copyright © 2008 prentice hall all rights reserved 5-1 activity-based costing and other cost...

Copyright © 2008 Prentice Hall All rights reserved5-1

Activity-Based Costingand Other Cost

Management ToolsChapter 5


Objective 1

Develop and use departmental overhead rates in place of a

traditional plant-wide rate


Traditional Plant-Wide Overhead Rate

Example:

Assume that Dell allocates manufacturing overhead based on direct labor (DL) hours

If Dell planned to incur $10 million of overhead costs and 500,000 direct labor hours a year, its manufacturing overhead rate would be:

$10 million/500,000 DL hours = $20/DL hour


Departmental Overhead Rates

Department Total Departmental Manufacturing Overhead Costs

Total Departmental Labor Hours

Departmental Overhead Rate

Servers $2 million 50,000 hrs $40/DL hour

Desktops $5 million 250,000 hrs $20/DL hour

Laptops $3 million 200,000 hrs $15/DL hour

TOTAL $10 million 500,000 hrs


Sharpening the Focus from Business Functions to Departments to Activities

Company-wide business functions in

the value chain

Departments in the production function

Activities in the desktop production

department

R&D

Design

Production

Marketing

Distribution

Customer service

Servers

Desktops

Laptops

Kitting

Motherboard preparation

Assembly

Software downloading

Testing

Boxing

Focus on

Broad Business functions such as production

Sharpen focus to:

Departments with a function

Further sharpen focus to:

Activities within a department

Single Indirect Cost rate for entire production function:

“Plant-wide overhead rate”

Different indirect cost rates for each department

“Departmental Overhead Rates”

Different indirect cost rates for each activity

“Activity cost allocation rates”


Objective 2

Develop activity-based costs (ABC) and use activity-based management (ABM) to make business decisions


Activity-Based Costing

• A way to allocate indirect cost to production

• Focuses on activities and cost of activities

• Each activity has its own cost driver

• Uses a separate allocation rate for each activity



Steps:1. Identify the activities2. Estimate the total indirect costs of each

activity3. Identify the allocation base for each

activity’s indirect costs (the primary cost driver)

4. Estimate the total quantity of each allocation base



Steps:5. Compute cost allocation rate for each

activityEstimated total indirect costs of activity

Estimated total quantity of cost allocation base

5. Obtain actual quantity of each allocation base used by the cost object

6. Allocate indirect costs to cost object


Examples of Cost Drivers

Activities: Cost Drivers:

Material purchasing # of purchase orders

Material handling # of parts

Production scheduling # of batches

Quality inspections # of inspections

Photocopying # of pages copied

Warranty service # of service calls


E5-22: Example for Using Seven Steps of Activity Based Costing

Steps:

1. Identify each activity Material handling Machine setup Insertion of parts Finishing

2. Estimate the total indirect costs of each activity

$12,000

3,400

48,000

80,000


E5-22: Continued

Steps:

3. Identify the allocation base for each activity’s indirect costs (the primary cost driver)

Activity Budgeted cost Allocation base

Material handling $12,000

Machine setup 3,400

Insertion of parts 48,000

Finishing 80,000

Total $143,400

For each activity, what is the appropriate

allocation base that should be applied to the budgeted cost? Hint: Think of the “cost driver” for

each activity described in the previous slide.


E5-22: Continued

Steps:

4. Estimate the total quantity of each allocation base

ActivityTotal Est.

Cost

Est. Quant. of Cost

Allocation Base

Mat. handling $12,000 ÷ 3,000 partsMachine setups $ 3,400 ÷ 10 setupsInsertion of parts $48,000 ÷ 3,000 partsFinishing $80,000 ÷ 2,000 hrs


E5-22: Continued

Steps:

5. Compute cost allocation rate for each activity

ActivityTotal Est.

Cost

Est. Quant. of Cost

Allocation Base

Cost Allocation Rate

Mat. handling $12,000 ÷ 3,000 parts = $ 4 per partMachine setups $ 3,400 ÷ 10 setups = $340 per setupInsertion of parts $48,000 ÷ 3,000 parts = $ 16 per partFinishing $80,000 ÷ 2,000 hrs = $ 40 per hour


E5-22: Continued6. Obtain actual quantity of each allocation

base used by the cost object–1,000 wheels

7. Allocate indirect costs to cost object

Average quantities of cost allocation bases used per wheel:

Parts: 3,000 ÷ 1,000 = 3

Setups: 10 ÷ 1,000 = 0.01

Finishing direct labor hrs: 2,000 ÷ 1,000 = 2


E5-22: Summary of Indirect Cost

Indirect Manufacturing Cost Per Wheel

Activity

Actual Quant of Cost Allocation Base Used per

Fender

Cost Alloc. Rate

Cost perWheel

Mat. handling 3.00 x $ 4.00 = $ 12.00Machine setups 0.01 x $340.00 = 3.40Insertion of parts 3.00 x $ 16.00 = 48.00Finishing 2.00 x $ 40.00 = 80.00Total indirect cost $143.40


