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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
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
be able to:be able to:
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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.
ObjectivesObjectives
ObjectivesObjectives
After studying thisAfter studying this
chapter, you shouldchapter, you should
be able to:be able to:
After studying thisAfter studying this
chapter, you shouldchapter, you should
be able to:be able to:
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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
Unit-Level Product Costing
Unit-Level Product Costing
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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
Unit-Level Product Costing (continued)
Unit-Level Product Costing (continued)
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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)
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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Overhead Assignment: Plant-wide Rates(continued)
Overhead Assignment: Plant-wide Rates(continued)
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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Overhead Assignment: Plant-wide Rates(continued)
Overhead Assignment: Plant-wide Rates(continued)
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)
Limitations of Plant-wide &
Departmental Rates (an example)
Goodmark Company produces two products: scented and
regular birthday cards.
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Limitations of Plant-wide &
Departmental Rates (an example)
Limitations of Plant-wide &
Departmental Rates (an example)
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
Unit Cost Computation: Departmental RatesUnit Cost Computation: Departmental Rates
Scented Cards Regular CardsScented Cards Regular Cards
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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Limitations of Plant-wide &
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
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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Goodmark CompanyAn ExampleGoodmark CompanyAn Example
Unit Cost Computation: Activity RatesUnit Cost Computation: Activity Rates
Scented Cards Regular CardsScented Cards Regular Cards
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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Scented Cards Regular CardsScented Cards Regular Cards
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
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
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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
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
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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
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
$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
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
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Bill of ActivitiesBill of Activities
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
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
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
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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Assigning Cost: Final Cost ObjectsAssigning Cost: Final Cost Objects
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
Intermediate
Treating patients: $3.44 x 10,000 $ 34,400Providing hygientic care: $5.44 x 2,500 13,600
Responding to requests: $1.93 x 40,000 77,200
Monitoring patients: $0.68 x 60,000 40,800
Total cost $166,000Units 5,000
Nursing cost per patient day $ 33.20
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Assigning Cost: Final Cost ObjectsAssigning Cost: Final Cost Objects
Cardiology Ward Example (Contd)Cardiology Ward Example (Contd)
Intensive Care
Treating patients: $3.44 x 15,000 $ 51,600Providing hygientic care: $5.44 x 8,500 46,240
Responding to requests: $1.93 x 10,000 19,300
Monitoring patients: $0.68 x 120,000 81,600
Total cost $198,740Units 3,000
Nursing cost per patient day $ 66.25
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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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Activity-Level ClassificationActivity-Level Classification
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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Activity-Level ClassificationActivity-Level Classification
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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Activity-Level ClassificationActivity-Level Classification
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
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?
Reducing the Size and Complexity of an
ABC System
Reducing the Size and Complexity of an
ABC System
Reducing the Size and Complexity of an
Reducing the Size and Complexity of an
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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
Reducing the Size and Complexity of an
ABC System
Reducing the Size and Complexity of an
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.