Jordan Managment Accounting 41

8/8/2019 Jordan Managment Accounting 41

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Activity-Based Costing: ATool to Aid Decision Making


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Activity Based Costing (ABC)

ABC is designed to providemanagers with cost

information for strategic andother decisions thatpotentially affect capacity

and therefore affect fixed aswell as variable costs.

ABC is agood supplementto our traditional

cost systemI agree!


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Learning Objective 1

Understand activity-basedUnderstand activity-basedcosting and how it differscosting and how it differsfrom a traditional costingfrom a traditional costing

system.system.


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How Costs are Treated Under ActivityBased Costing

ABC differs from traditional cost accounting in three ways.


Manufacturing

costs

Nonmanufacturing

costs

ABC assigns both types of costs to products.

Traditionalproduct costing

ABCproduct costing


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ABC does not assign all manufacturing costs to products.

Manufacturing

costs

Nonmanufacturing

costs

Traditionalproduct costing

ABCproduct costing

A l l M o s t , b u t n o t a l l

S o m e




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PlantwideOverhead

Rate

PlantwideOverhead

Rate

DepartmentalOverhead

Rates

DepartmentalOverhead

Rates

ActivityBasedCosting

ActivityBasedCosting

Number of cost pools

Level ofcomplexity

ABC uses more cost pools.




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Activity An event that causes theconsumption of overheadresources.

ActivityCost Pool

A cost bucket in whichcosts related to a particular

activity measure areaccumulated.

$

$

$ $

$$



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ActivityMeasureActivity

Measure

An allocation basein an activity-based

costing system.

An allocation basein an activity-based

costing system.


The term cost driver isalso used to refer toan activity measure.

The term cost driver isalso used to refer toan activity measure.


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Simple countof the number of times an activity

occurs.

Transactiondriver

A measureof the amount

of time neededfor an activity.

Durationdriver

Two common types of activitymeasures:



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Traditional cost systems usually rely on volumemeasures such as direct labor hours and/or machine

hours to allocate all overhead costs to products.

Traditional cost systems usually rely on volumemeasures such as direct labor hours and/or machine

hours to allocate all overhead costs to products.

ABC definesABC definesfive levels of activityfive levels of activity

that largely do not relatethat largely do not relateto the volume of unitsto the volume of units

produced.produced.


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ManufacturingManufacturingcompanies typically combinecompanies typically combinetheir activities into fivetheir activities into five

classifications.classifications.

Unit-LevelUnit-LevelActivityActivity

Batch-LevelBatch-LevelActivityActivity

Product-LevelProduct-LevelActivityActivity

Customer-LevelCustomer-LevelActivityActivityOrganization-Organization-

sustainingsustaining

ActivityActivity



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Characteristics of SuccessfulABC Implementations

Strong topmanagement supportStrong topmanagement support

Cross-functionalinvolvement

Cross-functionalinvolvement

Link to evaluationsand rewards

Link to evaluationsand rewards


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Classic Brass An ABCExample

SalesCost of goods sold 3,200,000$

Direct materials 975,000$Direct labor 351,250 Manufacturing overhead 1,000,000 2,326,250

Gross margin 873,750 Selling and administrative expenses

Shipping expenses 65,000

Marketing expenses 300,000 General administrative expenses 510,000 875,000

Net operating loss (1,250)$

Classic BrassIncome Statement Year Ended December 31, 2005

Manufacturing overhead is allocated to products using

a single plantwide overhead rate based on machine hours.

Manufacturing overhead is allocated to products using

a single plantwide overhead rate based on machine hours.


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Define Activities, Activity CostPools,

and Activity Measures

At Classic Brass, the ABC team, selected the followingactivity cost pools and activity measures:

At Classic Brass, the ABC team, selected the followingactivity cost pools and activity measures:

Activity Cost Pool Activity MeasureCustomer orders Number of customer ordersProduct design Number of product designsOrder size Machine-hoursCustomer relations Number of active customersOther Not applicable

Activity Cost Pools at Classic Brass


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Customer Orders - assigned all costs of resources that are consumed by taking andprocessing customer orders.

Product Designs - assigned all costs of resources consumed by designing products.

Order Size - assigned all costs of resourcesconsumed as a consequence of the number of units produced.

Customer Relations assigned all costsassociated with maintaining relations withcustomers.

Other assigned all overhead costs that are

not associated with the other cost pools.

Customer Orders - assigned all costs of resources that are consumed by taking andprocessing customer orders.

Product Designs - assigned all costs of resources consumed by designing products.

Order Size - assigned all costs of resourcesconsumed as a consequence of the number of units produced.

Customer Relations assigned all costsassociated with maintaining relations withcustomers.

Other assigned all overhead costs that are

not associated with the other cost pools.

Define Activities, Activity Cost Pools,and Activity Measures


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Assign costs to cost poolsAssign costs to cost poolsusing a first-stageusing a first-stage

allocation.allocation.


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Production DepartmentIndirect factory wages 500,000$Factory equipment deprecia tion 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

General Administrative DepartmentAdministrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000

Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000

Total overhead costs 1,810,000$

Overhead Costs at Classic Brass(Manufacturing and Nonmanufacturing)

ss gn ver ea os sto Activity Cost Pools


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Production DepartmentIndirect factory wages 500,000$Factory equipment deprecia tion 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

General Administrative DepartmentAdministrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000

Marketing DepartmentMarketing wages and salaries 250,000 Selling expenses 50,000 300,000

Total overhead costs 1,810,000$



Direct materials, direct labor, and shipping are excludedDirect materials, direct labor, and shipping are excludedbecause Classic Brass existing cost system can directlybecause Classic Brass existing cost system can directly

trace these costs to products or customer orders.trace these costs to products or customer orders.


