Activity Accounting: Another Way to Measure Costs

UAA – ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee

Issues in Managerial Accounting

Mgmt. Acct.

Yeah! A look at managerial

accounting issues!

DirectMaterials

DirectMaterials

DirectLabor

DirectLabor

Mfg.Overhead

Mfg.Overhead

Work-in-Process

Work-in-Process

FinishedGoods

FinishedGoods

Cost-ofGoods Sold

Cost-ofGoods Sold

Cost Measurement

Cost Accumulation

Cost Assignment

Goal: Accurately costed products.

Mgmt. Acct.

Cost Measuremen

t

Actual Costing System

Normal Costing System

Standard Costing System

Measuring Costs

Mgmt. Acct.

Cost Accumulation

Cost Accounting Systems

Product Costs

Job-Order Costing Process Costing

Total/Unit Cost

Mgmt. Acct.

Cost Assignment

Assigning Manufacturing Costs

Functional Based Costing

Activity Based Costing

Functional Based Costing

DirectMaterials

DirectMaterials

DirectLabor

DirectLabor

Mfg.Overhead

Mfg.Overhead

Work-in-Process

Work-in-Process

FinishedGoods

FinishedGoods

Cost-ofGoods Sold

Cost-ofGoods Sold

Cost of Goods SoldCost of Goods Sold

NonmanufacturingExpenses

NonmanufacturingExpenses

Sales

-= Gross Margin

-Net Income=

Income Statement

Sold

Pro

du

ct Co

sts

Period Costs

Goal: Accurately costed products

Timeliness is critical

DirectMaterials

DirectMaterials

DirectLabor

DirectLabor

Mfg.Overhead

Mfg.Overhead

Work-in-Process

Work-in-Process

FinishedGoods

FinishedGoods

Cost-ofGoods Sold

Cost-ofGoods Sold

These are not a problem. We can directly trace these to the product.

The problem lies here - in the manufacturing overhead.

Do you like peanut butter as much as I

do?

How do you make a peanut butter sandwich?

OK, let’s apply that same idea to product costing.

Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.

When, in fact, the individual product, services, etc., may use those resources in a nonuniform way.

Resources

Functions

Products

EfficiencyAnalysis

Performance Analysis

Functional-Based Management Model

Cost View

Operational View

DirectMaterials

DirectMaterials

DirectLabor

DirectLabor

Mfg.Overhead

Mfg.Overhead

Work-in-Process

Work-in-Process

FinishedGoods

FinishedGoods

Cost-ofGoods Sold

Cost-ofGoods Sold

These are not a problem. We can directly trace these to the product.

The problem lies here - in the manufacturing overhead.

Budgeted Overhead POR = --------------------------------------- Budgeted Activity Usage

Predetermined Overhead Rate (POR)

Estimated Overhead

Estimated Activity Base

Let’s take a closer look at calculating the predetermined overhead rate (POR)

Functional-Based Costing:Plantwide Rate

Overhead Costs

Assign Costs

Plantwide Pool

Assign Costs

Products

Direct Tracing

Stage One: Pool Formation

Unit-Level Driver

Stage Two: Costs Assigned

Plantwide Rates; Overhead Variance

Brooks Manufacturing uses a normal costing system. Budgeted overhead for the coming year is $1,500,000. Expected actual activity is 400,000 direct labor hours. During the year, Brooks worked a total of 384,000 direct labor hours and actual overhead totaled $1,400,000.

Required:

Compute the POR for Brooks Manufacturing.

Compute the applied overhead.

Compute the overhead variance and label it as underapplied or overapplied.

Explain why predetermined rates are used.

Summary of Overhead Concepts

Estimated Overhead Cost

Actual Overhead Cost

Applied Overhead Cost

The amount of estimated

overhead costs.

The amount of overhead costs

actually incurred.

The amount of overhead costs applied to WIP.

Compute the Predetermined Overhead Rate (POR) . . .

Estimated Total MOH Costs POR = -------------------------------------------- Estimated Total Units in Base

Estimated Total MOH Costs POR = -------------------------------------------- Estimated Direct Labor Hours

Compute the Predetermined Overhead Rate (POR) . . .

$1,500,000 ------------------- = $3.75 Per DLH 400,000

Estimated Total MOH Costs POR = -------------------------------------------- Estimated Direct Labor Hours

Required:

Compute the POR for Brooks Manufacturing.

Compute the applied overhead.

Compute the overhead variance and label it as underapplied or overapplied.

Explain why predetermined rates are used.

DM Inv.

WIP Inv.

FG Inv.

Manufacturing Costs Balance Sheet

Unfinished

Finished

UnusedUsed

Used

Applied

DM

DL

MOH

Dir

ec

tly

D

ire

ctl

y

Tra

ced

Tra

ced

WIP

Overhead is applied by multiplying the number of direct labor hours actually

worked times the predetermined overhead rate (POR).

384,000 x $3.75 = $1,440,000

Required:

Compute the POR for Brooks Manufacturing.

Compute the applied overhead.

Compute the overhead variance and label it as underapplied or overapplied.

Explain why predetermined rates are used.

Summary of Overhead Concepts

Estimated Overhead Cost

Actual Overhead Cost

Applied Overhead Cost

The amount of estimated overhead

costs.

The amount of overhead costs

actually incurred.

