversion 217.50 49.50
Total unit product cost $ 257.50 $ 78.50
These amounts did not

change as a result of
using ABC.
4-45
Now compare the unit product costs using the

traditional costing system and our ABC system.
Costing Method Product A Product B

Activity-based costing $ 257.50 $ 78.50
Traditional costing 130.00 104.00
Remember, we used one overhead

rate based on direct labor hours.
4-46


Adopting activity-based costing usually results

in a shift of batch-level and product-level
overhead costs from high-volume standard
products to low-volume, more complex products.
4-47


Can you see how different allocation

methods might lead to making
different management decisions?
4-48

Based on these results Bilson also decides to use ABC to assign
its $500,000 customer service costs. The applicable activity is
number of customer consultations. Customers buying Product A,
the deluxe model, require more consultations than those buying
Product B, the standard model.
Cost per consultation = $500,000 ÷ 125,000 consultations = $4.00

4-49

No change in sales price
ABC Costing
Product A Product B
Volume 5,000 25,000
Sales Price $ 195.00 $ 156.00
Sales Revenue $ 975,000 $ 3,900,000

Direct Material $ 40.00 200,000 $ 29.00 725,000
Conversion 217.50 1,087,500 49.50 1,237,500
Gross Margin $ (62.50) $ (312,500) $ 77.50 $ 1,937,500
Product operating income $ (512,500) $ 1,637,500
Let’s
Let’scompare
compareproduct
product income
income using
usingtraditional
traditionaland
andABC
ABCcosting.
costing.
4-50
Product A Product B
Volume 5,000 25,000
Sales Price $ 195.00 $ 156.00
ABC
Sales Revenue $ 975,000 $ 3,900,000
Direct Material $ 40.00 200,000 $ 29.00 725,000 Costing
Conversion 217.50 1,087,500 49.50 1,237,500
Gross Margin $ (62.50) $ (312,500) $ 77.50 $ 1,937,500
Product operating income $ (512,500) $ 1,637,500
Product A Product B
Volume 5,000 25,000
Sales Price $ 195.00 $ 156.00
Sales Revenue $ 975,000 $ 3,900,000

Traditional
Direct Material $ 40.00 200,000 $ 29.00 725,000 Costing
Direct Labor 30.00 150,000 25.00 625,000
Overhead 60.00 300,000 50.00 1,250,000
Gross Margin $ 65.00 $ 325,000 $ 52.00 $ 1,300,000
Product operating income $ 225,000 $ 900,000
4-51
4-52
Product Profitability
Should Bilson
drop Product A?
Should Bilson Should Bilson

increase the price reduce the price
of Product A? of Product B?
Now that we have

measured product
costs accurately,
we see how profitable
each product really is.
4-53
Product Profitability
 The price of Product A, the deluxe model, should

probably be increased. Customers who buy
deluxe models may buy based on features
instead of price.
 The price of Product B, the standard model, may
be too high. Customers who buy standard
models are price sensitive. Decreasing
the price would increase volume,
possibly resulting in more income.
4-54
Customer Profitability
Service calls
What are the costs and
benefits of serving
Buy/sell orders
specific customers?
Order changes
Activity-based analysis can

be used to track the costs
of serving customers and
those customers’ contribution
to company profits.
4-55
Estimating Costs of New Products
 Apply ABC analysis of present product

lines to proposed new products.
 This is valid as long as the activities
involved with the new products are
similar to those for the present
products.
4-56
4-57
ABC in Service and Merchandising

Companies
The process is exactly the same as for manufacturing!
 Identify and classify the activities

related to the company’s products or
services.
 Estimate the cost of each activity
identified in .
 Calculate a cost-driver rate for each
activity.
 Assign activity costs to products using
the relevant cost-driver rates.
4-58
ABC– Benefits and Limitations

 More
 More accurate
accurate and
and informative
informative
product
product costs
costs lead
lead to
to better
better pricing
pricing
decisions.
decisions.
 The
The activities
activities driving
driving costs
costs are
are more
more
accurately
accurately measured.
measured.
 Managers
Managers gaingain easier
easier access
access toto the
the
relevant
relevant costs.
costs.
An
An ABC
ABC system
system is
is very
very expensive
expensive
to
to develop
develop and
and implement,
implement, and
and
very
very time-consuming
time-consuming to to maintain.
maintain.
4-59
When Should a Company Use ABC?

