Activity-Based Costing:Based Costing: A Tool to Aid...

Activity-Based Costing:Activity Based Costing:A Tool to Aid Decision Making

Chapter 8

© 2010 The McGraw-Hill Companies, Inc.

Activity Based Costing (ABC)Activity–Based Costing (ABC)

ABC is designed to id i h

ABC is agood supplement

provide managers with cost information for strategic and other

to our traditional cost system

I agree!strategic and other

decisions that potentially affect capacity and affect capacity and

therefore affect “fixed”as well as variable costs.

McGraw‐Hill/Irwin Slide 2

Learning Objective 1Learning Objective 1

U d d i iU d d i i b d b d Understand activityUnderstand activity--based based costing and how it differs costing and how it differs ggfrom a traditional costing from a traditional costing

systemsystemsystem.system.


How Costs are Treated UnderActivity Based CostingActivity–Based Costing

ABC differs from traditional cost accounting in three ways.ABC differs from traditional cost accounting in three ways.

Manufacturingcosts

Nonmanufacturingcosts

TraditionalTraditionalproduct costingproduct costing

ABCABCproduct costingproduct costing

ABC assigns both types of costs to products


ABC assigns both types of costs to products.


ABC differs from traditional cost accounting in three ways.ABC differs from traditional cost accounting in three ways.

Manufacturingcosts

Nonmanufacturingcosts

All

Som

e

TraditionalTraditionalproduct costingproduct costing

ABCABCproduct costingproduct costing

ABC does not assign all manufacturing costs to products

product costingproduct costing product costingproduct costing


ABC does not assign all manufacturing costs to products.


ABC differs from traditional cost accounting in three ways.

Activity–Basedxity


Departmental

Activity BasedCosting

mpl

ex

DepartmentalOverhead

Rates

l of c

o

Plantwide Overhead

RateLeve

l

Rate

Number of cost poolsABC t l


ABC uses more cost pools.



Each ABC cost pool has its


Each ABC cost pool has itsown unique measure of activity.

Traditional cost systems usually relyTraditional cost systems usually relyon volume measures such as direct laboron volume measures such as direct laboron volume measures such as direct laboron volume measures such as direct laborhours and/or machine hours to allocatehours and/or machine hours to allocate

all overhead costs to productsall overhead costs to products

ABC uses more cost pools.

all overhead costs to products.all overhead costs to products.


p

How Costs are Treated UnderActivity Based Costing

An event that causes the

Activity–Based Costing

Activity consumption of overhead resources.

Activity Cost Pool

A “cost bucket” in which costs related to a single

activity measure areCost Pool activity measure are accumulated.$

$ $

$$$$ $



Activity The term cost driver is also used to refer toMeasure also used to refer to an activity measure.

An allocation basein an activity-based

costing system.



T t f ti it


Two common types of activity measures:

Transaction Durationdriver driver

Simple countSimple countof the number ofof the number of

A measureA measureof the amountof the amount

times an activitytimes an activityoccurs.occurs.

of time neededof time neededfor an activity.for an activity.



ABC definesABC definesfive levels of activityfive levels of activityfive levels of activityfive levels of activity

that largely do not relatethat largely do not relateto the volume of unitsto the volume of unitsto the volume of unitsto the volume of units

produced.produced.

Traditional cost systems usually rely on volumeTraditional cost systems usually rely on volumeTraditional cost systems usually rely on volumeTraditional cost systems usually rely on volumemeasures such as direct labor hours and/or machinemeasures such as direct labor hours and/or machine

hours to allocate all overhead costs to productshours to allocate all overhead costs to products


hours to allocate all overhead costs to products.hours to allocate all overhead costs to products.


Unit-LevelA ti it

Batch-Level A ti it


Activity Activity

Manufacturingcompanies typically combinep yp y

their activities into fiveclassifications.

Product-Level Customer-LevelProduct-LevelActivity

Customer-LevelActivityOrganization-

sustaining


Activity

Characteristics of Successful ABC ImplementationsImplementations

Strong topmanagement supportmanagement support

Link to evaluationsand rewards

Cross-functionalinvolvement


involvement

Baxter Battery An ABC ExampleBaxter Battery – An ABC ExampleBaxter Battery Company

I St t t

Sales 50 000 000$

Income StatementYear Ended December 31, 2009

Sales 50,000,000$Cost of goods sold

Direct materials 15,000,000$ Direct labor 12,000,000 , ,Manufacturing overhead 14,000,000 41,000,000

Gross margin 9,000,000 Selling and administrative expenses

Shipping expenses 3,000,000 Marketing expenses 2,000,000 General administrative expenses 6,000,000 11,000,000

Net operating loss (2 000 000)$Net operating loss (2,000,000)$

Manufacturing overhead is allocated to products using


a single plantwide overhead rate based on machine hours.

