Activity Based Costing: A Tool to Aid Decision Making
Activity Based Costing: A Tool to Aid Decision Making Activity Based Costing (ABC) Both Both manufacturing manufacturing and and nonmanufacturing nonmanufacturing costs costs may may be be assigned assigned to to products. products. AA number number of of cost cost pools pools each each allocated allocated to to aa product product or or cost cost object. object. Some Some manufacturing
manufacturing costs costs may may be be excluded excluded from from product product costs. costs. Allocation Allocation bases bases often often differ differ from from traditional traditional costing costing systems. systems. Overhead Overhead rates rates may may be be based based on on activity activity at at capacity. capacity. How Costs are Treated Under Activity-Based Costing
Activity Activity Based Based Costing Costing Departmental Departmental Overhead Overhead Rates Rates Plantwide Plantwide Overhead Overhead Rate Rate ty i x e pl m o C f o l e v Le Overhead Allocation Cost of Idle Capacity Traditional Cost Accounting The predetermined overhead rate is
based on budgeted activity. This results in applying overhead costs of unused, or idle, capacity. Activity Based Costing Products are charged for the costs of capacity they use not for the costs of capacity they dont use. Difference Between ABC and Traditional Product Costs Batch-level or product-level costs will ordinarily shift overhead costs from high-volume products produced in large batches to low-volume products produced in small batches. Under ABC both manufacturing and nonmanufacturing costs may be assigned to products. Organizationsustaining costs and the costs of idle capacity are not assigned to products. Designing an ABC System
Cost Objects (e.g., products and customers) Activities Consumption of Resources Cost Designing of an ABC System Steps for Implementing ABC Identify and define activities and activity cost pools. Trace costs to activities and cost objects. Assign costs to activity cost pools. Calculate activity rates. Assign costs to cost objects. Identify and Define Activities and Activity Cost Pools Unit-Level Batch-Level Activity Activity A part of the production process for which management wants a separate reporting of the
costs of the activity involved. Product-Level Activity Organizationsustaining Activity Customer-Level Activity Identify and Define Activities and Activity Cost Pools Activity Cost Pool is a bucket in which costs are accumulated that relate to a single activity measure in the ABC system. $$ $ $ $ $ Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs
Overhead Costs First-Stage Allocation Activity 1 Activity 2 Activity 3 Activity 4 Cost Objects: Products, Products, Customer Customer Orders, Orders, Customers Customers Other Assign Costs to Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. Activity Cost Pools Customer Product Order Orders Design Size Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Shipping costs ** General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries
**Not included because they are directly traced to customer orders. Assign Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and NonManufacturing) Activity 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 $ 125,000 Production Department Indirect factory wages $ CostFactory Poolsequipment depreciation Product Order Customer Factory utilities Factory building Design Sizelease Relations
Shipping costs traced to customer orders General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total overhead costs 500,000 300,000 120,000 80,000 $ Other 400,000 50,000 60,000 1,000,000 Total 40,000 510,000 250,000 50,000 $ Indirect $500,000 Indirect factory factory wages wages $500,000 Percent 25% Percent consumed consumed by by customer
customer orders orders 25% $125,000 $125,000 300,000 1,850,000 Assign Costs to Activity Cost Pools Activity Cost Pools Customer Product Orders Design 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 Order Size Customer Relations Other Total
- 160,000 22,500 60,000 400,000 50,000 60,000 50,000 5,000 $ 315,000 25,000 $ 257,000 $ 380,000 150,000 35,000 $ 367,500 25,000 10,000 $ 490,500 250,000 50,000 $ 1,810,000 Calculate Activity Rates The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .
1,000 customer orders 200 new designs 20,000 machine-hours 100 customer relations activities Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels. Calculate Activity Rates Computation of Activity Rates Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost $ 315,000 257,000 380,000 367,500 490,500 (b) Total Activity 1,000 orders 200 designs 20,000 MHs 100 customer Not applicable (a) (b) Activity Rate $315 per order $1,285 per design $19 per MH $3,675 per customer
Not applicable Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs Traced Traced Traced Traced Cost Objects: Products, Products, Customer Customer Orders, Orders, Customers Customers Overhead Costs Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs
Assigning Costs to Cost Objects Lets take a look at how our system works for just one customer Windward Yachts. Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours . 3. Selling price is $34 each. 4. Direct materials total $2,110. 5. Direct labor totals $1,850. 6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours . 3. Selling price is $650 each. 4. Direct materials total $13. 5. Direct labor totals $50. 6. Shipping costs total $25. Assigning Costs to Cost Objects Overhead Cost for the Standard Stanchions Activity Cost Pools Customer orders Product design Order size Customer relations (a) Activity Rate $ 315 1,285 19 3,675 The customer-level cost is assigned to customers directly; it is not assigned to
315 1,285 76 Limitations of ABC ABC systems are a major project requiring substantial resources. The benefits of increased accuracy must outweigh these additional costs. ABC produces numbers, like product margins, that are at odds with numbers produced by traditional costing system. Some managers find it difficult to adjust to this change. ABC data can be misinterpreted and must be used with care when making decisions.
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