Activity-Based Costing
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1 4-1
2 Activity-Based Costing Managerial Accounting Fifth Edition Weygandt Kimmel Kieso 4-2
3 4-3 study 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 activitybased costing. 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.
4 4-4 preview of chapter 4
5 Managerial Accounting Basics Managerial accounting, also called management accounting, is a field of accounting that provides economic and financial information for managers and other internal users. Managerial accounting applies to all types of businesses. Corporations Proprietorships Partnerships Not-for-profit 4-5
6 Traditional Costing and Activity-Based Costing Traditional Costing Systems Allocates overhead using a single predetermined rate. Job order costing: direct labor cost is assumed to be the relevant activity base. Process costing: machine hours is the relevant activity base. Assumption was satisfactory when direct labor was a major portion of total manufacturing costs. Wide acceptance of a high correlation between direct labor and overhead costs. 4-6 SO1 Recognize the difference between traditional costing and activity-based costing.
7 Traditional Costing and Activity-Based Costing The Need for a New Approach Tremendous change in manufacturing and service industries. Decrease in amount of direct labor usage. Significant increase in total overhead costs. Inappropriate to use plant-wide predetermined overhead rates when a lack of correlation exists. Complex manufacturing processes may require multiple allocation bases; this approach is called Activity-Based Costing (ABC). Illustration 4-1 Traditional one-stage costing system 4-7 SO1 Recognize the difference between traditional costing and activity-based costing.
8 Traditional Costing and Activity-Based Costing Activity-Based Costing Allocates overhead to multiple activity cost pools, and Assigns the activity cost pools to products or services by means of cost drivers. 4-8 SO1 Recognize the difference between traditional costing and activity-based costing.
9 Traditional Costing and Activity-Based Costing Activity-Based Costing Activity: any event, action, transaction, or work sequence that incurs cost when producing a product or providing a service. Activity Cost Pool: the overhead cost attributed to a distinct type of activity For example: ordering materials or setting up machines Cost Drivers: any factor or activity that have a direct cause-effect relationship with the resources consumed. 4-9 SO1 Recognize the difference between traditional costing and activity-based costing.
10 Traditional Costing and Activity-Based Costing Activity-Based 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. SO1 Recognize the difference between traditional costing and activity-based costing.
11 Traditional Costing and Activity-Based Costing Activity-Based Costing Illustration 4-2 Activities and related cost drivers 4-11 SO1 Recognize the difference between traditional costing and activity-based costing.
12 Traditional Costing and Activity-Based Costing Activity-Based Costing Illustration 4-3 ABC system design Lift Jack Company 4-12 SO1 Recognize the difference between traditional costing and activity-based costing.
13 Traditional Costing and Activity-Based Costing Indicate whether the following statements are true or false. False True True 1. A traditional costing system allocates overhead by means of multiple overhead rates. 2. Activity-based costing allocates overhead costs in a two-stage process. 3. Direct material and direct labor costs are easier to trace to products than overhead. Solution on notes page 4-13 SO1 Recognize the difference between traditional costing and activity-based costing.
14 Traditional Costing and Activity-Based Costing Indicate whether the following statements are true or false. False True 4. As manufacturing processes have become more automated, more companies have chosen to allocate overhead on the basis of direct labor costs. 5. In activity-based costing, an activity is any event, action, transaction, or work sequence that incurs cost when producing a product. Solution on notes page 4-14 SO1 Recognize the difference between traditional costing and activity-based costing.
15 Example of ABC Versus Traditional 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 SO2 Identify the steps in the development of an activity-based costing system.
16 Example of ABC Versus Traditional Costing Illustration: Atlas Company produces two automobile 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, ) 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 Required: Calculate unit costs under ABC SO2 Identify the steps in the development of an activity-based costing system.
17 Example of ABC Versus Traditional Costing Illustration: Products Manufacturing costs The Boot The Club Direct materials $40 $30 Direct labor Overhead 30* 30* Total unit cost $82 $72 * Overhead rate = $900,000/30,000 DLH = $30 per DLH Overhead = ($30 X 1 hr. = $30) 4-17 SO2 Identify the steps in the development of an activity-based costing system.
