Chapter 5 Activity-Based Costing and Management MBA 631 Dr. Luchs Ball State University.

Chapter 5Chapter 5

Activity-Based Costing and Management

Activity-Based Costing and Management

MBA 631Dr. LuchsBall State University

Learning Objective

1

Learning Objective

1

5-2

Traditional, Volume-Based Traditional, Volume-Based Product-Costing SystemProduct-Costing System

• Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.

• The following information is obtained from company records:

• Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III.

• The following information is obtained from company records:

Mode I Mode I I Mode I I IProduction: Units 10,000 20,000 4,000 Runs 1 run of 10,000

units 4 runs of

5,000 units 10 runs of 400 units

5-3


Additional information includes:Mode I Mode I I Mode I I I

Direct materials 50.00$ 90.00$ 20.00$ Direct labor (hr/board) 3 4 2 Setup time (hr/run) 10 10 10 Machine time (hr/board) 1 1.25 2

Manufacturing overhead is determined as follows5-4


Budgeted manufacturing overhead Budgeted manufacturing overhead $3,894,000 $3,894,000 Budgeted direct-labor hours 118,000Budgeted direct-labor hours 118,000 = $33 per hour= $33 per hour

5-5


With these product costs, Aerotech established target selling prices (Cost × 125%).

209.00 x 1.255-6

Learning Objective

2

Learning Objective

2

5-7

Activity Based Costing System Activity Based Costing System (ABC)(ABC)

ABC systems follow a two-stagetwo-stage procedure to assign overhead costs to products.

Stage OneIdentify significant activities and assign overhead costs to each activity in proportion to resources used.

Stage TwoIdentify cost drivers appropriate to each activity and allocate overhead to the products.

5-8

Learning Objective

3

Learning Objective

3

5-9

Overhead CostsOverhead CostsTotal budgeted cost = $3,894,000Total budgeted cost = $3,894,000

ActivityActivityCostCostPoolsPools

MachineryMachinerycost poolcost pool

$1,212,600$1,212,600

SetupSetupcost poolcost pool$3,000$3,000

EngineeringEngineeringcost poolcost pool$700,000$700,000

FacilityFacilitycost poolcost pool$507,400$507,400

UnitLevel

BatchLevel

Product-Sustaining

Level

FacilityLevel

Identificationof ActivityCost Pools

Identificationof ActivityCost Pools

ActivityActivitymust bemust bedone ondone oneach uniteach unitproduced.produced.

ActivityActivityperformedperformedon eachon eachbatchbatch

produced.produced.

Activities needed to supportActivities needed to supportan entire product linean entire product line

Activity required in orderActivity required in orderfor the productionfor the productionprocess to occur.process to occur.

5-10

Receiving/InspectionReceiving/Inspectioncost pool cost pool $200,000$200,000

Material-HandlingMaterial-Handlingcost pool cost pool $600,000$600,000

Quality-AssuranceQuality-Assurancecost pool cost pool $421,000$421,000

Packaging/ShippingPackaging/Shippingcost pool cost pool $250,000$250,000

MachineryMachinerycost poolcost pool

$1,212,600$1,212,600

SetupSetupcost poolcost pool$3,000$3,000

EngineeringEngineeringcost poolcost pool$700,000$700,000

FacilityFacilitycost poolcost pool$507,400$507,400

UnitLevel

BatchLevel

Product-Sustaining

LevelFacilityLevel

5-11

Learning Objectives

3 & 4

Learning Objectives

3 & 4

5-12

Machinery Cost PoolMachinery Cost PoolTotal budgeted cost = $1,212,600

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

ActivityActivitycostcostpoolpool

STAGE ONESTAGE ONE

Various overheadVarious overheadcosts relatedcosts relatedto to machinerymachinery

5-13

CalculateCalculatethe poolthe pool

raterate

Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour$28.20/hour

CostCostAssignmentAssignment

STAGE TWOSTAGE TWO

=

=

5-14

Calculation ofCalculation oftotal total setup costsetup cost

Setup Cost PoolSetup Cost PoolTotal budgeted cost = $3,000


STAGE ONESTAGE ONE

5-15


raterate

Budgeted Setup Costs $3,000Planned Production Runs 15 runs $200 per run$200 per run


STAGE TWOSTAGE TWO

=

=

5-16

Various overheadVarious overheadcosts relatedcosts related

to to engineeringengineering

Engineering salaries

Engineering supplies

Engineering software

Depreciation

Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000


STAGE ONESTAGE ONE

5-17

Allocate basedAllocate basedon on engineeringengineering

transactionstransactions


STAGE TWOSTAGE TWO

Engineering Cost PoolEngineering Cost PoolTotal budgeted cost = $700,000

5-18

Various overheadVarious overheadcosts relatedcosts related

to to generalgeneraloperationsoperations

Plant depr.

