activity-based costing chapter04nppts

8/6/2019 Activity-Based Costing Chapter04NPPTs

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Activity-Activity-BasedBased

CostingCosting


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1. Describe the basics of plant wide and

departmental overhead costing.

2. Explain why plant wide and departmental

overhead costing may not be accurate.

3. Provide a detailed description of activity-

based product costing.

Continued

ObjectivesObjectives


After studying thisAfter studying thischapter, you shouldchapter, you should

be able to:be able to:

After studying thisAfter studying thischapter, you shouldchapter, you should



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4. Explain how the number of activity rates can

be reduced.

5. Describe activity-based system concepts

including an ABC relational database and

ABC software.



After studying thisAfter studying this

chapter, you shouldchapter, you should


After studying thisAfter studying this

chapter, you shouldchapter, you should



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Unit-Level Product Costing

q Function-based product costing assigns only

manufacturing costs to products

y Direct costs are traced

y Assignment of manufacturing overhead relies on

driver tracing or allocation

q Pooled costs are assigned to products using

predetermined overhead rates based on unit-leveldriversy Overhead rate = Budgeted annual overhead

Budgeted annual driver level




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Functional-Based ProductCosting Model

DirectDirect

MaterialsMaterialsDirectDirect

LaborLaborOverheadOverhead

PRODUCTSPRODUCTS

Direct

Tracing

Direct

TracingPlant/DepartmentalPlant/Departmental

Cost PoolsCost Pools

Direct Tracing

Driver TracingAllocation

Unit-Based Driver


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Unit-Level Product Costing (continued)

q Unit-level drivers are factors that measure thedemands placed on unit-level activities by products

q Unit-level activities are activities performed each

and every time a unit of product is produced.

q Commonly used unit-level drivers include:

y Units produced

y Direct labor hours

y Direct labor dollars

y Machine hours

y Direct material dollars




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Overhead Assignment: Plant-wide RatesOverhead Assignment: Plant-wide Rates

Plant-wide or departmental predetermined

overhead rates are used to assign or apply

overhead costs to production as the actual

production activity unfolds.

The predetermined overhead rate is the

basis for per-unit overhead cost

calculation.


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Overhead Assignment: Plant-wide Rates(continued)


Applied overhead is the total manufacturing

overhead assigned to actual production at

any point in time.

It is computed using the following formula:

Applied overhead = Overhead rate X Actual driver usage


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The amount of overhead applied to

production usually differs from actual

overhead since the predetermined overhead

rate is based on estimates.

As a result, applied overhead is either over-or under-applied


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The difference between the amount of actualoverhead and applied overhead is the overheadvariance.

Under-applied overheadoccurs when actual overhead ishigher than applied overhead

Over-applied overheadoccurs when actual overhead islower than applied overhead

Overhead variances are disposed of in two waysbased on materiality:

If an immaterial amount: assigned to COGS

If material: assigned to WIP, FG inventory and COGS


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Limitations of Plant-wide &

Departmental Rates (an example)



Goodmark Company produces two products: scented and

regular birthday cards.


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Note: When overhead rates are a significant

percentage of total manufacturing costs asignificant cost distortion can result.

When this happens, plant- and department-

wide overhead rates do not work well.


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Goodmark CompanyAn ExampleGoodmark CompanyAn Example

Scented Cards Regular Cards TotalScented Cards Regular Cards Total

Unit produced per year 20,000 200,000 --

Prime costs $160,000 $1,500,000 $1,660,000

Direct labor hours 20,000 160,000 180,000

Number of setups 60 40 100

Machine hours 10,000 80,000 90,000

Inspection hours 2,000 16,000 18,000Number of moves 180 120 300

Product Costing DataProduct Costing Data


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Cutting Dept. Printing Dept. TotalCutting Dept. Printing Dept. Total

