4-1 copyright © 2004 by nelson, a division of thomson canada limited. activity-based accounting 4...

4-1Copyright © 2004 by Nelson, a division of Thomson Canada Limited.

Activity-Based Activity-Based AccountingAccounting

44

PowerPresentation® prepared by PowerPresentation® prepared by

David J. McConomy, Queen’s UniversityDavid J. McConomy, Queen’s University


Learning ObjectivesLearning Objectives

Discuss the importance of unit costs to managers’ decisions.

Describe functional-based costing approaches.

Explain why functional-based costing approaches may produce distorted costs.


Learning Objectives (continued)Learning Objectives (continued)

Explain how an activity-based costing system works.

Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates.


Describe activity-based customer and supplier costing.

Learning Objectives (continued)Learning Objectives (continued)


Unit CostsUnit CostsThe unit cost is the total cost associated with the units

produced divided by the number of units produced

Although the concept is simple, the practical reality ofthe

computation can be somewhat more complex because of

the following issues:

– What is meant by “total cost”?

– How do we measure the costs to be assigned?

– How do we assign costs to the product?


Unit Costs (continued)Unit Costs (continued)

Unit costs are important for:

inventory valuation

income determination

providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders


Measurement SystemsMeasurement SystemsTwo possible measurement systems are actual costing and normal costing.

Actual costing assigns the actual costs of direct materials, direct labour, and overhead to products.

Normal costing assigns the actual costs of direct materials and direct labour to products; however, overhead cots are assigned to products using predetermined rates.


Activity Capacity MeasuresActivity Capacity Measures

Units (of driver)

Theoretical

Practical

Expected actual

Normal

Time


Functional-Based Costing:Functional-Based Costing:Plantwide RatePlantwide Rate

Overhead Costs

Assign Costs

Plantwide Pool

Cost Assignment

Products

Direct Tracing

Stage One: Pool Formation

Unit-Level Driver

Stage Two: Costs Assigned


Belring, Inc.Belring, Inc.

Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following estimated and actual data:

Budgeted overhead $360,000

Expected activity (DLH) 100,000

Actual overhead $380,000

Actual activity (DLH) 100,000


Belring, Inc. (continued)Belring, Inc. (continued)

Predetermined

Overhead Rate = Budgeted overhead Expected

activity

= $360,000 100,000 DLH

= $3.60 per DLH


Belring, Inc. (continued)Belring, Inc. (continued)

CordlessRegular

Units produced 10,000100,000

Prime costs $78,000$738,000

Direct labour hours 10,00090,000


Belring, Inc. – Unit Cost Computation:Belring, Inc. – Unit Cost Computation:Plantwide RatePlantwide Rate

Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

$3.60 x 10,000 36,000 ---

$3.60 x 90,000 --- 324,000

Total mfg. costs $114,000 $1,062,000

Units produced 10,000 100,000

Unit cost$ 11.40 $ 10.62

======= ========


Functional-Based Costing:Functional-Based Costing:Departmental Rates Departmental Rates

Overhead Costs

Assign Costs

Department A Pool

Assign Costs

Products

Department B Pool

Assign Costs

Products

Stage One: Pool Formation

Unit-Level Drivers

Stage Two: Costs

Assigned


Belring, Inc. – Departmental DataBelring, Inc. – Departmental Data

Fabrication Assembly

Budgeted OH $252,000 $108,000

======= =======

Expected and actual usage (DLH):

Cordless 7,000 3,000

Regular 13,000 77,000

20,000 80,000

===== =====

Expected and actual usage (MH):

Cordless 9,000 1,000

Regular 36,000 4,000

45,000 5,000

===== =====


Belring, Inc. – Departmental RatesBelring, Inc. – Departmental Rates

Overhead Rates:

Fabrication Rate = Budgeted OH / Expected MH

= $252,000/45,000

= $5.60 per fabrication MH

Assembly Rate = Budgeted OH / Expected DLH

= $108,000/80,000

= $1.35 per assembly DLH


Belring, Inc. – Unit Cost Computation: Belring, Inc. – Unit Cost Computation: Departmental RateDepartmental Rate

Cordless Regular

Prime costs $ 78,000 $738,000

Overhead costs:

($5.60 x 9,000) + ($1.35 x 3,000) 54,450 ---

($5.60 x 36,000) + ($1.35 x 77,000) --- 305,500

Total mfg. costs $132,450 $1,043,550

Units produced 10,000 100,000

Unit cost$ 13.25 $ 10.44

======= ========


Symptoms of an OutdatedSymptoms of an OutdatedFunctional Cost SystemFunctional Cost System

The outcome of bids is difficult to explain.