E5-26: ContinuedTotal Budgeted Indirect Manufacturing Cost

Activity

Actual Quant of Cost Allocation Base Used per Fender

Cost AllocationRate Total

Mat. handling 10,000 x $ 3.75 = $37,500 Machine setups 30 x $300.00 = 9,000 Insertion of parts 10,000 x $ 24.00 = 240,000 Finishing 3,500 x $ 50.00 = 175,000 Total budgeted indirect cost

$461,500


E5-26: ContinuedIndirect Manufacturing Cost Per Rim - Standard

ActivityCost Allocation

Rate

Quant of Cost Alloc. Base Used

Cost perRim

Mat. handling $3.75 x 4 = $ 15.00Machine setups $300 x .015 = 4.50Insertion of parts $24 x 4 = 96.00Finishing $50 x 1 = 50.00Total indirect cost $165.50


E5-26: ContinuedIndirect Manufacturing Cost Per Rim - Deluxe

ActivityCost Allocation

Rate

Quant of Cost Alloc. Base Used

Cost perRim

Mat. handling $3.75 x 6 = $ 22.50Machine setups $300 x .015 = 4.50Insertion of parts $24 x 6 = 144.00Finishing $50 x 2.5 = 125.00Total indirect cost $296.00


E5-26: Continued

Budgeted total indirect overhead cost $461,500

Budgeted direct labor hrs 5,000

Single allocation rate per $461,500direct labor hr 5,000

= $92.30


E5-26: Continued

Indirect manufacturing cost per wheel:

Standard model:

2 $92.30 = $184.60

Deluxe model:

3 $92.30 = $276.90


E5-26: Continued

Enke

Indirect Manufacturing Costs Per Unit

Model

Standard Deluxe

ABC costs $165.50 $296.00

Single-rate costs $184.60 $276.90


Decisions

• Pricing and product mix

• Cutting costs Value engineering – reevaluating activities to

reduce costs while satisfying customer needs

• Routine Planning and Control Decisions Create budgets Evaluate workers


ABC in Merchandising and Service Companies

Allocate operating (period) costs among product or service lines instead of manufacturing overhead costs


E5-27

Enke CompanyABC Data Gross Profits

Standard DeluxeSale price $300.00 $440.00Direct materials 30.00 46.00Direct labor 45.00 50.00Indirect overhead 165.50 296.00Gross profit $59.50 $48


E5-27: Continued

Enke CompanyABC Data Gross Profits

Standard DeluxeSale price $300.00 $440.00Direct materials 30.00 46.00Direct labor 45.00 50.00Indirect overhead 184.60 276.90 Gross profit $40.40 $67.10


E5-27: Continued

Finishing activity cost per rim:

2.0 hrs per rim x ____ per hour =

$80 per rim

Remember the finishing cost

noted under the Indirect

Manufacturing Cost per Wheel in

E5-26?


E5-27: Continued

New cost of deluxe rim:Direct materials $46.00Direct labor 50.00Indirect costs:

Materials handling 22.50Machine setups 4.50Insertion parts 144.00Finishing 80.00

Total $347.00


Objective 3

Explain when ABC is most likely to pass the cost-benefit test


Cost-Benefit Test

• System should be refined enough to provide accurate product costs

• Simple enough for managers to understand

• ABC and ABM pass the cost-benefit test when the benefits of adopting exceed the costs of implementation


Objective 4

Describe a just-in-time

(JIT) production system


Just-in-Time Systems

Receive order from customer

Schedule production

Defect-free materials are delivered by suppliers just in time for production

Finished product is delivered to customer


Just-in-Time Systems

cutting

shapinggrinding

smoothing Finished Goods


Just-in-Time

• Production activities in self-contained cells

• Short setup times

• Broad employee roles

• Small batches produced just in time

• Shortened manufacturing cycle times

• Emphasis on quality

• Supply-chain management


Just-in-Time Costing

• “Backflush costing” – records cost of production when units are completed

• Impacts two inventory accounts Raw and In-Process Inventory Finished Goods Inventory

• Impacts two manufacturing cost accounts Direct materials Conversion costs


Exercise 5-35

GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

(in millions)

Raw & In Process Inventory 6,500

Accounts Payable6,500

Conversion Costs 7,420

Various accounts7,420


Exercise 5-35: ContinuedGENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Finished Goods Inventory 11,200

Raw and In Process Inventory (200x$24)