Plant mgmt.

Plant maint.

Property taxes

Insurance

Security

Facility Cost PoolFacility Cost PoolTotal budgeted cost = $507,400


STAGE ONESTAGE ONE

5-19

Budgeted Facilities Cost $507,400Budgeted Direct-Labor Hours 118,000 $4.30/hour$4.30/hour


STAGE TWOSTAGE TWO

=

=


raterate

5-20

Other Overhead CostsOther Overhead CostsBoard Overhead × % ÷ Units = Cost/UnitMode I 200,000$ × 6% ÷ 10,000 = 1.20$ Mode II 200,000 × 24% ÷ 20,000 = 2.40 Mode III 200,000 × 70% ÷ 4,000 = 35.00

Receiving and Inspection Cost Pool

Board Overhead × % ÷ Units = Cost/UnitMode I 600,000$ × 7% ÷ 10,000 = 4.20$ Mode II 600,000 × 30% ÷ 20,000 = 9.00 Mode III 600,000 × 63% ÷ 4,000 = 94.50

Material-Handling Cost Pool


Quality-Assurance Cost Pool


Packaging and Shipping Cost Pool

5-21


Packaging and Shipping Cost Pool


Quality-Assurance Cost Pool

Other Overhead CostsOther Overhead Costs


Receiving and Inspection Cost Pool


Material-Handling Cost Pool

$14.82$14.82

5-22

Product Cost from ABCProduct Cost from ABCThese are the new product costs when Aerotech

uses ABC.

5-23

Learning Objective

5

Learning Objective

5

5-24

Distorted Product CostsDistorted Product CostsBoth original and ABC target selling prices are

based on (Cost × 125%).

[$209.00 × 1.25] [$183.44 × 1.25]

The selling price of Mode I and II are reducedThe selling price of Mode I and II are reducedand the selling price for Mode III is increased.and the selling price for Mode III is increased.

5-25

Can you identify any problems Aerotech is likely to face as a result of this distortion?

Traditional costing understates the costTraditional costing understates the costof complex, low volume products.of complex, low volume products.

Distorted Product CostsDistorted Product Costs

5-26

Two Key PointsTwo Key Points

A large proportion of non-unit-level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately.

A large proportion of non-unit-level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately.

Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs.

Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs.

5-27

Learning Objective

6

Learning Objective

6

5-28

Cost DriversCost Drivers

A characteristic of an event or activity that results in the incurrence of costs. In selecting a cost

driver, we must consider . . .

Degree ofDegree ofCorrelationCorrelation

Cost ofCost ofMeasurementMeasurement

BehavioralBehavioralEffectsEffects

5-29

Learning Objective

7

Learning Objective

7

5-30

COLLECTING ABC DATACOLLECTING ABC DATA

INTERVIEWS AND PAPER TRAILS - The information for ABC systems initially comes from interviews with employees in the support departments and a review of each department’s records.

STORYBOARDING - A procedure used to develop a detailed process flow chart, which visually represents activities and the relationships among activities.

MULTIDISCIPLINARY ABC PROJECT TEAMS – To gather information from all facets of an organizations operations, it is essential to involve personnel from a variety of functional areas. A typical ABC project team includes ACCOUNTING, FINANCE, PRODUCTION, OPERATIONS, ENGINEERS, MARKETING etc.

5-31

Learning Objective

8

Learning Objective

8

5-32

Activity-Based ManagementActivity-Based Management

The use ofABC costing information

to helpmanagement

make decisions

5-33

Activity-Based ManagementActivity-Based Management

Activity-based costing establishes relationshipsbetween overhead costs and activities so that

we can better allocate overhead costs.

Activity-based management focuses on managing activities to reduce costs.

5-34

Two-Dimensional ABC and Two-Dimensional ABC and Activity-Based ManagementActivity-Based Management

Activities

5-35


Cost ObjectsCost ObjectsCost ObjectsCost Objects

Activities

Resource costsResource costsResource costsResource costs

Cost Assignment ViewCost Assignment View

5-36


ActivityActivityTriggersTriggersActivityActivityTriggersTriggers

Cost ObjectsCost ObjectsCost ObjectsCost Objects

ActivitiesRootRoot

CausesCausesRootRoot

CausesCauses

Process ViewProcess ViewActivity AnalysisActivity Analysis

Resource costsResource costsResource costsResource costs

Cost Assignment ViewCost Assignment View

PerformancePerformanceMeasuresMeasures

PerformancePerformanceMeasuresMeasures

Activity EvaluationActivity Evaluation

5-37

Elimination of Non-Value-Added Elimination of Non-Value-Added CostsCosts

Nonvalue-added

activities

NecessaryNecessaryUnnecessaryUnnecessary

ActivitiesActivities

Reduce orReduce orEliminateEliminate

Continually Evaluate Continually Evaluate

and Improveand Improve 5-38

Using ABM to Eliminate Non-Using ABM to Eliminate Non-Value-Added Activities and CostsValue-Added Activities and Costs