The amount of overhead costs applied to WIP.

Difference equals Under- or Over- applied Overhead.

The Manufacturing Overhead Account

Overhead Applied to WIP

Amounts rarely agree

MOH Control

A “Clearing” Account

xxx xxx

Actual Overhead Costs

Calculating the Overhead Variance

Actual OH

Applied OH

Overhead Control

$1,400,000 $1,440,000

$40,000

Given Calculated

Functional-Based Costing:Departmental Rates

Overhead CostsOverhead Costs

Assign CostsAssign Costs

Department A Pool

Assign Costs

Products

Department B Pool

Assign Costs

Products

Stage One: Pool Formation

Unit-Level Drivers

Stage Two: CostsAssigned

Refining A Cost System

Refining a Cost System

Reclassify indirect costs as direct costs.

Define more cost pools.

Identify cost drivers.

Use Activity-Based Costing.

Resources

Activities

Products & Customers

Driver Analysis

Performance Analysis

Activity-Based Management Model

Cost View

Operational View

Activity Vs. Plantwide OH Rates; Resource Drivers;

Activity Drivers;

Milan Machining Company has identified the following OH activities, costs, and activity drivers for the coming year:

Activity

Expected Cost

Activity Driver

Activity Capacity

Setup $60,000 # of Setups 300

Inspecting 45,000 Insp. Hours 4,500

Grinding 90,000 MH 18,000

Receiving 25,000 # of Parts 50,000

The company produces several different machine subassemblies used by other manufacturers. Information on separate batches for two of these subassemblies follows:

Item

Subassembly

A B

Direct Materials $850 $950

Direct Labor $600 $600

Units Completed 100 50

Number of Setups 1 1

Inspection Hours 4 2

Machine Hours 20 30

Parts Used 20 40

The company’s normal activity is 4,000 direct labor hours.

Each batch uses 50 hours of direct labor.

Required:

2. Determine the unit cost for each product using direct labor hours to apply overhead.

Calculate the POR using DLH.

Activity

Expected Cost

Activity Driver

Activity Capacity

Setup $60,000 # of Setups 300

Inspecting 45,000 Insp. Hours 4,500

Grinding 90,000 MH 18,000

Receiving 25,000 # of Parts 50,000

Normal Activity in

DLH

Subassembly

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead ($55 x 50) 2,750 2,750

Total Costs $4,200 $4,300

Units 100 50

Unit Cost $42.00 $86.00

Each batch uses 50 DLH

Each batch uses 50 DLH

Subassembly

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead ($55 x 50) 2,750 2,750

Total Costs $4,200 $4,300

Units 100 50

Unit Cost $42.00 $86.00

Required:

3. Determine the unit cost for each product using the four activity drivers.

Setup: $60,000/300 = $200/Setup

Inspecting: $45,000/4,500 = $10/IH

Grinding: $90,000/18,000 = $5/MH

Receiving $25,000/50,000 = $0.50/Part

Pool Rates:

Setup: $60,000/300 = $200/Setup

Inspecting: $45,000/4,500 = $10/IH

Grinding: $90,000/18,000 = $5/MH

Receiving $25,000/50,000 = $0.50/Part

Activity

Expected Cost

Activity Driver

Activity Capacity

Setup $60,000 # of Setups 300

Inspecting 45,000 Insp. Hours 4,500

Grinding 90,000 MH 18,000

Receiving 25,000 # of Parts 50,000

Now . . . Use the Pool Rates we just calculated

Item

Subassembly

A B

Direct Materials $850 $950

Direct Labor $600 $600

Units Completed 100 50

Number of Setups 1 1

Inspection Hours 4 2

Machine Hours 20 30

Parts Used 20 40

These are the activities for each

subassembly.

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead:

Setup ($200x1; $200x1) 200 200

Inspecting ($10x4; $10x2) 40 20

Grinding ($5x20; $5x30) 100 150

Receiving ($.5x20; $.5x40) 10 20

Total Costs $1,800 $1,940

Units 100 50

Unit Cost $18.00 $38.80

These haven’t

changed.

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead:

Setup ($200x1; $200x1) 200 200

Inspecting ($10x4; $10x2) 40 20

Grinding ($5x20; $5x30) 100 150

Receiving ($.5x20; $.5x40) 10 20

Total Costs $1,800 $1,940

Units 100 50

Unit Cost $18.00 $38.80

Here is the MOH using ABC.

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead:

Setup ($200x1; $200x1) 200 200

Inspecting ($10x4; $10x2) 40 20

Grinding ($5x20; $5x30) 100 150

Receiving ($.5x20; $.5x40) 10 20

Total Costs $1,800 $1,940

Units 100 50

Unit Cost $18.00 $38.80

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead:

Setup ($200x1; $200x1) 200 200

Inspecting ($10x4; $10x2) 40 20

Grinding ($5x20; $5x30) 100 150

Receiving ($.5x20; $.5x40) 10 20

Total Costs $1,800 $1,940

Units 100 50

Unit Cost $18.00 $38.80

Subassembly

Sub. A Sub. B

Direct Materials $850 $950

Direct Labor 600 600

Overhead ($55 x 50) 2,750 2,750

Total Costs $4,200 $4,300

Units 100 50

Unit Cost $42.00 $86.00