Define Activities, Activity Cost Pools,and Activity Measuresand Activity Measures

A B B h ABC l d h f ll iAt Baxter Battery, the ABC team, selected the followingactivity cost pools and activity measures:


Define Activities, Activity Cost Pools,and Activity MeasuresCustomer Orders - assigned all costs of resources

and Activity Measures

that are consumed by taking and processing customer orders.Design Changes - assigned all costs of resources consumed by customer requested design changes.O d Si i d ll t fOrder Size - assigned all costs of resources consumed as a consequence of the number of units producedproduced.Customer Relations – assigned all costs associated with maintaining relations with customers.with maintaining relations with customers.Other – assigned all organization-sustaining costs and unused capacity costs


p y


A i l A i l Assign costs to cost pools Assign costs to cost pools using a firstusing a first--stage allocationstage allocation. . gg gg


Assign Overhead Costs to Activity CostPoolsPools



Direct materials, direct labor, and shipping are excludedDirect materials, direct labor, and shipping are excludedbecause Baxter Battery’s existing cost system can directlybecause Baxter Battery’s existing cost system can directly


because Baxter Battery s existing cost system can directlybecause Baxter Battery s existing cost system can directlytrace these costs to products or customer orders.trace these costs to products or customer orders.

Assign Overhead Costs to Activity CostPools

At Baxter Battery the following distribution of resource

Pools

At Baxter Battery the following distribution of resource consumption across activity cost pools is determined.



Indirect factory wages $6,000,000Percent consumed by customer orders 30%


$1,800,000


Factory equipment depreciation $3,500,000Percent consumed by customer orders 20%


$ 700,000


C i iC i iCompute activityCompute activityrates for cost pools.rates for cost pools.pp


Calculate Activity RatesCalculate Activity Rates

The ABC team determines that Baxter Battery will haveThe ABC team determines that Baxter Battery will have these total activities for each activity cost pool . . .

10 000 customer orders10 000 customer orders10,000 customer orders,10,000 customer orders,4,000 design changes,4,000 design changes,800 000 machine800 000 machine hourshours800,000 machine800,000 machine--hours,hours,2,000 customers served.2,000 customers served.

Now the team can compute the individual ti it t b di idi th t t l t factivity rates by dividing the total cost for

each activity by the total activity levels.


Calculate Activity RatesCalculate Activity Rates


A ti it B d C ti t B t B ttDirect

M t i lDirectL b

ShippingC t Overhead Costs

Activity–Based Costing at Baxter Battery

Materials Labor Costs Overhead Costs

Traced Traced Traced

Cost Objects:Cost Objects:P d t C t O d C tP d t C t O d C t


Products, Customer Orders, CustomersProducts, Customer Orders, Customers

A ti it B d C ti t B t B ttDirect

M t i lDirectL b

ShippingC t Overhead Costs

Activity–Based Costing at Baxter Battery

Materials Labor Costs Overhead Costs

First-Stage Allocation

CustomerCustomer OrderOrder CustomerCustomerDesignDesignCustomerCustomerOrdersOrders

OrderOrderSizeSize

CustomerCustomerRelationsRelations OtherOtherDesignDesign

ChangesChanges

Cost Objects:Cost Objects:P d t C t O d C tP d t C t O d C t


Products, Customer Orders, CustomersProducts, Customer Orders, Customers

A ti it B d C ti t B t B ttActivity–Based Costing at Baxter BatteryDirect

M t i lDirectL b

ShippingC t Overhead CostsMaterials Labor Costs Overhead Costs

First-Stage Allocation

CustomerCustomer OrderOrder CustomerCustomerDesignDesignCustomerCustomerOrdersOrders

OrderOrderSizeSize

CustomerCustomerRelationsRelations OtherOther

S dS d St All tiSt All ti

DesignDesignChangesChanges

SecondSecond--Stage AllocationsStage Allocations

$/Order $/Change $/MH $/Customer

Cost Objects:Cost Objects:P d t C t O d C tP d t C t O d C t Unallocated


Products, Customer Orders, CustomersProducts, Customer Orders, Customers Unallocated


A i bj A i bj Assign costs to a cost object Assign costs to a cost object using a secondusing a second--stage stage gg gg

allocation. allocation.