Direct labor hours:Scented cards 10,000 10,000 20,000

Regular cards 150,000 10,000 160,000

Total 160,000 20,000 180,000

Machine hours:Scented cards 2,000 8,000 10,000

Regular cads 8,000 72,000 80,000

Total 10,000 80,000 90,000

Product Costing DataProduct Costing Data

Departmental DataDepartmental Data

ContinuedContinuedContinuedContinued


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Cutting Dept. Printing Dept. TotalCutting Dept. Printing Dept. Total

Overhead costs:

Setting up equipment $120,000 $120,000 $240,000

Moving materials 60,000 60,000 120,000Machining 20,000 180,000 200,000

Inspecting products 16,000 144,000 160,000

Total $216,000 $504,000 $720,000

Departmental DataDepartmental Data


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Plantwide Overhead RatePlantwide Overhead Rate

Plantwide rate =Total overhead cost

Direct labor hours

=$720,000

180,000 DLH

= $4 per direct labor hour


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Unit Cost Computation: Plantwide RatesUnit Cost Computation: Plantwide Rates

Prime costs $160,000 $1,500,000

Overhead costs:

$4.00 x 20,000 80,000

$4.00 x 160,000 640,000

Total manufacturing costs $240,000 $2,140,000

Units of production 20,000 200,000Unit cost $ 12.00 $ 10.70

Scented Cards Regular CardsScented Cards Regular Cards


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Departmental RatesDepartmental Rates

Cutting Department rate =Dept. overhead cost

Cutting Dept. DLH

=$216,000

160,000 DLH

= $1.35 per dlh


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Departmental RatesDepartmental Rates

Printing Department rate =Dept. overhead cost

Printing Dept. MH

=$504,000

80,000 MH

= $6.30 per mh


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Unit Cost Computation: Departmental RatesUnit Cost Computation: Departmental Rates


Prime costs $160,000 $1,500,000

Overhead costs:

[($1.35 x 10,000) + ($6.30 x 8,000)] 63,900

[($2.35 x 150,000) +

($6.30 x 72,000)] 656,100

Total manufacturing costs $223,900 $2,156,100Units of production 20,000 200,000

Unit cost $ 11.20 $ 10.78*

*Rounded to nearest cent

*


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Departmental Rates(continued)

As was said earlier, there are at least two major factors

that can impair the ability of the unit-based plantwide

and departmental rates to assign overhead costs

accurately:

(1) the proportion of nonunit-related overhead costs

to total overhead costs is large, and

(2) there is a great degree of product diversity.


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Product Diversity: Consumption RatiosProduct Diversity: Consumption Ratios

Overhead Activity Scented Cards Regular Cards Activity DriversOverhead Activity Scented Cards Regular Cards Activity Drivers

Setups 0.60 0.40 Production runs

Moving materials 0.60 0.40 Number of movesMachining 0.11 0.89 Machine hours

Inspection 0.11 0.89 Inspection hours

a a

b b

c* c*

d* d*

a

b

c

d

60/100 (scented) and 40/100 (regular)

180/300 (scented) and 120/300 (regular)

10,000/90,000 (scented) and 80,000/90,000 (regular)

2,000/18,000 (scented) and 16,000/18,000 (regular)

*rounded


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q One solution to overcoming the distortions causedby the unit-level rates is to expand the number ofrates used so that the rates reflect the actual

consumption of overhead costs by the variousproducts.

q Instead of pooling the overhead costs in plant and

departmental pools, rates would be calculated foreach individual overhead activity.

y These rates would be based on causalfactors that would measure consumption.