 Indirect
Indirectcosts
costsare
aresignificant
significantin
inproportion
proportionto
todirect
directcosts.
costs.
 Goods
Goodsareare complex,
complex, requiring
requiringmany
many inputs
inputs and
andprocesses.
processes.
 Complex,
Complex, low-volume
low-volumeproducts
products are areprofitable
profitablewhile
while
standard,
standard, high-volume
high-volumeproducts
productsare arenot.
not.
 Different
Differentdepartments
departmentsbelieve
believecosts
costsare
areassigned
assigned
inaccurately.
inaccurately.
 The
Thecompany
companyloses
losesbids
bidsititthought
thought were
werelow,
low, and
andwins
winsbids
bids
itit thought
thoughtwere
werehigh.
high.
 Operations
Operationshave havechanged
changedsignificantly,
significantly,but
butthe
thecosting
costing
system
system hashasnot
notchanged.
changed.
 Introduction
Introductionof ofnew
newmodels
modelsresult
resultin
inhigher
highersales,
sales, apparent
apparent
profits
profitsper
per unit,
unit, but
butan
anoverall
overallincome
incomedecline.
decline.
Activity Based Costing
• Product Costs Appear on the income
statement when
– Direct labor goods are sold, prior
to that time they are
– Direct materials stored on the balance
sheet as inventory.
– Factory Overhead
Appear on the income
• Period Costs statement in the
period incurred.
– Administrative expense
– Sales expense
• Product Costs Direct labor and direct
materials are easy to
– Direct labor trace to products.
– Direct materials The problem comes

with factory
– Factory Overhead overhead.
• Period Costs
– Administrative expense
– Sales expense
• Typically used one rate to allocate overhead to
products.
• This rate was often based on direct labor
dollars or direct labor hours.
• This made sense, as direct labor was a major
cost driver in early manufacturing plants.
Problems with Traditional Costing
Systems
• Manufacturing processes and the products
they produce are now more complex.
• This results in over-costing or under-costing.
– Complex products are not allocated an adequate
amount of overhead costs.
– Simple products get too much.
Today’s Manufacturing Plants
• Are more complex
• Are often automated
• Often make more than one product
• Use proportionately smaller amount of direct
labor making direct labor a poor allocation
base for factory overhead.
When the manufacturing process is
more complex:
• Then multiple allocation bases should be
used to allocate overhead expense.
• In such situations, managers need to
consider using activity based costing
(ABC).
ABC Definitions
• Activity based costing is an approach for
allocating overhead costs.
• An activity is an event that incurs costs.
• A cost driver is any factor or activity that has a
direct cause and effect relationship with the
resources consumed.
ABC Steps
• Overhead cost drivers are determined.
• Activity cost pools are created.
– A activity cost pool is a pool of individual costs
that all have the same cost driver.
• All overhead costs are then allocated to one of
the activity cost pools.
ABC Steps:
• An overhead rate is then calculated for each
cost pool using the following formula:
– Costs in activity cost pool/base
– The base is, of course, the cost driver
• Overhead costs are then allocated to each
product according to how much of each base
the product uses.
Let’s work an example . . .
• Assume that a company makes widgets
• Management decides to install an ABC system
Overhead Cost Drivers are Determined:
• Management decides that all overhead costs
only have three cost drivers—sometimes
called activities (obviously a simplification of
the real world)
– Direct labor hours
– Machine hours
– Number of purchase orders
All overhead costs are then allocated to one of the
activity cost pools.
Direct Labor
General Ledger
Payroll taxes $1,000
Machine maintenance $500
Purchasing Dept. labor $4,000
Fringe benefits $2,000 Machine Hours
Purchasing Dept. Supplies $250
Equipment depreciation $750
Electricity $1,250
Unemployment insurance $1,500
# of Purchase Orders
Which overhead costs do you

think are driven by direct labor
hours?
Direct Labor
General Ledger
Payroll taxes $1,000 $1,000
2,000
Machine maintenance $500 1,500
Purchasing Dept. labor $4,000 $4,500

Equipment depreciation $750
Electricity $1,250
Overhead driver by direct labor

hours
Direct Labor
General Ledger
2,000

$ 500
Equipment depreciation $750 750
1,250
Electricity $1,250
$2,500
Which overhead costs are

driven by machine hours?
Direct Labor
General Ledger
2,000

$ 500
Equipment depreciation $750 750
1,250
Electricity $1,250
$2,500
And finally, which overhead $4,000

costs are driven by # of 250
$4,250
purchase orders?
An overhead rate is then calculated for each cost
pool:
Direct Labor
Again the formulas is:
$1,000
Costs in Activity Cost Pool/Base = rate 2,000
1,500
Assume the following bases: $4,500
Machine Hours
Direct labor hours = 1,000
Machine hours = 250
$ 500
Purchase orders = 100 750
1,250
$2,500
The ABC rates are: # of Purchase Orders

