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Activity Based Costing: A Tool to Aid Decision Making. UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee. Chapter. Direct Materials. Direct Labor. Work-in- Process. Finished Goods. Cost-of Goods Sold. Mfg. Overhead.

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Activity based costing a tool to aid decision making l.jpg

Activity Based Costing: A Tool to Aid Decision Making

UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

Chapter


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Direct

Materials

Direct

Labor

Work-in-

Process

Finished

Goods

Cost-of

Goods Sold

Mfg.

Overhead

Cost Measurement

Remember this?

Cost Accumulation

Cost Assignment

Goal: Accurately costed products.


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Measuring Costs

Actual DM

Actual DL

Actual MOH

Actual Costing System

Normal Costing System

Actual DM

Actual DL

Estimated MOH

Standard Costing System

Standard DM

Standard DL

Standard MOH


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Cost Accounting Systems

Product Costs

Job-Order Costing

Process Costing

Total/Unit Cost


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Functional Based Costing

Activity Based Costing

Assigning Manufacturing Costs


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ABC is a

good supplement to our traditional cost system

Activity Based Costing (ABC)

ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” costs.

I agree!


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Activity Based Costing (ABC)

Both manufacturing

and nonmanufacturing

costs may be

assigned to

products.

A number

of cost pools each allocated to a product

or cost object.

Some manufacturing

costs may be excluded

from product

costs.

Allocation bases often

differ from

traditional costing

systems.

Overhead rates may

be based on activity

at capacity.


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How Costs are Treated Under Activity-Based Costing

Activity Based

Costing

Departmental

Overhead

Rates

Level of Complexity

Plantwide

Overhead

Rate

Overhead Allocation



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Raw

Materials

Cost

Direct

Labor

Hours

Machine

Hours

Stage Two:

Costs applied

to products

Products

Departmental Allocation Bases

Departmental Overhead Rates

Indirect

Labor

Indirect

Materials

Other

Overhead

Stage One:

Costs assigned

to pools

Department

1

Department

2

Department

3

Cost pools


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Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.


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Functional-Based Management Model uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.

Cost View

Resources

Operational View

Efficiency

Analysis

Functions

Performance Analysis

Products


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The problem with this approach is that individual products, services, etc., may use those resources in a nonuniform way.

The end result is that some products will be overcosted while others will be undercosted.


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Refining a Cost System services, etc., may use those resources in a nonuniform way.

  • Reclassify indirect costs as direct costs.

  • Define more cost pools.

  • Identify cost drivers.

  • Use Activity-Based Costing.


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Activity-Based Management Model services, etc., may use those resources in a nonuniform way.

Cost View

Resources

Operational View

Driver Analysis

Activities

Performance Analysis

Products & Customers


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Activities services, etc., may use those resources in a nonuniform way.

Consumption

of Resources

Cost

Designing an ABC System

Cost Objects

(e.g., products

and customers)


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Designing an ABC System services, etc., may use those resources in a nonuniform way.

  • Identify and define activities and activity cost pools.

  • Whenever possible, directly trace costs to activities and cost objects.

  • Assign costs to activity cost pools.

  • Calculate activity rates.


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Designing an ABC System services, etc., may use those resources in a nonuniform way.

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

  • Prepare management reports.


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Step 1 services, etc., may use those resources in a nonuniform way.

Identify and Define Activities and Activity Cost Pools


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An services, etc., may use those resources in a nonuniform way.Activity Cost Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system.

$

$

$

$

$

$

Step #1:Identify and Define Activities and Activity Cost Pools


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Activity Levels (Step #1) services, etc., may use those resources in a nonuniform way.

Batch

Level

Product Level

Activity Levels

Unit

Level

Customer Level

Organization-Sustaining Level


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Step #1: Identify and Define Activities and Activity Cost Pools Step #1 For Classic Brass

At Classic Brass, the ABC team, selected the following activity cost pools and activity measures:


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Step #1:Identify and Define Activities and Activity Cost Pools

  • Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders.