A Possible Solution:

Activity Rates

A Possible Solution:

Activity Rates


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Unit Cost Computation: Activity RatesUnit Cost Computation: Activity Rates


Prime costs $160,000 $1,500,000

Overhead costs:Setting up:

$2,400 x 60 144,000

$2,400 x 40 96,000

Machining:$2.20 x 10,000 22,200

$2.20 x 80,000 177,600

ContinuedContinuedContinuedContinued


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Overhead costs(contd):Inspecting:

$8.89 x 2,000 17,780

$8.89 x 16,000 142,240

Moving materials:

$400 x 180 72,000

$400 x 120 48,000

Total manufacturing costs $415,980 $1,963,840

Units of production 20,000 200,000

Unit cost $ 20.80 $ 9.82

RoundedRounded


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Activity-Based Costing ModelActivity-Based Costing Model

Cost of ResourcesCost of Resources

ActivitiesActivities

Costs assigned using driver

tracing and direct tracing

ProductsProducts

Costs assigned using

activity drivers


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1. Identify, define, and classify activities and keyattributes.

2. Assign the cost of resources to activities.3. Assign the cost ofsecondary activities toprimary

activities.4. Identify cost objects and specify the amount of each

activity consumed by specific cost objects.

5. Calculate primary activity rates.6. Assign activity costs to cost objects.

Please see the Illustrative Example on page 136 in yourtextbook.

Design Steps for an Activity-

Based Costing System

Design Steps for an Activity-

Based Costing System


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Aprimary activity is an activity that is consumed bya final cost object such as a product or customer.

Asecondary activity is one that is consumed byintermediate cost objects such as primary activities,

materials, or other secondary activities.

Activity-Based CostingActivity-Based Costing


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Activity

Name

Activity

Description

Activity

Type

Cost

Object(s)

Activity

Driver

Providing Bathing, Primary Patient types Labor hours

hygienic care changing

bedding and

clothes, walking

patients

Responding to Answering Primary Patient types Number of

patient calls, counseling, requests

requests providing

snacks, etc.

Monitoring Monitoring Primary Patient types Monitoring

patients vital signs hours

and posting

patient information


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Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)

Activity Supervisor Nurses

Supervising nurses 100 % 0 %Treating patients 0 25

Providing hygienic care 0 20

Responding to requests 0 40Monitoring patients 0 15

Percentage of Time for Each ActivityPercentage of Time for Each Activity


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Unbundling of General Ledger Costs

Chart of Accounts View

Unbundling of General Ledger Costs

Chart of Accounts View

Supervising $ 50,000

Supplies 40,600

Uniforms 8,200

Salaries 300,000

Computer 1,200Monitor 80,000

Total $480,000



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Unbundling of General Ledger Costs ABC

View

Unbundling of General Ledger Costs ABC

View

Supervising nurses $ 52,280

Treating patients 90,000

Providing hygienic care 76,600

Responding to requests 133,200

Monitoring patients 127,920Total $480,000



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Treating patients $103,070

Providing hygienic care 87,056

Responding to requests 154,112

Monitoring patients 135,762

Assignment of Secondary Activity

Costs to Primary Activities

Assignment of Secondary Activity

Costs to Primary Activities


$90,000 + (0.25 x $52,280)$90,000 + (0.25 x $52,280)$76,600 + (0.20 x $52,280)$76,600 + (0.20 x $52,280)

$133,200 + (0.40 x $52,280)$133,200 + (0.40 x $52,280)

$127,920 + (0.15 x $52,280)$127,920 + (0.15 x $52,280)


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Treating patients: $103,070/30,000 = $3.44 per

treatment

Providing hygienic care: $87,056/16,000 = $5.44 per hour of

care

Responding to requests: $154,112/80,000 = $1.93 per request

Monitoring patients: $135,762/200,000 = $0.68 per

monitoring hour

Treating patients: $103,070/30,000 = $3.44 per

treatment

Providing hygienic care: $87,056/16,000 = $5.44 per hour of

care

Responding to requests: $154,112/80,000 = $1.93 per request

Monitoring patients: $135,762/200,000 = $0.68 per

monitoring hour

Rate CalculationsRate Calculations



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Bill of ActivitiesBill of Activities