$4,500/1,000 = $4.50 per direct labor hour
$4,000
$2,500/250 = $10 per machine hour
250
$4,250/100 = $42.50 per purchase order $4,250
Overhead costs are then allocated to each
product according to how much of each base the
product uses.
The ABC rates are:
$4,500/1,000 = $4.50 per direct labor hour

$2,500/250 = $10 per machine hour
$4,250/100 = $42.50 per purchase order
Lets assume the company makes two products, Widget A and Widget B:
Let’s also assume that each product uses the following quantity
of overhead cost drivers:
Base Widget A Widget B Total

Notice that
Direct labor hours 400 600 1,000
all base units
Machine hours 100 150 250 are
Purchase orders 50 50 100 accounted
for.
Now let’s allocate overhead to Widget
A:
Base A Rate Allocated
Direct labor hours 400 $ 4.50 $ 1,800.00
Just like we learned in Accounting 2020, we multiply

the base used by the rate.
In this case, 400 hours used to make Widget A is
multiplied by the rate of $4.50. This gives total overhead
applied for this activity cost pool of $1,800 to
Widget A.
Continuing the calculation:
Let’s do the same thing for the other two rates, to get the total amount
of overhead applied to Widget A:
Widget A Base Rate Allocated

Machine hours 100 $ 10.00 $ 1,000.00
Purchase orders 50 $ 42.50 $ 2,125.00
Total $ 4,925.00
Now let’s allocate overhead to Widget
B:
Let’s do the same thing for the other two rates, to get the total amount
of overhead applied.
Widget B Base Rate Allocated

Machine hours 150 $ 10.00 $ 1,500.00
Purchase orders 50 $ 42.50 $ 2,125.00
Total $ 6,325.00
The original overhead to be applied was $4,500 of direct labor

driven overhead + $2,500 of machine hour driven overhead + $4,250 of
purchase order driven overhead = $11,250 total overhead to apply.
The actual overhead allocated was $4,925 for Widget A + $6,350 =

$11,250 overhead applied.
Same Problems Traditional Method
• Okay, so what if we had allocated the
overhead in this company using traditional
cost accounting allocation.
• Let’s assume the base is direct labor hours.
• What would be the amount allocated to each
product?
Calculation
General Ledger
Payroll taxes $1,000 This the total

overhead we were
Machine maintenance $500
given, the total
Purchasing Dept. labor $4,000 amount is $11,250
Fringe benefits $2,000 as explained on
the previous slide.
Equipment depreciation $750 Total direct labor
Electricity $1,250 hours are 1,000, also
given earlier.
Base Widget A Widget B Total

Direct labor hours 400 600 1,000
Machine hours 100 150 250
Purchase orders 40 60 100
Calculation
• The rate would be:
– OH Rate = Overhead/Direct Labor Hours
– $11,250/1,000 = $11.25 per hour.
• Applying overhead using this rate:
– Widget A: 400 hours x $11.25 = $4,500
– Widget B: 600 hours x $11.25 = $6,750
– Total overhead applied = $11,250
Comparison
Widget A Widget B Total
Traditional Method $4,500 $6,750 $11,250
Activity Based $4,925 $6,325 $11,250
Costing
Difference -$425 $425 -0-
Which is more accurate?