18 Example of ABC Versus Traditional Costing Activity-based costing involves the following four steps. 1. Identify and classify the major activities and allocate manufacturing overhead costs to the appropriate cost pools. 2. Identify the cost driver that has a strong correlation to the costs in the cost pool. 3. Compute the overhead rate for each pool. 4. Assign overhead costs for each costs to products using the overhead rates SO3 Know how companies identify the activity cost pools used in activity-based costing.
19 Example of ABC Versus Traditional Costing Identify and Classify Activities and Allocate Overhead to Cost Pools (Step 1) Overhead costs are assigned directly to the appropriate activity cost pool. Illustration SO3 Know how companies identify the activity cost pools used in activity-based costing.
20 Example of ABC Versus Traditional Costing Identify Cost Drivers (Step 2) The cost driver must accurately measure the actual consumption of the activity by the various products. Illustration SO4 Know how companies identify and use cost drivers in activity-based costing.
21 Example of ABC Versus Traditional Costing Compute Overhead Rates (Step 3) Next, the company computes an activity-based overhead rate per cost driver. Illustration 4-6 Illustration SO4 Know how companies identify and use cost drivers in activity-based costing.
22 Example of ABC Versus Traditional Costing Assign Overhead Cost to Products (Step 4) In assigning overhead costs, it is necessary to know the expected use of cost drivers for each product. Because of its low volume, The Club requires more set-ups and inspections than The Boot. Illustration SO4 Know how companies identify and use cost drivers in activity-based costing.
23 Example of ABC Versus Traditional Costing Assign Overhead Cost to Products (Step 4) To assign overhead costs, Atlas multiplies the activity-based overhead rates per cost driver (Ill. 4-7) by the number of cost drivers expected to be used per product (Ill. 4-8). Illustration SO4 Know how companies identify and use cost drivers in activity-based costing.
24 Example of ABC Versus Traditional Costing Assign Overhead Cost to Products (Step 4) To assign overhead costs, Atlas multiplies the activity-based overhead rates per cost driver (Ill. 4-7) by the number of cost drivers expected to be used per product (Ill. 4-8). Illustration SO4 Know how companies identify and use cost drivers in activity-based costing.
25 Example of ABC Versus Traditional Costing Comparing Unit Costs Illustration 4-10 A likely consequence of the differences in assigning overhead is that Atlas has been overpricing The Boot and possibly losing market share to competitors. It also has been sacrificing profitability by underpricing The Club SO4 Know how companies identify and use cost drivers in activity-based costing.
26 Example of ABC Versus Traditional Costing Comparing Unit Costs Under ABC, overhead costs are shifted from the high volume product (The Boot) to the low volume product (The Club) because: Low volume products often require more special handling. Assigning overhead using ABC will usually increase the cost per unit of low volume products SO4 Know how companies identify and use cost drivers in activity-based costing.
27 Example of ABC Versus Traditional Costing Lift Jack Company has seven activity cost pools and two products. It expects to produce 200,000 units of its automobile scissors jack and 80,000 units of its truck hydraulic jack. Having identified its activity cost pools and the cost drivers for each cost pool, Lift Jack Company accumulated the following data relative to those activity cost pools and cost drivers SO4 Know how companies identify and use cost drivers in activity-based costing.
28 Example of ABC Versus Traditional Costing Lift Jack Company has seven activity cost pools and two products. It expects to produce 200,000 units of its automobile scissors jack and 80,000 units of its truck hydraulic jack. Having identified its activity cost pools and the cost drivers for each cost pool, Lift Jack Company accumulated the following data relative to those activity cost pools and cost drivers. Using the previous data, do the following: a. Prepare a schedule showing the computations of the activitybased overhead rates per cost driver. b. Prepare a schedule assigning each activity s overhead cost to the two products. c. Compute the overhead cost per unit for each product. d. Comment on the comparative overhead cost per unit SO4 Know how companies identify and use cost drivers in activity-based costing.