Activity Intensive

Activity Driver Normal Intermediate Care Total

Production (output) Patient days 10,000 5,000 3,000

Treating patients Treatments 5,000 10,000 15,000 30,000

Providing hygienic care Hygienic hours 5,000 2,500 8,500 16,000

Responding to requests Requests 30,000 40,000 10,000 80,000Monitoring patients Monitoring hours 20,000 60,000 120,000 200,000


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Assigning Cost: Final Cost ObjectsAssigning Cost: Final Cost Objects


Normal

Treating patients: $3.44 x 5,000 $ 17,200Providing hygientic care: $5.44 x 5,000 27,200

Responding to requests: $1.93 x 30,000 57,900

Monitoring patients: $0.68 x 20,000 13,600

Total cost $115,900Units 10,000

Nursing cost per patient day $ 11.59


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Intermediate







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Intensive Care







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Unit-level activitiesare those that are performed

each time a unit is produced.

Examples: Power and machine hours are used

each time a unit is produced. Directmaterials and direct labor activities

are also unit-level activities, even

though they are not overhead costs.

Activity-Level ClassificationActivity-Level Classification


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Batch-level activitiesare those

that are performed each time a

batch of products is produced.

Examples: Setups,

inspections,

purchasing, and

material handling.


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Product-level (sustaining) activities are those activities

performed that enable the various products of a

company to be produced. These activities and their

costs tend to increase as the number of differentproducts increases.

Examples: Engineering changes, developing

product-testing procedures, introducing

new products, and expediting goods.


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

Examples: Plant management, landscaping,

maintenance, security, property taxes, and plantdepreciation.


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Activities Classification andActivities Classification and

Homogeneous SetsHomogeneous Sets

Activities Classification andActivities Classification and

Homogeneous SetsHomogeneous Sets

AA AA AA AA AA11 22 33 44 55

ProcesProces

sLevelsLevel

FilterFilter

Activity

PP PP PP PP11 22 33 44

To activity filter

Processed Processed

classifiedclassified

activitiesactivities

From processed-classification activities


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ActivitActivit

y Levely Level

FilterFilter

From processed-classification activities

UnitUnit

LevelLevelBatchBatch

LevelLevelProductProduct

LevelLevelFacilityFacility

LevelLevel

Level-Level-

ClassificationClassification

activitiesactivities

DriveDrive

rr

FilterFilter

DriveDrive

rr

FilterFilter

DriveDrive

rr

FilterFilter

Set 1Set 1 Set 2Set 2 Set 3Set 3 Set 4Set 4 Set 5Set 5 Set 6Set 6 Set 7Set 7

Homogenous setsHomogenous sets

Reducing the Size and Complexity of an



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q ABC requires an activity rate for each

activity.

q However, an organization may have

hundreds of activities and activity rates,

increasing the costs of calculating and

keeping track of them, and creating

complexity in reporting.q Question: is more always better?


ABC System


ABC System




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q Not always:a few activity rates may be preferable to a large number, resulting in anapproximately relevant ABC System rather than a precisely useless one!

q The example on pages 144-146 shows how a few activity drivers can sometimes be aseffective as using a lot.

In this example, manufacturing overhead was assigned as follows:

Allocation Method Wafer A Wafer B

Plant-wide: $1,400,000 $600,000

12 Activities $800,000 $1,200,000

4 Activities* $820,000 $1,180,000

2 Activities** $800,000 $1,200,000

*Reduced ABC System Assignment

** Reduced equally accurate ABC System Assignment


ABC System


ABC System


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ABC System ConceptsABC System ConceptsABC System ConceptsABC System Concepts

The emergence of ABC as a viable alternative to

existing cost management systems is largely due to

significant advances in information technology.

ABC requires the development of anABC Database

and use of an ABC Software program (such as an ERP

System).


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ABC DatabaseABC DatabaseABC DatabaseABC Database

AnABC database is the collected data sets that areorganized and interrelated for use by an organizations

activity-based costing information system.

A data setis a grouping of logically related data.

activity-based costing chapter04nppts

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