Managerial accounting tool for business decision making chapter 04

Chapter
4-1


CHAPTER 4

Activity-Based Costing

Managerial Accounting, Fifth Edition
Chapter
4-2


Study
Study Objectives
Objectives
1.

Recognize the difference between traditional
costing and activity based costing.

2.

Identify the steps in the development of an
activity-based costing system.

3.

Know how companies identify the activity cost
pools used in activity-based costing.

4.

Know how companies identify and use cost
drivers in activity-based costing.

Chapter
4-3


Study
Study Objectives
Objectives
5. Understand the benefits and limitations of
activity-based costing.
6. Differentiate between value-added and
non-value-added activities.
7. Understand the value of using activity
levels in activity-based costing.
8. Apply activity-based costing to service
industries.
Chapter
4-4


Traditional
Traditional Costing
Costing
To allocate as fairly as possible the true
costs of the products.
When management has more accurate costs,

better decisions can be made.
Direct Materials and Direct Labor costs are
easiest to trace through:
Material requisitions.
Payroll time sheets.

Chapter
4-5

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Hard
Hard Part
Part of
of Determining
Determining Product
Product Costs
Costs is?
is?

Determining the proper amount of
overhead to assign to each product,
service or job.

Chapter
4-6

Traditional
Traditional Costing
Costing and
and ABC
ABC

Chapter
4-7


Traditional
Traditional Costing
Costing
Allocates overhead using a single predetermined
rate.
Job order costing: Direct labor cost is assumed
to be the relevant activity base.
Assumption was satisfactory when direct labor
was a major portion of total manufacturing
costs.

There should be of a high correlation
between direct labor costs and overhead
costs.

Chapter
4-8

SO 1: Recognize the differences between traditional costing and
activity-based costing.

Traditional
Traditional Costing
Costing
Allocates overhead using a single
predetermined rate.
Process Costing: Machine hours is assumed
to be the relevant activity base.

Assumption was satisfactory when
machine hours was a major portion of
total manufacturing costs.
There should be of a high correlation
between machine hours and overhead costs.

Chapter
4-9

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Why
Why Do
Do Companies
Companies Need
Need aa New
New Approach?
Approach?

Tremendous change in manufacturing and
service industries.
Decrease in amount of direct labor usage.
Significant increase in total overhead costs.
May be inappropriate to use plant-wide
predetermined overhead rates based on direct
labor or machine hours when a lack of
correlation exists.
Complex manufacturing processes may require
multiple allocation bases; this approach is called
Activity-Based Costing (ABC).
Chapter
4-10

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Activity-Based
Activity-Based Costing
Costing





Chapter
4-11

Is another approach (other than traditional costing) to

allocate manufacturing overhead.
An overhead cost allocation system that allocates
overhead to multiple activity cost pools,
and
Assigns the activity cost pools to products or services
by means of cost drivers that represent the activities
used.

SO 1: Recognize the differences between traditional costing and
activity-based costing.


ABC
ABC Definitions
Definitions
Activity: Any event, action, transaction, or work
sequence that causes a cost to be incurred in
producing a product or providing a service.
Activity Cost Pool: The overhead cost attributed
to a distinct type of activity.
Examples:
Purchasing materials.
Setting up machines.
Cost Drivers: Any factors or activities that have
a direct cause-effect relationship with the
resources consumed.
Chapter
4-12

SO 1: Identify the steps in management’s decision-making process.

Activity-Based
Activity-Based Costing
Costing

Products consume activities,
and
Activities consume resources.

Chapter
4-13

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Activity-Based
Activity-Based Costing
Costing
ABC allocates overhead costs in two stages:
Stage 1: Overhead costs are allocated to activity
cost pools.
Stage 2: The overhead costs allocated to the cost
pools is assigned to products using cost drivers.
The more complex a product’s manufacturing
operation, the more activities and cost drivers
likely to be present.
Chapter
4-14

SO 1: Recognize the differences between traditional costing and
activity-based costing.


