AGENDA: Activity-Based Costing (ABC)

TM 8-1

AGENDA: Activity-Based Costing (ABC)

1.The activity-based costing model.

2.Differences between traditional costing and activity-based costing.

3.Steps for implementing activity-based costing.

4.The ABC cost hierarchy.

5.An example of activity-based costing.

6.Contrasting traditional costing and activity-based costing product costs.

7.Typical impacts on product costs from implementing activity-based costing.

8.(Appendix 8A) Action analysis report

ACTIVITY-BASED COSTING MODEL

Cost Objects

(e.g., products, customers, orders)

Activities

Consumption of Resources

Cost

The emphasis is on decision-making and managing activities, not on assigning costs to products for external financial reports.

DIFFERENCES BETWEEN TRADITIONAL COSTING
AND ACTIVITY-BASED COSTING

•In traditional costing systems:

•All manufacturing costs are assigned to products whether or not they are caused by the products.

•Nonmanufacturing costs are not assigned to products—even those nonmanufacturing costs that are caused by the products.

•The entire facility may have only one overhead cost pool and a single measure of activity such as direct labor-hours.

•Predetermined overhead rates are based on estimated costs at the budgeted or expected level of activity.

•In activity-based costing:

•Nonmanufacturing costs, as well as manufacturing costs, may be assigned to products.

•Some manufacturing costs may be excluded from product costs.

•There are a number of overhead cost pools, each of which has its own unique measure of activity.

•The allocation bases (i.e., measures of activity) often differ from those used in traditional costing.

•The activity rates (i.e., overhead rates) may be based on the level of activity at capacity rather than on the budgeted or expected level of activity.

STEPS FOR IMPLEMENTING ACTIVITY-BASED COSTING

1.Identify and define activities and activity pools.

2.Wherever possible, directly trace overhead costs to activities and cost objects.

3.Allocate costs to activity cost pools.

4.Calculate activity rates.

5.Assign costs to cost objects using the activity rates and activity measures.

6.Prepare management reports.

COST HIERARCHY

1.Unit-level activities are performed each time a unit is produced. The costs of unit-level activities should be proportional to the number of units produced.

2.Batch-level activities are performed each time a batch is handled or processed, regardless of how many units are in the batch. Costs at the batch level do not depend on the number of units produced, the number of units sold, or other unit-level measures of volume.

3.Product-level activities relate to specific products and typically must be carried out regardless of how many batches or units of product are produced or sold.

4.Customer-level activities relate to specific customers and include activities such as sales calls, catalog mailings, and general technical support that are not tied to any specific product.

5.Organization-sustaining activities are carried out regardless of which products are produced, how many batches are run, or how many units are made.

THE CLASSIC BRASS EXAMPLE

Activity Cost Pools at Classic Brass
Activity Cost Pool / Activity Measure
Customer Orders / Number of customer orders
Product Design / Number of product designs
Order Size / Machine-hours
Customer Relations / Number of active customers
Other / Not applicable

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8-2
Annual Overhead Costs
(both Manufacturing and Nonmanufacturing)
at Classic Brass
Production Department:
Indirect factory wages...... / $500,000
Factory equipment depreciation.... / 300,000
Factory utilities...... / 120,000
Factory building lease...... / 80,000 / $1,000,000
Shipping costs*...... / 40,000
General Administrative Department:
Administrative wages and salaries.. / 400,000
Office equipment depreciation..... / 50,000
Administrative building lease...... / 60,000 / 510,000
Marketing Department:
Marketing wages and salaries...... / 250,000
Selling expenses...... / 50,000 / 300,000
Total overhead cost...... / $1,850,000

*Shipping costs are traced directly to customer orders.

TM 8-1

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8-3
Results of Interviews
Activity Cost Pools
Customer Orders / Product Design / Order Size / Customer Relations / Other / Total
Production Department:
Indirect 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%
Shipping costs*
General Administrative Department:
Administrative wages and salaries / 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 Department:
Marketing wages and salaries.... / 20% / 10% / 0% / 60% / 10% / 100%
Selling expenses...... / 10% / 0% / 0% / 70% / 20% / 100%

*Shipping costs are directly traced to customer orders.

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8-4
First-Stage Allocations to Activity Cost Pools
Activity Cost Pools
Customer Orders / Product Design / Order Size / Customer Relations / Other / Total
Production Department:
Indirect factory wages...... / $125,000 / $200,000 / $100,000 / $50,000 / $25,000 / $500,000
Factory equipment depreciation.. / 60,000 / 0 / 180,000 / 0 / 60,000 / 300,000
Factory utilities...... / 0 / 12,000 / 60,000 / 0 / 48,000 / 120,000
Factory building lease...... / 0 / 0 / 0 / 0 / 80,000 / 80,000
Shipping costs*
General Administrative Department:
Administrative wages and salaries / 60,000 / 20,000 / 40,000 / 120,000 / 160,000 / 400,000
Office equipment depreciation... / 15,000 / 0 / 0 / 12,500 / 22,500 / 50,000
Administrative building lease.... / 0 / 0 / 0 / 0 / 60,000 / 60,000
Marketing Department:
Marketing wages and salaries.... / 50,000 / 25,000 / 0 / 150,000 / 25,000 / 250,000
Selling expenses...... / 5,000 / 0 / 0 / 35,000 / 10,000 / 50,000
Total...... / $315,000 / $257,000 / $380,000 / $367,500 / $490,500 / $1,810,000

*Shipping costs are directly traced to customer orders.

TM 8-1

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8-5
Computation of Activity Rates
Activity Cost Pools / (a)
Total Cost / (b)
Total Activity / (a) ÷ (b)
Activity Rate
Customer orders.... / $315,000 / 1,000 / orders / $315 / per order
Product design...... / $257,000 / 200 / designs / $1,285 / per design
Order size...... / $380,000 / 20,000 / MHs / $19 / per MH
Customer relations... / $367,500 / 100 / customers / $3,675 / per customer
Other...... / $490,500 / Not applicable / Not applicable

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8–7

Data Concerning the Products Ordered by Windward Yachts

Standard Stanchions

1.This is a standard design that does not require any new design resources.

2.Four hundred units were ordered during the year, comprising two separate orders.

3.Each stanchion required 0.5 machine-hour, for a total of 200 machine-hours.

4.The selling price per unit was $34, for a total of $13,600.

5.Direct materials for 400 units totaled $2,110.

6.Direct labor for 400 units totaled $1,850.

7.Shipping costs for the two orders totaled $180.

Custom Compass Housing

1.This is a custom product that requires new design resources.

2.There was only one order for a single unit during the year.

3.The compass housing required 4 machine-hours.

4.The selling price was $650.

5.Direct materials were $13.

6.Direct labor was $50.

7.Shipping costs were $25.

THE CLASSIC BRASS EXAMPLE (cont’d)

Exhibit 8-8
Computation of Overhead Costs
Activity Cost Pools / (a)
Activity Rate / (b)
Activity / (a) × (b)
ABC Cost
Standard Stanchions
Customer orders.... / $315 / per order / 2 / orders / $630
Product design...... / $1,285 / per design / 0 / designs / $0
Order size...... / $19 / per MH / 200 / MHs / $3,800
Customer relations... / $3,675 / per customer / Not applicable
Custom Compass Housing
Customer orders.... / $315 / per order / 1 / order / $315
Product design...... / $1,285 / per design / 1 / design / $1,285
Order size...... / $19 / per MH / 4 / MHs / $76
Customer relations... / $3,675 / per customer / Not applicable