29 Example of ABC Versus Traditional Costing a. Prepare a schedule showing the computations of the activity-based overhead rates per cost driver Solution on notes page SO4 Know how companies identify and use cost drivers in activity-based costing.
30 b. Prepare a schedule assigning each activity s overhead cost to the two products Solution on notes page SO4
31 b. Prepare a schedule assigning each activity s overhead cost to the two products Solution on notes page SO4
32 Example of ABC Versus Traditional Costing c. Compute the overhead cost per unit for each product. d. Comment on the comparative overhead cost per unit. These data show that the total overhead assigned to 80,000 hydraulic jacks is nearly as great as the overhead assigned to 200,000 scissors jacks. However, the overhead cost per hydraulic jack is $41. It is only $17.60 per scissors jack SO4 Know how companies identify and use cost drivers in activity-based costing.
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34 Activity-Based Costing: A Closer Look Benefits of ABC More accurate product costing through: Use of more cost pools to assign overhead costs Enhanced control over overhead costs Better management decisions 4-34 SO5 Understand the benefits and limitations of activity-based costing.
35 Activity-Based Costing: A Closer Look Limitations of ABC Can be expensive to use Some arbitrary allocations continue 4-35 SO5 Understand the benefits and limitations of activity-based costing.
36 4-36
37 Activity-Based Costing: A Closer Look When to Use ABC Factors to consider: 1. Product lines differ in volume and manufacturing complexity. 2. Product lines are numerous and diverse. 3. Overhead costs constitute a significant portion of total costs. 4. The manufacturing process or the number of products has changed significantly. 5. Production or marketing managers are ignoring data provided by the existing system SO5 Understand the benefits and limitations of activity-based costing.
38 Activity-Based Costing: A Closer Look Value-Added Versus Non Value-Added Activities Activity-Based Management (ABM): An extension of ABC from a product costing system to a management function that focuses on reducing costs and improving processes and decision making. Value-added activities Non value-added activities 4-38 SO6 Differentiate between value-added and non value-added activities.
39 Activity-Based Costing: A Closer Look Value-Added Versus Non Value-Added Activities An activity that increases the worth of a product or service such as: Manufacturing Company Engineering design Machining services Assembly Painting Packaging Service Company Performing surgery Legal research Delivering packages 4-39 SO6 Differentiate between value-added and non value-added activities.
40 Activity-Based Costing: A Closer Look Value-Added Versus Non Value-Added Activities An activity that adds cost to, or increases the time spent on, a product/service without increasing its market value such as: Manufacturing Company Repair of machines Storage of inventory Moving of inventory Building maintenance Inspections Inventory control Service Company Taking appointments Reception Bookkeeping and billing Traveling Ordering supplies Advertising 4-40 SO6 Differentiate between value-added and non value-added activities.
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42 Activity-Based Costing: A Closer Look Classify each of the following activities within a dental practice as value-added (VA) or non value-added (NVA). NVA NVA VA VA NVA VA 1. Ordering supplies. 2. Taking appointments. 3. Completing continuing education requirements. 4. Explaining dental-hygiene techniques to patients. 5. Completing insurance documents. 6. Examining patients Solution on notes page SO6 Differentiate between value-added and non value-added activities.
43 Activity-Based Costing: A Closer Look Classification of Activity Levels ABC activities levels: 1. Unit-level activities 2. Batch-level activities 3. Product-level activities 4. Facility-level activities 4-43 SO7 Understand the value of using activity levels in activity-based costing.
44 Activity-Based Costing: A Closer Look Classification of Activity Levels 4-44 Illustration 4-13 SO7
45 Activity-Based Costing: A Closer Look Morgan Toy Company manufactures six primary product lines in its Morganville plant. As a result of an activity analysis, the accounting department has identified eight activity cost pools. Each of the toy products is produced in large batches, with the whole plant devoted to one product at a time. Classify each of the following activities as either unit-level, batchlevel, product-level, or facility-level: Product-level Batch-level Product-level Facility-level a. Engineering design, b. Machine setup, c. Inventory management, d. Plant cafeteria, 4-45 Solution on notes page SO7 Understand the value of using activity levels in activity-based costing.
