CHAPTER Activity-Based Costing
Objectives 1. Discuss the importance of unit costs. 2. Describe functional-based costing approaches. 3. Explain why functional-based costing approaches may produce distorted costs. 4. Explain how an activity-based costing system works for product costing. continued
Objectives 5. Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates. 6. Describe activity-based customer and supplier costing.
Unit cost is the total cost associated with the units produced divided by the number of units produced. Unit cost is used for-- • Inventory valuation • Income determination • Providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders
Product cost is often defined as the sum of direct materials, direct labor, and manufacturing overhead. This definition is required for external financial reporting.
Cost measurement consists of determining the dollar amounts of direct materials, direct labor, and overhead used in production.
The process of associating the costs, once measured, with the units produced is called cost assignment.
Measurement Systems • Two possible measurement systems are actual costing and normal costing. Actual costingassigns the actual costs of direct materials, direct labor, and overhead to products. Normal costingassigns the actual costs of direct materials and direct labor to products; however, overhead cots are assigned to products using predetermined rates.
Budgeted (estimated) cost Estimated activity usage Measurement Systems A predetermined overhead rate is a rate based on estimated data.
Examples of Unit-Level Drivers • Units produced • Direct labor hours • Direct labor dollars • Machine-hours • Direct material dollars
Theoretical Practical Expected actual Normal Activity Cost Measures Units (of driver) Time
Assign Costs Direct Tracing (single rate) Plantwide Pool Stage One: Pool Formation Assign Costs Unit-Level Driver (multiple rate) Products Stage Two: Costs Assigned Functional-Based Costing: Plantwide Rate (overhead rate total) Overhead Costs Distribution (company), Allocation (dept.), Assignment (product)
Belring, Inc. • Belring, Inc. produces two telephones: a cordless (nircable) and a regular model (cable). The company has the following actual and budgeted data: • . Budgeted overhead $360,000 Expected activity (DLH) 100,000 Actual activity (DLH) 100,000 Actual overhead $380,000
Belring, Inc. Predetermined Overhead Rate = Budgeted (estimated) cost $360,000 Estimated activity usage 100,000 DLH Predetermined Overhead Rate = $3.60 per DLH • Predetermined Overhead Rate =
The total overhead assigned to actual production is called applied overhead. Overhead rate x Actual activity output Applied overhead =
Belring, Inc. Applied overhead Overhead rate x Actual activity output = = $3.60 x 100,000 DLH = $360,000
Per-Unit Cost Belring, Inc. • CordlessRegular • Prime costs $ 78,000 $ 738,000 • Overhead costs: • $3.60 x 10,000 36,000 --- • $3.60 x 90,000 --- 324,000 • Total manufacturing costs $114,000 $1,062,000 • Units produced 10,000 100,000 • Unit cost $ 11.40 $ 10.62
Allocation Assign Costs Driver Tracing Direct Tracing Stage One: Pool Formation Department A Pool Department B Pool Assign Costs Assign Costs Unit-Level Drivers Stage Two: Costs Assigned Products Products Functional-Based Costing Department Rates Overhead Costs
Symptoms of an Outdated Functional Cost System 1. The outcome of bids is difficult to explain. 2. Competitors’ prices appear unrealistically low. 3. Products that are difficult to produce show high profits. 4. Operational managers want to drop products that appear profitable. 5. Profit margins are difficult to explain. Continued
Symptoms of an Outdated Functional Cost System 6. The company has a highly profitable niche all to itself. 7. Customers do not complain about price increases. 8. The accounting department spends a lot of time supplying cost data for special projects. 9. Some departments are using their own accounting system. 10. Product costs change because of changes in financial reporting regulations.
Non-unit activity drivers are factors that measure the consumption of non-unit activities by products and other cost objects.
Product diversity means that the products consume overhead activities in systematically different proportions.
A primary activity is one that is consumed by a product or customer. A secondary activity is one that is consumed by other primary and secondary activities.
Resource drivers are factors that measure the consumption of resources by activities.
Classification of Activities • Unit-level activities are those that are performed each time a unit is produced. Order 40 chairs & 4 cupboards • Examples: : a unit of product : Power and machine hours are used each time a unit is produced. Direct materials and direct labor activities are also unit-level activities, even though they are not overhead costs. Imagine in order costing method
Classification of Activities • Batch-level activities are those that are performed each time a batch of products is produced. • Examples: for 40 chairs and 4 cupboards : Setups, inspections, production scheduling, and material handling.
Classification of Activities • Product-level (sustaining) activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold. • Examples: for 40 chairs different to 4 cupboards : Engineering changes, process engineering, and expediting.
Classification of Activities • Facility-level activities are those that sustain a factory's general manufacturing processes. • Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.
Activity Level Filter Unit Level Batch Level Product Level Facility Level Driver Filter Driver Filter Driver Filter Set 1 Set 2 Set 3 Set 4 Set 5 Set 6 Set 7 A A A A A 1 2 3 4 5
Just in Time (JIT) • Demand pull system • Objectives: eliminate waste by producing only when it is needed and in the quantity demanded by customers • Benefits: better quality, increased productivity, reduced lead times, major reduction in inventory, reduced setup times, lower manufacturing costs.
Companies implement JIT • Wall mart General Motors Toys R Us • Ford General Electric Black & Decker • Chrysler Hewlett-Packard Harley Davidson • Motorola AT & T Xerox • Intel Borg Warner Westinghouse • John Deere Mercury Marine
Chapter Four The End