OVERHEAD
OVERHEAD COSTS
COSTS

Illustration 4-2
Chapter
4-15

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Overhead
Overhead Costs
Costs

Illustration 4-3
Chapter
4-16

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Activity-Based

Activity-Based Costing
Costing
ABC does not replace an existing job
order/process cost system.
ABC does segregate overhead into
various cost pools to provide more
accurate cost information.
ABC, thus, supplements – it does not
replace – the traditional cost system.
Chapter
4-17

SO 2 Identify the steps in the development of an activity-based system.


Activity-Based
Activity-Based Costing
Costing
Atlas Company produces two automotive antitheft
devices:

The Boot: A high volume item with sales totaling 25,000 per year.
The Club: A low volume item with sales totaling 5,000 per year.

Each product requires 1 hour of direct labor

Total annual direct labor hours (DLH) 30,000 (25,000 + 5000).
Direct labor cost $12 per unit for each product.

Expected annual manufacturing overhead costs

$900,000
Direct materials cost:
The Boot - $40 per unit.
The Club - $30 per unit.
Chapter
4-18

SO 1: Recognize the differences between traditional costing and
activity-based costing.


Costing
Costing Under
Under Traditional
Traditional Costing
Costing

Manufacturing Costs The Boot
Direct Materials
$40
Direct Labor
12
Overhead
30
Total unit cost
$82

Products
The Club
$30

12
30*
$72

* Predetermined overhead rate: $900,000 ÷ 30,000 DLH = $30 per DLH
Overhead = predetermined overhead rate times direct labor hours
($30 × 1 hr. = $30)
Chapter
4-19

Illustration 4-10

SO 2 Identify the steps in the development of an activity-based system.


Four
Four Steps
Steps of
of Activity-Based
Activity-Based Costing
Costing
Identify and classify the major activities and
allocate manufacturing overhead costs to the
appropriate cost pools.
Identify the cost driver that has a strong
correlation to the costs in the cost pool.
Compute the overhead rate for each pool.
Assign overhead costs for each cost pool to
products using the overhead rates.
Chapter

4-20

SO 2 Identify the steps in the development of an activity-based system.


Activity
Activity Cost
Cost Pools
Pools and
and Estimated
Estimated
Overhead
Overhead
Activity Cost Pools Estimated Overhead
Setting up machines $300,000
Machining
500,000
Inspecting
100,000
Total $900,000

Illustration 4-4
Chapter
4-21

SO 3 Know how companies identify the activity cost pools
and use activity-based costing.


Identify

Identify Cost
Cost Drivers
Drivers
Expected Use
of Cost Drivers
Activity Cost Pools
Activity
Setting up machines
Machining
Inspecting
2,000

Cost Drivers

Per

Number of setups 1,500
Machine hours 50,000
Number of Inspections

Illustration 4-5

Chapter
4-22

SO 4 Know how companies identify and use cost drivers in
activity-based costing


Formula

Formula for
for Computing
Computing Activity-Based
Activity-Based
Overhead
Overhead Rate
Rate
Estimated Overhead Per Activity
= Activity-Based Overhead Rate
Expected Use of Cost Drivers Per Activity
Illustration 4-6

Expected Use
Estimated
of Cost Drivers
Activity-Based
Activity Cost Pools Overhead Per Activity
Overhead Rates
Setting up machines $300,000
1,500 setups
$200 per setup
Machining
500,000
50,000 machine hrs.
$ 10 per mach. hour
Inspecting
100,000
2,000 inspections
$ 50 per inspection
Total

$900,000

Illustration 4-7
SO 4 Know how companies identify and use cost drivers in activity-based costing

Chapter
4-23


Expected
Expected Use
Use of
of Costs
Costs to
to Products
Products

Illustration 4-8

Chapter
4-24

SO 4 Know how companies identify and use cost drivers in
activity-based costing


Assignment
Assignment of
of Activity
Activity Cost

Cost Pools
Pools to
to
Products
Products

Illustration 4-9

Chapter
4-25

SO 4 Know how companies identify and use cost drivers in
activity-based costing