Competitors’ prices appear unrealistically low.

Products that are difficult to produce show high profits.

Operational managers want to drop products that appear profitable.

Profit margins are difficult to explain.


Symptoms of an Outdated Functional Symptoms of an Outdated Functional Cost System (continued)Cost System (continued)

The company has a highly profitable niche all to itself.

Customers do not complain about price increases.

The accounting department spends a lot of time supplying cost data for special projects.

Some departments are using their own accounting system.

Product costs change because of changes in financial reporting regulations.


Belring, Inc.Belring, Inc. – Activity Usage– Activity Usage

Cordless Regular Total

Units produced per year 10,000 100,000 110,000

Prime costs $78,000 $738,000 $816,000

Direct labour hours 10,000 90,000 100,000

Machine hours 10,000 40,000 50,000

Production runs 20 10 30

Number of moves 60 30 90


Belring, Inc. – Additional OH Cost DataBelring, Inc. – Additional OH Cost Data

Activity Activity Cost

Setups $120,000

Material handling 60,000

Machining 100,000

Testing 80,000

Total $360,000

=======


ABC: Two-Stage AssignmentABC: Two-Stage Assignment

Cost Of Resources

Assign Costs

Activities

Assign Costs

Products

Direct Tracing Driver tracing

Driver Tracing


Belring, Inc. – Activity RatesBelring, Inc. – Activity Rates

Activity rates are computed below:

Setup rate: $120,000/30 = $4,000 per run

Material-handling rate: $60,000/90 = $666.67 per move

Machining rate: $100,000/50,000 = $2 per MH

Testing rate: $80,000/100,000 = $0.80 per DLH


Belring, Inc. – Activity-Based CostingBelring, Inc. – Activity-Based CostingUnit Cost ComputationUnit Cost Computation

Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

Setups 80,000 40,000

Material handling 40,000 20,000

Machining 20,000 80,000

Testing 8,000 72,000

Total mfg. costs $226,000 $ 950,000

Units produced 10,000 100,000Unit cost $ 22.60 $ 9.50

===== =====


Comparison of Unit CostsComparison of Unit Costs

Cordless Regular

Activity based unit cost 22.60 9.50

Functional based unit cost:

Plantwide rate $11.40 $10.62

Departmental rate 13.25 10.44


Activity CategoriesActivity Categories

Unit-level activities are those performed each time a unit is produced.

Examples: Power and machine hours are used each time a unit is produced. Direct materials and direct labour activities are also unit-level activities, even though they are not overhead costs.


Activity Categories (continued)Activity Categories (continued)

Batch-level activities are those performed each time a batch of products is produced.

Examples: Setups, inspections, production scheduling, and material handling.



Product-level (sustaining) activities are those performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold.

Examples: Engineering changes, development of product testing procedures, marketing a product and process engineering.



Facility-level activities are those that sustain a factory's general manufacturing processes.

Examples: Plant management, landscaping, support of community programs, security, property taxes, and plant amortization.


ABC Customer CostingABC Customer Costing

Use Customer as Cost Object

Diversity Issues: Order Frequency Delivery Frequency Geographic Distances Sales and Promotional Support Engineering Support


ABC Customer CostingABC Customer Costing

Use Customer as Cost Object

Used For:

•Pricing•Customer Mix•Improving profitability


ABC Supplier CostingABC Supplier Costing

Use Supplier as Cost Object

Relating To:

•Purchase Cost•Quality•Supplier Reliability•Delivery Performance

4-1 copyright © 2004 by nelson, a division of thomson canada limited. activity-based accounting 4...

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