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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

Activity Based Costing: A Tool to Aid Decision Making

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

Chapter

slide2
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.

slide3
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

slide4
Cost Accounting Systems

Product Costs

Job-Order Costing

Process Costing

Total/Unit Cost

activity based costing abc
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!

activity based costing abc7
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.

how costs are treated under activity based costing
How Costs are Treated Under Activity-Based Costing

Activity Based

Costing

Departmental

Overhead

Rates

Level of Complexity

Plantwide

Overhead

Rate

Overhead Allocation

slide10
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

slide11

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

slide12
Functional-Based Management Model

Cost View

Resources

Operational View

Efficiency

Analysis

Functions

Performance Analysis

Products

slide13
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.

refining a cost system
Refining a Cost System
  • Reclassify indirect costs as direct costs.
  • Define more cost pools.
  • Identify cost drivers.
  • Use Activity-Based Costing.
slide15
Activity-Based Management Model

Cost View

Resources

Operational View

Driver Analysis

Activities

Performance Analysis

Products & Customers

designing an abc system
Activities

Consumption

of Resources

Cost

Designing an ABC System

Cost Objects

(e.g., products

and customers)

designing an abc system17
Designing an ABC System
  • 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.
designing an abc system18
Designing an ABC System
  • Assign costs to cost objects using the activity rates and activity measures.
  • Prepare management reports.
slide19
Step 1

Identify and Define Activities and Activity Cost Pools

step 1 identify and define activities and activity cost pools
An 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
activity levels step 1
Activity Levels (Step #1)

Batch

Level

Product Level

Activity Levels

Unit

Level

Customer Level

Organization-Sustaining Level

step 1 identify and define activities and activity cost pools22
Step #1: Identify and Define Activities and Activity Cost PoolsStep #1 For Classic Brass

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

step 1 identify and define activities and activity cost pools23
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.
step 1 identify and define activities and activity cost pools24
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.
slide25
Step 2

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

slide27
Step 3

Assign Costs to Activity Cost Pools

assign costs to activity cost pools
Assign Costs to Activity Cost 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.

assign costs to activity cost pools30
Assign Costs to Activity Cost Pools

Indirect factory wages $500,000

Percent consumed by customer orders 25%

$125,000

assign costs to activity cost pools31
Assign Costs to Activity Cost Pools

Factory equipment depreciation $300,000

Percent consumed by customer orders 20%

$ 60,000

slide33
Step 4

Calculate the Activity Rates

step 1 identify and define activities and activity cost pools34
Step #1: Identify and Define Activities and Activity Cost PoolsActivity Cost Pools For Classic Brass

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

calculate activity rates
Calculate Activity Rates

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.

slide37
Traced

Traced

Traced

Activity-Based Costing at Classic Brass

Direct

Materials

Direct

Labor

Shipping

Costs

Overhead Costs

Cost Objects:

Products, Customer Orders, Customers

slide38
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

Cost Objects:

Products, Customer Orders, Customers

activity based costing at classic brass
Activity-Based Costing at Classic BrassActivity-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

slide40
Step 5

Assign Costs to Cost Objects

assigning costs to cost objects
Assigning Costs to Cost Objects

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.

slide42
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.

slide43
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.

slide44
Step 6

Prepare Management Reports

product margins
Predetermined manufacturing

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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