1. Identify Activities.

2. Identify Non-Value-Added Activities.

3. Understand Activity Linkages, Root Causes, and Triggers.

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

SpecifySpecifypartsparts

SpecifySpecifypartsparts

SelectSelectvendorvendorSelectSelectvendorvendor

ReceiveReceivepartsparts

ReceiveReceivepartsparts

ProduceProducegoodsgoods

ProduceProducegoodsgoods

InspectInspectfinishedfinishedgoodsgoods

InspectInspectfinishedfinishedgoodsgoods

ReworkReworkdefectivedefectiveproductsproducts

ReworkReworkdefectivedefectiveproductsproducts

5-39

Using ABM to Eliminate Non-Using ABM to Eliminate Non-Value-Added Activities and CostsValue-Added Activities and Costs

Inspection time

Process time

Storage time

Move time Waiting time

5-40

Learning Objective

9

Learning Objective

9

5-41

Customer Profitability AnalysisCustomer Profitability Analysis

Customer profitability analysis usesactivity-based costing to determine

the activities, costs, and profit associated with serving particular customers.

5-42


Orderssmall

quantities.

Ordersfrequently.

Oftenchangesorders.

Requiredspecial

packaging.

Demandfast

service.

A costly customer 5-43


Customer-Related Activities Cost Driver Base Cost Drive

Rate Order processing Purchase orders 150$ Sales contacts (phone calls, faxes, etc.) Contacts 100 Sales visits Visits 1,000 Shipment processing Shipments 200 Billing and collection Invoices 160 Design/engineering change orders Design changes 4,000 Special packaging Units packaged 40 Special handling Units handled 60

Customer-Related Activities Cost Driver Base Cost Drive

Rate Order processing Purchase orders 150$ Sales contacts (phone calls, faxes, etc.) Contacts 100 Sales visits Visits 1,000 Shipment processing Shipments 200 Billing and collection Invoices 160 Design/engineering change orders Design changes 4,000 Special packaging Units packaged 40 Special handling Units handled 60

A company may use these customerrelated costs to help determine the

profitability of each customer.

A company may use these customerrelated costs to help determine the

profitability of each customer.

5-44

Customer Profitability AnalysisCustomer Profitability AnalysisCustomer Profitability

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25.0%

50.0%

75.0%

100.0%

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5-45

Learning Objective

10

Learning Objective

10

5-46

Activity-Based Management in the Activity-Based Management in the Service IndustryService Industry

Activity Analysis

CustomerProfitability

Analysis

5-47

Learning Objective

11

Learning Objective

11

5-48

Just-in-Time Inventory and Just-in-Time Inventory and Production ManagementProduction Management

No materials are purchased and no products are manufactured until they are needed.

The primary goal of aThe primary goal of aJIT production system isJIT production system is

to reduce or eliminateto reduce or eliminateinventories at everyinventories at everystage of production.stage of production.

The primary goal of aThe primary goal of aJIT production system isJIT production system is

to reduce or eliminateto reduce or eliminateinventories at everyinventories at everystage of production.stage of production.

5-49

Key Features of the JIT ApproachKey Features of the JIT Approach

Smooth, uniform production rate

Pull method of production

Purchase is small lot sizes

Quick, inexpensive setups

High quality materials

Effective preventive maintenance

Teamwork

Multiskilled workers

5-50

JIT PurchasingJIT Purchasing

Long-termLong-termcontracts withcontracts with

suppliers.suppliers.

Long-termLong-termcontracts withcontracts with

suppliers.suppliers.

Only a fewOnly a fewsuppliers.suppliers.

Only a fewOnly a fewsuppliers.suppliers.

Parts deliveredParts deliveredin small lots.in small lots.

Parts deliveredParts deliveredin small lots.in small lots.

MinimalMinimalinspection ofinspection of

materials.materials.

MinimalMinimalinspection ofinspection of

materials.materials.

GroupedGroupedpayments topayments to

vendor.vendor.

GroupedGroupedpayments topayments to

vendor.vendor.

5-51

End of Chapter 5End of Chapter 5This is

my kind of cost pool!

5-52

Practice ProblemsProblem 5-46Problem 5-49

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Chapter 5 Activity-Based Costing and Management MBA 631 Dr. Luchs Ball State University.

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