Slide 1 5.2 Activity Based Costing o Supplemental costing method added to traditional costing methods o Non-manufacturing as well as manufacturing costs may be assigned to products o Some manufacturing costs may NOT be assigned to products o None traditional allocation bases o Several overhead cost pools using activity rates to allocate overhead to cost objects Slide 2 Overhead Rate POHR = Estimated Manufacturing Overhead Estimated Allocation Base Plant wide overhead rate odirect labor hours omachine hours Department overhead rate odirect labor hours odirect labor cost omachine hours ounits of product Slide 3 Cost of Idle Capacity Traditional overhead rates are computed by dividing budgeted overhead by the budgeted allocation base This practice transfers the cost of idle capacity to the product thus clouding the true product cost
Slide 4 Designing an ABC System Steps for Implementation 1. Identify and define activities and activity cost pools 2. Wherever possible, directly trace costs to activities and cost objects 3. Assign 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 Slide 5 1. Identify and define activities o Unit-level activities o Batch-level activities o Product-level activities o Customer-level activities o Organization sustaining activities Slide 6 Determine what level of activity Determine which level of activity the following activities fall into. Use: U for unit-level B for batch-level C for customer-level P for product-level o Receive raw materials from suppliers o Do rough milling work on products o Issue purchase orders for a job o Design new products o Send new catalogs to distributors o Perform periodic maintenance on factory equipment o Manage parts inventories o Interview and process new employees in the Personnel department
Slide 7 Solution: what level of activity Determine which level of activity the following activities fall into. Use: U for unit-level B for batch-level C for customer-level o Receive raw materials from suppliers B o Do rough milling work on products U o Issue purchase orders for a job B o Design new products P o Send new catalogs to distributors C P for product-level o Perform periodic maintenance on factory equipment OS o Manage parts inventories B o Interview and process new employees in the Personnel department OS Slide 8 Activity Cost Pools & Measures COST Activity Cost Pool: o A bucket or pool in which costs are accrued COST POOL o i.e. a customer order cost pool would include all costs in receiving and processing customer orders Cost Activity Measure: o AKA cost driver o Should drive the cost being allocated o Rough measures of resource consumption Cost Driver Slide 9 Activity Cost Pools & Measures o Transaction Drivers o Least accurate o Simple counts of number of times an activity occurs o Duration Drivers o Measures time required to perform an activity o Accurate measures of resource consumption o More effort to record
Slide 1 Step 2: Trace overhead o Directly trace overhead costs to activities and cost drivers o Shipping can be directly traced to product o In traditional costing considered a period cost o Usually easy to trace to products Slide 11 Step 3: Assign costs to cost pools Most costs are classified in the accounting system to the departments that incur them o Rent o Salaries o Supplies o Makes it easy to allocate in this instance o First Stage Allocation o Assigning costs from overhead department to activity cost pools Slide 12 Step 3: Assign costs to cost pools Maintenance Worker wages General Factory Office Expenses Maintenance Worker wages Equipment Operating Expenses General Factory Office Expenses Equipment Operating Expenses Machine Setups 33% 1 1 Purchase Orders 3 75% $15, 6,4 6,2 7,15 General s Factory 67% 9 6 25%
Slide 13 Step 3: Assign costs to cost pools Maintenance Worker wages Maintenance Worker wages Equipment Operating Expenses General Factory Office Expenses Equipment Operating Exp General Factory Office Exp Machine Setups 5 64 62 6,26 Purchase Orders 1,86 5,72 7,58 $15, 6,4 6,2 7,15 General Factory 1, 5,76 3,72 1,43 22,55 s 15, 6,4 6,2 7,15 35,895 Slide 14 Step 4: Calculate Activity Rates Estimated Activity Cost Pool Overhead Costs Activity Cost Pool $6,26 $7,58 $22,55 Estimated Overhead Cost $6,26 $7,58 $22,55 XYZ Expected Activity 253 1,5 11 313 3,32 41 GHS 6 1,532 291 Activity Rate $2. 2.5 55. 313 3,32 41 Calculations 6,26/313 7,58/332 22,55/41 Slide 15 Step 5: Assign Costs to Cost Objects Activity Cost Pool Activity Cost Pool Activity Rate $2. 2.5 55. Activity Rate $2. 2.5 XYZ 253 1,5 11 GHS 6 1,532 $ 5,6 3,75 6,5 $14,86 $ 1,2 3,83 $2 x 253 $2.5 x 1,5 $55 x 11 Second Stage Allocation $2 x 6 $2.5 x 1,532 55. 291 16,5 $21,35 $55 x 291
Slide 16 Step 6: Prepare Reports Product XYZ GHS Units Cost Overhead produced Allocated Per Unit Cost 743 $14,86 $2./unit 4,27 $21,35 $5./unit Slide 17 Step 6: Prepare Reports Product Profitability XYZ GHS Sales Price $46.7 $25.13 Direct Materials 3.25 2.76 Direct Labor 15. 11.5 Shipping 2.85 2.85 Overhead 2. 5. Product Margin $ 5.6 $ 3.2 Slide 18 Differences between traditional and ABC o Costs calculated using ABC can be very different from traditional o A product can be unprofitable under traditional and show great profitability under ABC and vice versus o Overhead costs are often applied to products that: o never incur that particular cost or o Incur less of the cost than applied