Cost Management ACCOUNTING AND CONTROL

1. Cost ManagementACCOUNTING AND CONTROL HANSEN & MOWEN

2. 4 CHAPTER Activity-Based Costing

3. 1 OBJECTIVE Functional-Based Product Costing Model Unit-Level Product Costing

4. 1 OBJECTIVE Unit-Level Product Costing Overhead costs are assigned to products using predetermined overhead rates. Predetermined Overhead rate Budgeted annual overhead Budgeted annual driver level = Applied overhead = Overhead rate  Actual driver usage

5. 1 OBJECTIVE Unit-Level Product Costing Overhead Assignment: Plantwide Rates Suncalc, Inc. Budgeted overhead $360,000 Expected activity (in direct labor hours) 120,000 Actual activity (in direct labor hours): Pocket calculator 40,000 Currency translator 60,000 100,000 Actual overhead $320,000 Units produced: Pocket calculator 80,000 Currency translator 90,000 Predetermined overhead rate = $360,000 / 120,000 = $3 per DLH

6. 1 OBJECTIVE Unit-Level Product Costing Per-Unit Overhead Cost Pocket Currency Calculator Translator Units produced 80,000 90,000 Direct labor hours 40,000 60,000 Overhead applied to production ($3 DLH) $120,000 $180,000 Overhead per unit* $1.50 $2.00 *Applied overhead/Units produced.

7. 1 OBJECTIVE Unit-Level Product Costing Overhead Variances The difference between actual overhead and applied overhead is an overhead variance. If actual overhead > applied overhead: underapplied overhead If actual overhead < applied overhead: overapplied overhead Disposal of variance: If immaterial, assign to cost of goods sold. If material, allocate among inventories and cost of goods sold.

8. 1 OBJECTIVE Unit-Level Product Costing Overhead Application: Departmental Rates $280,000 20,000 $80,000 80,000 Fabrication rate = Assembly rate = = $14 per MH = $1 per DLH

9. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Non-Unit-Related Overhead Costs The use either plantwide or departmental rates assumes that the number of units produced causes overhead costs to increase. There are some overhead costs that are not driven by the number of units produced. Example: setup costs or engineering costs Product diversity can also cause product cost distortion.

10. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Example of Unit-Based Overhead Rates This schedule uses the data from exhibit 4-2 to determine unit cost using a plantwide overhead rate. The plantwide rate is multiplied by the actual direct labor hours to determine the overhead to be applied to scented and regular cards.

11. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Example of Unit-Based Overhead Rates This schedule uses the data from exhibit 4-2 to determine unit cost using department overhead rates. The cutting department’s rate is multiplied by the actual direct labor hours and the printing department’s rate is multiplied by actual machine hours to determine the overhead to be applied to scented and regular cards.

12. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Example of Activity-Based Overhead Rates

13. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Example of Activity-Based Overhead Rates The schedule on the previous slide uses the data from exhibit 4-2 and the consumption ratios from exhibit 4-5 to determine unit cost using activity overhead rates. Each activity (set-up, machining, inspecting and moving materials) applies some of the total overhead The activity rate is multiplied by the actual activity driver to determine the overhead to be applied to scented and regular cards.

14. 2 OBJECTIVE Limitations of Plantwide and Departmental Rates Activity-based costing is most beneficial when • Multiple products are produced • Product diversity exists • Non-unit-level overhead is a significant percentage of production costs.

15. 3 OBJECTIVE Activity-Based Costing System Design Steps for an ABC System • Identify, define, and classify activities and key attributes. • Activity inventory • Activity dictionary • Activity classification (primary or secondary)

16. 3 OBJECTIVE Activity-Based Costing System Design Steps for an ABC System • Assign the cost of resources to activities using direct and driver tracing. Resources consumed by activities may include • labor • materials • capital • energy

17. 3 OBJECTIVE Activity-Based Costing System Design Steps for an ABC System • Assign the cost of secondary activities to primary activites. Example: a supervisor’s salary is assigned to a primary activity.

18. 3 OBJECTIVE Activity-Based Costing System Design Steps for an ABC System • Identify cost objects and specify the amount of each activity consumed by specific cost objects. Cost objects are identified. Examples include products, services, materials, and customers. Activity drivers are used to measure the demands placed on activities. Transaction drivers and duration drivers are used in most ABC systems.

19. 3 OBJECTIVE Activity-Based Costing System Design Steps for an ABC System • Calculate primary activity rates. Primary activity rates are computed by dividing budgeted activity costs by estimated activity output. • Assign activity costs to cost objects. Primary activity rates are multiplied by the actual activity output to determine total costs. Total costs are then divided by the number of units to determine unit cost.

20. 3 OBJECTIVE Activity-Based Costing System Classifying Activities • Classifying activities into categories aids in product costing because the cost behavior differs by level. The four levels are: • Unit-level • Batch-level • Product-level • Facility-level

21. 4 OBJECTIVE Reducing the Size and Complexity of an ABC System • Approximately Relevant ABC Systems • Use only the most expensive activities for ABC assignment. These costs are assigned using cause-and-effect drivers. • All other activity costs are added to cost pools of the expensive activities and assigned arbitrarily.

22. 4 OBJECTIVE Reducing the Size and Complexity of an ABC System • Equally Accurate Reduced ABC Systems • Use expected consumption ratios to reduce the number of drivers. • Equally accurate systems can be derived from complex ABC systems. • Perceived complexity is eliminated • Only actual driver data is collected

23. 5 OBJECTIVE ABC System Concepts ABC Database • Steps to create an ABC database: • Define and model the entities (objects) involved in the operation of an ABC system. • Develop a conceptual view portraying the entities and their relationships. • Identify the attributes associated with each entities.

24. 5 OBJECTIVE ABC System Concepts ABC Database First Stage - After the database is created, the data can be retrieved. Activity rates are then calculated. Second Stage – Pooled activity costs are assigned to individual products.

25. 5 OBJECTIVE ABC System Concepts ABC and ERP Systems ABC system – focus on customer and product profitability and seek to identify opportunities for process improvement. Because predetermined activity rates are used, costs assigned do not necessarily equal actual costs. ABC

26. 5 OBJECTIVE ABC System Concepts ABC and ERP Systems ERP system – primarily concerned with the company’s operational control system and focus on supporting continuous improvement. Requires highly accurate, timely and detailed information. ERP

27. End of Chapter 4