46 Activity-Based Costing: A Closer Look Morgan Toy Company manufactures six primary product lines in its Morganville plant. As a result of an activity analysis, the accounting department has identified eight activity cost pools. Each of the toy products is produced in large batches, with the whole plant devoted to one product at a time. Classify each of the following activities as either unit-level, batchlevel, product-level, or facility-level: Batch-level Unit-level Unit-level Batch-level e. Inspections after each setup, f. Polishing parts, g. Assembling parts, h. Health and safety Solution on notes page SO7 Understand the value of using activity levels in activity-based costing.
47 Activity-Based Costing in Service Industries Overall objective: Identify key cost-generation activities and keep track of quantity of activities performed for each service provided. General approach is to identify activities, cost pools, and cost drivers. Labeling of activities as value-added or non-value-added. A larger proportion of overhead costs are company-wide costs that cannot be directly traced to specific services provided by the company SO8 Apply activity-based costing to service industries.
48 Activity-Based Costing in Service Industries Traditional Costing Example The public accounting firm of Check and Doublecheck prepares the following condensed annual budget. Illustration SO8
49 Activity-Based Costing in Service Industries Traditional Costing Example Under traditional costing Check and Doublecheck would compute applied overhead and operating income as: Illustration SO8 Apply activity-based costing to service industries.
50 Activity-Based Costing in Service Industries Activity-Based Costing Example Check and Doublecheck distributes its estimated annual overhead costs of $1,200,000 to several activity cost pools. Illustration SO8 Apply activity-based costing to service industries.
51 Activity-Based Costing in Service Industries Activity-Based Costing Example Assigning overhead in a service industry Illustration SO8 Apply activity-based costing to service industries.
52 Activity-Based Costing in Service Industries Activity-Based Costing Example Comparison of traditional costing with ABC in a service company. Illustration SO8 Apply activity-based costing to service industries.
53 The average worker wastes about 2.1 hours per eight-hour workday. This does not include lunch and scheduled breaks. According to human resources managers, companies assume that employees will waste about one hour per day. The top time-wasting activities cited by employees are surfing the Internet, socializing with coworkers, and conducting personal business. 4-53
54 Older people waste less time at work than younger people. Men and women waste about the same amount of time. The average worker earns $19.13 per hour. If, as stated above, the average worker wastes about 1.1 hours more per day than employers expect, then the total lost salary dollars is about $759 billion per year. A third (33%) of survey respondents said that they waste time at work because they do not have enough work to do. About a quarter (23%) of respondents said they waste time at work because they are not paid enough. 4-54
55 A recent survey found that only about 11% of full-time students spend more than 25 hours a week preparing for class (which is about the number of hours that instructors say is needed to do well in college). About 44% of the students in the survey said that they spend less than 10 hours per week. 4-55
56 Many self-help books and websites offer suggestions on how to improve your time management. Should you minimize the non value-added hours in your life by adopting the methods suggested by these sources? YES: There are a limited number of hours in a day. You should try to maximize your chances of achieving your goals by eliminating the time that you waste. NO: Life is about more than working yourself to death. Being an efficiency expert doesn t guarantee that you will be happy. Schedules and daily planners are too constraining. 4-56
57 Just-in-Time Processing. JIT manufacturing is dedicated to having the right amount of materials, parts, or products just as they are needed. Illustration 4A SO9 Explain just-in-time (JIT) processing.
58 Just-in-Time Processing Objective of JIT Processing To eliminate all manufacturing inventories. Elements of JIT Processing Dependable suppliers. Multiskilled work force. Total quality control system SO9 Explain just-in-time (JIT) processing.
59 Just-in-Time Processing Benefits of JIT Processing Significant reduction or elimination of manufacturing inventories. Enhanced product quality. Reduction or elimination of rework costs and inventory storage costs. Production cost savings from the improved flow of goods through the processes SO9 Explain just-in-time (JIT) processing.
60 Copyright Copyright 2010 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 4-60
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