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Customer Orders

ProductDesign

Order Size

Customer Relations Other Total

Production DepartmentIndirect factory wages 25% 40% 20% 10% 5% 100%Factory equipment depreciation 20% 0% 60% 0% 20% 100%Factory utilities 0% 10% 50% 0% 40% 100%Factory building lease 0% 0% 0% 0% 100% 100%

General Administrative DepartmentAdministrative wages and salari 15% 5% 10% 30% 40% 100%Office equipment depreciation 30% 0% 0% 25% 45% 100%Administrative building lease 0% 0% 0% 0% 100% 100%

Marketing DepartmentMarketing wages and salaries 22% 8% 0% 60% 10% 100%Selling expenses 10% 0% 0% 70% 20% 100%

Activity Cost Pools

At Classic Brass the following distribution of resourceconsumption across activity cost pools is determined.



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Customer Orders

ProductDesign

Order Size


Production DepartmentIndirect factory wages 125,000$Factory equipment depreciationFactory utilities

Factory building leaseGeneral Administrative Department

Administrative wages and salariesOffice e quipment depreciationAdministrative building lease

Marketing DepartmentMarketing wages and sala riesSelling expenses

Total

Activity Cost Pools

Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%

$125,000$125, 000

Indirect factory wages $500,000Indirect factory wages $500,000Percent consumed by customer orders 25%Percent consumed by customer orders 25%

$125,000$125, 000

Production DepartmentIndirect factory wages 500,000$Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

General Administrative DepartmentAdministrative wages and salaries 400,000 Office equipme nt depreciation 50,000 Administrative building lease 60,000 510,000

Marketing Department

Marketing wages and salarie s 250,000 Selling expenses 50,000 300,000 Total overhead costs 1,810,000$




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Customer Orders

ProductDesign

Order Size


Production DepartmentIndirect factory wages 125,000$Factory equipment depreciation 60,000 Factory utilities

Factory building leaseGeneral Administrative Department

Administrative wages and salariesOffice e quipment depreciationAdministrative building lease

Marketing DepartmentMarketing wages and sala riesSelling expenses

Total

Activity Cost Pools

Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%

$ 60,000$ 60, 000

Factory equipment depreciation $300,000Factory equipment depreciation $300,000Percent consumed by customer orders 20%Percent consumed by customer orders 20%

$ 60,000$ 60, 000

Production DepartmentIndirect factory wages 500,000$Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$

General Administrative DepartmentAdministrative wages and salaries 400,000 Office equipme nt depreciation 50,000 Administrative building lease 60,000 510,000

Marketing Department

Marketing wages and salarie s 250,000 Selling expenses 50,000 300,000 Total overhead costs 1,810,000$




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Customer Orders

ProductDesign

Order Size


Production DepartmentIndirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$Factory equipment depreciation 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000

Factory building lease - - - - 80,000 80,000 General Administrative Department

Administra tive wages and sa la rie s 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment depreciation 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000

Marketing DepartmentMarketing wages and salaries 55,000 20,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000

Total 320,000$ 252,000$ 380,000$ 367,500$ 490,500$ 1,810,000$

Activity Cost Pools



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Compute activityCompute activityrates for cost pools.rates for cost pools.


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Calculate Activity Rates

The ABC team determines that Classic Brass willhave these total activities for each activity cost

pool . . .

1,000 customer orders,1,000 customer orders, 400 new designs,400 new designs, 20,000 machine-hours,20,000 machine-hours, 250 customer relations activities.250 customer relations activities.

Now the team can compute the individualactivity rates by dividing the total cost for

each activity by the total activity levels.

Now the team can compute the individualactivity rates by dividing the total cost for

each activity by the total activity levels.


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(a) (b) (a) (b) Activity Cost Pools Total Cost Total Activity Activity RateCustomer orders 320,000$ 1,000 orde rs $320 per order Product design 252,000 400 designs $630 per designOrder size 380,000 20,000 MHs $19 per MHCustomer relations 367,500 250 customer $1,470 per customer Other 490,500 Not applicable Not applicable

Computation of Activity Rates

Calculate Activity Rates


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TracedTraced TracedTraced TracedTraced

Activity-Based Costing at Classic Brass

DirectMaterials

DirectMaterials

DirectLabor DirectLabor

ShippingCosts

ShippingCosts Overhead CostsOverhead Costs

Cost Objects:Cost Objects:Products, Customer Orders, CustomersProducts, Customer Orders, Customers



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Activity-Based Costing at Classic Brass

DirectMaterials

DirectMaterials

DirectLabor DirectLabor

ShippingCosts

ShippingCosts



Customer Customer OrdersOrders

Customer Customer OrdersOrders

Order Order SizeSize

Order Order SizeSize

Customer Customer RelationsRelationsCustomer Customer RelationsRelations Other Other Other

Other

Overhead CostsOverhead Costs

First-Stage Allocation

Second-Stage AllocationsSecond-Stage AllocationsSecond-Stage AllocationsSecond-Stage Allocations

$/Order $/Order $/Design$/Design $/MH$/MH $/Customer $/Customer

UnallocatedUnallocated

ProductProductDesignDesignProductProductDesignDesign

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Jordan Managment Accounting 41

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