4,800

Conversion Costs(200x$32)6,400

Cost of Goods Sold ($196x56) 10,976

Finished Goods Inventory10,976


Exercise 5-35: Continued

GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

Cost of Goods Sold 1,020

Conversion Costs1,020

Conversion Costs

7,420 6,400

Bal. 1,020


Exercise 5-35: Continued

Finished Goods Inventory

Beg bal 100 10,976 Goods sold

Bal. 324

Goods completed 11,200


Objective 5

Describe the four types of quality costs and use them to make

decisions


Total Quality Management

Goals:

• To provide customers with superior products and services

• Continuous improvement Improve quality Eliminate defects and waste


4 Types of Quality Costs

1. Prevention costs – avoid poor quality goods or services Employee training Improved materials Preventive maintenance



2. Appraisal costs – detect poor quality goods or services Inspection throughout production Inspection of final product Product testing



3. Internal failure costs – avoid poor quality goods or services before delivery to customers Production loss caused by downtime Rejected product units



4. External failure costs – when poor quality products are delivered to customers and company has to make things right with customer Lost profits from lost customers Warranty costs Service costs at customer sites Sales returns due to quality problems


E5-33

Prevention costs:

• Training employees in TQM

• Training suppliers in TQM

• Identifying preferred suppliers who commit to on-time delivery of perfect quality materials


E5-33: Continued

Appraisal costs:

• Strength testing one item from each batch of panels

• Avoid inspection of raw materials

Internal failure costs:

• Avoid rework and spoilage


E5-33: Continued

External failure costs:

• Avoid lost profits from lost sales due to disappointed customers

• Avoid warranty costs


E5-33: Continued

Costs of Adopting New Quality Program:

Prevention costs:

Training employees in TQM $ 30,000

Training suppliers in TQM 40,000

Identifying preferred suppliers 60,000

Appraisal costs:

Strength testing 65,000

Total costs of adopting new program $195,000


E5-33: Continued

Costs of Not Adopting New Quality Program:

Appraisal costs:

Inspection of raw materials $ 45,000

Internal failure costs:

Rework and spoilage. 55,000

External failure costs:

Lost profits from lost sales 90,000

Warranty costs 15,000

Total costs of not adopting $205,000


Objective 6 (Appendix)

Use JIT costing to record costs in a

JIT production environment


Features of JIT Costing

Just-in-time (JIT) costing, sometimes called backflush costing, is a costing system that starts with output completed and then assigns manufacturing costs to units sold and to finished goods inventories


Four Major Differences Between JIT Costing and Traditional Job Costing

1. JIT systems wait until the units are completed to record the costs of production

2. JIT systems do not track costs attached to units in the production process; therefore, JIT systems to not need Work in Process Inventory account

3. JIT companies combine all production labor and manufacturing overhead costs into an account called Conversion Costs which are allocated to completed units

4. Standard costs are used to record inventory units


Example of JIT Costing

GENERAL JOURNAL


Raw and In Process Inventory 3,020,000

Accounts Payable 3,020,000

Mintel does not use a separate Work in Process Inventory account. Instead

it uses Raw and In Process Inventory and Finished Goods. Mintel has

$100,000 of Raw and In Process Inventory and $900,000 of Finished

Goods Inventory at July 31, and it uses JIT costing to record August

transactions.

1. Mintel purchases $3,020,000 of direct materials on account


GENERAL JOURNAL


Conversion Costs 18,540,000

Various Accounts (Wages Payable and

and Accumulated Depreciation on Property

Plant, and Equipment) 18,540,000

2. Mintel incurs $18,540,000 on labor and overhead costs


GENERAL JOURNAL


Finished Goods Inventory 21,000,000

Raw and In Process Inventory 3,000,000

Conversion Costs 18,000,000

3. Mintel completed 3,000,000 circuits. The standard cost of each circuit

Is $7 ($1 standard direct materials cost and $6 standard conversion

cost). The debit to Finished Goods is $21,000,000 (3,000,000

completed circuits x $7.) There is no Work in Process Inventory in JIT

costing, so Mintel credits:• Raw and In Process Inventory $3,000,000 (3,000,000 completed circuits x $1 standard

direct material cost per circuit) • Conversion Costs, $18,000,000 (3,000,000 completed circuits x $6 standard

conversion cost per completed circuit) for the labor and other indirect costs allocated to the finished circuits


Mintel’s Major JIT Costing Accounts

Raw and In Process Inventory

MaterialPurchases

Completed Completed circuitscircuits

Transferred Transferred in from In in from In Process Process Inventory Inventory and and Conversion Conversion CostsCosts

Standard cost of converting materials to finished goods

Conversion Costs

Finished Goods

Converted circuits


End of Chapter 5

copyright © 2008 prentice hall all rights reserved 5-1 activity-based costing and other cost...

Documents

activity slide

cost of activities

prentice hall

cost object

compute cost allocation

manufacturing overhead

activitybased costs

allocation base slide