  • Product Designs - assigned all costs of resources consumed by designing products.

  • Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.


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Step #1:Identify and Define Activities and Activity Cost Pools

  • Customer Relations – assigned all costs associated with maintaining relations with customers.

  • Other – assigned all overhead costs that are not associated with the other cost pools.


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Step 2 Pools

Whenever Possible, Directly Trace Overhead Costs to Activities and Cost Objects.



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Step 3 Pools

Assign Costs to Activity Cost Pools



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Assign Costs to Activity Cost Pools Pools

At Classic Brass the following distribution of resource consumption across activity cost pools is determined.

**Not included because they are directly traced to customer orders.


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Assign Costs to Activity Cost Pools Pools

Indirect factory wages $500,000

Percent consumed by customer orders 25%

$125,000


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Assign Costs to Activity Cost Pools Pools

Factory equipment depreciation $300,000

Percent consumed by customer orders 20%

$ 60,000



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Step 4 Pools

Calculate the Activity Rates


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Step #1: Identify and Define Activities and Activity Cost Pools Activity Cost Pools For Classic Brass

At Classic Brass, the ABC team, selected the following activity cost pools and activity measures:


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Calculate Activity Rates Pools

The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .

  • 1,000 customer orders

  • 200 new designs

  • 20,000 machine-hours

  • 100 customer relations activities

Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.



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Traced Pools

Traced

Traced

Activity-Based Costing at Classic Brass

Direct

Materials

Direct

Labor

Shipping

Costs

Overhead Costs

Cost Objects:

Products, Customer Orders, Customers


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Activity-Based Costing at Classic Brass Pools

Direct

Materials

Direct

Labor

Shipping

Costs

Overhead Costs

First-Stage Allocation

Order

Size

Customer

Orders

Product

Design

Customer

Relations

Other

Cost Objects:

Products, Customer Orders, Customers


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Activity-Based Costing at Classic Brass Pools

Activity-Based Costing at Classic Brass

Direct

Materials

Direct

Labor

Shipping

Costs

Overhead Costs

First-Stage Allocation

Order

Size

Customer

Orders

Product

Design

Customer

Relations

Other

Second-Stage Allocations

$/MH

$/Order

$/Design

$/Customer

Cost Objects:

Products, Customer Orders, Customers

Unallocated


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Step 5 Pools

Assign Costs to Cost Objects


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Assigning Costs to Cost Objects Pools

Let’s take a look at how our system works for just one customer – Windward Yachts.

Standard Stanchions (no design required)

1. 400 units ordered with 2 separate orders.

2. Each stanchion required 0.5 machine-hours .

3. Selling price is $34 each.

4. Direct materials total $2,110.

5. Direct labor totals $1,850.

6. Shipping costs total $180.

Custom Compass Housing (requires new design)

1. One order during the year.

2. Each housing required 4 machine-hours .

3. Selling price is $650 each.

4. Direct materials total $13.

5. Direct labor totals $50.

6. Shipping costs total $25.


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Standard Stanchions (no design required) Pools

1. 400 units ordered with 2 separate orders.

2. Each stanchion required 0.5 machine-hours .

3. Selling price is $34 each.

4. Direct materials total $2,110.

5. Direct labor totals $1,850.

6. Shipping costs total $180.


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Custom Compass Housing (requires new design) Pools

1. One order during the year.

2. Each housing required 4 machine-hours .

3. Selling price is $650 each.

4. Direct materials total $13.

5. Direct labor totals $50.

6. Shipping costs total $25.


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Step 6 Pools

Prepare Management Reports


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Predetermined manufacturing Pools

overhead rate

$1,000,000

20,000 MH

=

= $50/MH

Product Margins

Traditional Cost Accounting System

400 units x 0.5 MH/unit x $50/MH = $10,000


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