ABC Costing!
Note these are total costs. To get per-unit costs we would divide by the
number of units produced.
When do we use ABC costing?
• When one or more of the following conditions
are present:
• Product lines differ in volume and
manufacturing complexity.
• Product lines are numerous and diverse, and
they require different degrees of support
services.
• Overhead costs constitute a significant portion
of total costs.
When do we use ABC costing?
• The manufacturing process or number of
products has changed significantly—for
example, from labor intensive to capital
intensive automation.
• Production or marketing managers are
ignoring data provided by the existing system
and are instead using “bootleg” costing data
or other alternative data when pricing or
making other product decisions.
Additional Uses of ABC
• Activity Based Management (ABM)
– Extends the use of ABC from product costing to a
comprehensive management tool that focuses on
reducing costs and improving processes and
decision making.
ABM
• ABM classifies all activities as value-added or
non-value-added.
– Value-added activities increase the worth of a
product or service to the customer.
• Example: Addition of a sun roof to an automobile.
– Non-value added activities don’t.
• Example: The cost of moving or storing the product
prior to sale.
The Objective of ABM . . .
• To reduce or eliminate non-value related
activities (and therefore costs).
• Attention to ABM is a part of continuous
improvement of operations and activities.
Possible Cost Drivers
• Machine hours
• Direct labor hours
• Number of setups
• Number of products
• Number of purchase orders
• Number of employees
• Number of square feet
Common Classification System
• Unit-level activities. Activities performed for
each unit of production.
• Batch-level activities. Activities performed for
each of bath of products.
• Product-level activities. Activities performed in
support of an entire product line.
• Facility-level activities. Activities required to
sustain an entire production process.
Common Classification System
• This system provides a structured way of
thinking about relationship between activities
and the resources they consume.
Facility Sustaining Activities
• Have no good cost driver
• May or may not be allocated to products
depending upon the purpose for which the
information is to be used
• Examples
– Housekeeping
– Factory yard maintenance
Manufacturing Systems
• Traditional
– “Just-in-Case.”
• Inventories of raw materials are maintained just in case
some items are of poor quality or key suppliers don’t
delivery on time.
– Push approach manufacturing.
• Materials are pushed through the manufacturing
process.
– Based on standard costs. Once a standard is
reached improvement ceases.
Manufacturing Systems
• Progressive
– “Just in Time.”
• Raw materials arrive just in time for use in production.
• Finished goods are manufactured just in time to meet
customer needs.
– Pull approach manufacturing.
• Raw materials are not put into the process until the
next department requests them.
– Continuous quality improvement.
Three important elements must exist
for JIT systems to work:
• Dependable suppliers who can delivery on
short notice.
• Multiskilled workforce who can work in work
cells or work stations.
– One worker may operate several kinds of
machines.
• Total quality management. Objective is no
defects.
Objectives of JIT
• Reduction or elimination of inventories
• Enhanced production quality
• Reduction or elimination of rework costs
• Production cost savings from improved flow of
goods through the process.
TERIMA KASIH
Tugas
1. Mengapa metode akuntansi biaya tradisional sudah tidak tepat untuk
digunakan pada perusahaan yg berproduksi dengan teknologi tinggi?
2. Apa yang dimaksud dengan ABC, dan mengapa lebih cocok digunakan
sebagai penentu HPP?
3. Apa yg dimaksud dengan activity, activity cost, resource, resource cost,
cost driver, cost object, activity pool
4. Sebut keunggulan dan kelemahan ABC
5. Sebutkan hirarki biaya dalam ABC
6. Jelaska dengan yg dimaksud teori kendala
7. Jelaskan langkah-langkah menyusun ABC

Activity-Based Costing Systems: Mcgraw-Hill/Irwin

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Activity-Based Costing Systems: Mcgraw-Hill/Irwin

Uploaded by

Copyright:

Available Formats

9

Traditional Costing Systems

Traditional Costing Systems

Traditional Costing Systems

Overhead Rate = $120 ÷ 8 direct labor hours

Job 1 = 2 hours × $15 per hour = $30

Traditional Costing Systems

The company introduces

Traditional Costing Systems

Overhead Rate = $420 ÷ 3 direct labor hours

Job 1 = 2 hours × $140 per hour = $280

Traditional Costing Systems

Is this a reasonable costing method?

Activity-Based Costing (ABC)

Activity-Based Costing (ABC)

Design Machine Customer

Activity-Based Costing (ABC)

ABC Compared with Traditional Costing

ABC Compared with Traditional Costing

Directly traced Directly traced

Cost Pools: Cost Pools:

Activity-Based Costing (ABC)

Four Steps in the ABC Process

 Identify and Classify Activities

 Identify and Classify Activities

 Estimate the Cost of Activities

 Calculate Cost-Driver Rates for

 Calculate Cost-Driver Rates for

 Calculate Cost-Driver Rates for

 Calculate Cost-Driver Rates for

Practical Capacity Note

Practical Capacity Note

80%, or $800 20%, or $200 should

 Assign Activity Costs to Products

 Assign Activity Costs to Products

Example: Yazz, Inc. produces 130,000 units of Product A

 Assign Activity Costs to Products

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Bilson’s unit product costs using

Bilson marks its products up by 50 percent and allocates

Activity-Based Costing Example

Sales Revenue $ 975,000 $ 3,900,000

$975,000 ÷ ($975,000 +$3,900,000) × $500,000

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Management has identified the following five activities

Total conversion cost

Activity-Based Costing Example

The following transaction data has been

Activity Total Product A Product B

Activity-Based Costing Example

These data can be used to develop predetermined

Total Rate per

$ 800,000 ÷ 5,000 Machine setups = $160.00 per setup

Activity-Based Costing Example

The activity-based overhead rates we just calculated

Activity-Based Costing Example

The activity-based overhead rates we just calculated

Activity-Based Costing Example

The activity-based overhead rates we just calculated