Assigning Overhead to Products

Baxter Battery Information

Assigning Overhead to Products

ySureStart1.1. Requires no new design resources.Requires no new design resources.q gq g2.2. 800,000 batteries ordered with 4,000 separate orders.800,000 batteries ordered with 4,000 separate orders.3.3. Each SureStart requires 36 minutes of machineEach SureStart requires 36 minutes of machine

time for a total of 480,000 machinetime for a total of 480,000 machine--hours.hours.time for a total of 480,000 machinetime for a total of 480,000 machine hours.hours.

LongLifeLongLife1. Requires new design resources.2. 400,000 batteries ordered with 6,000 separate orders.3 4 000 t d i d3. 4,000 custom designs prepared.4.4. Each LongLife requires 48 minutes of machineEach LongLife requires 48 minutes of machine

time for a total of 320,000 machinetime for a total of 320,000 machine--hours.hours.


Assigning Overhead to ProductsAssigning Overhead to Products


Assigning Overhead to Customers

Let’s take a look at how Baxter Battery’s system works for just

Assigning Overhead to Customers

Let s take a look at how Baxter Battery s system works for just one of the 2,000 customers – Acme Auto Parts who placed a total of twelve orders. Note that the four orders for LongLifes

required a design change.

Orders11 Ei ht d f 60 S St t dEi ht d f 60 S St t d1.1. Eight orders for 60 SureStarts per order.Eight orders for 60 SureStarts per order.2.2. Four orders for 50 LongLifes per order.Four orders for 50 LongLifes per order.

Machine-hours1.1. The 480 SureStarts required 288 machineThe 480 SureStarts required 288 machine--hours.hours.2.2. The 200 LongLifes required 160 machine hours.The 200 LongLifes required 160 machine hours.


Assigning Overhead to CustomersAssigning Overhead to Customers



U i iU i i b d i b d i Use activityUse activity--based costing to based costing to compute product and compute product and p pp p

customer margins.customer margins.


Prepare Management ReportsPrepare Management ReportsProduct Margin Calculations

The first step in computing product margins is togather each product’s sales and direct cost data.

SureStarts LongLifes TotalSales 31,300,000$ 18,700,000$ 50,000,000$

g p

, ,$ , ,$ , ,$Direct costs

Direct material 9,000,000 6,000,000 15,000,000 Direct labor 7,000,000 5,000,000 12,000,000Direct labor 7,000,000 5,000,000 12,000,000 Shipping 2,000,000 1,000,000 3,000,000



The second step in computing product margins is toincorporate the previously computed activity-based

t i t t i i t h d tcost assignments pertaining to each product.

SureStarts LongLifes TotalgSales 31,300,000$ 18,700,000$ 50,000,000$ Direct costs

Direct material 9,000,000 6,000,000 15,000,000 Direct labor 7,000,000 5,000,000 12,000,000 Shipping 2,000,000 1,000,000 3,000,000

ABC cost assignmentsCustomer orders 1,808,000 2,712,000 4,520,000 Design changes 3,040,000 3,040,000 Order size 3,120,000 2,080,000 5,200,000



The third step in computing productmargins is to deduct each product’sg pdirect and indirect costs from sales.

SureStarts LongLifesSales 31,300,000$ 18,700,000$ Costs

Direct material 9,000,000$ 6,000,000$

SureStarts LongLifes

, , , ,Direct labor 7,000,000 5,000,000 Shipping 2,000,000 1,000,000 Customer orders 1,808,000 2,712,000 Design changes 3,040,000 Order size 3,120,000 2,080,000

Total cost 22,928,000 19,832,000 P d t i 8 372 000$ (1 132 000)$


Product margin 8,372,000$ (1,132,000)$

Prepare Management ReportsProduct Margin Calculations

Prepare Management Reports

The product margins can be reconciled withthe company’s net operating income as follows:

SureStarts LongLifes TotalSales 31 300 000$ 18 700 000$ 50 000 000$

p y p g

Sales 31,300,000$ 18,700,000$ 50,000,000$ Total costs 22,928,000 19,832,000 42,760,000 Product margins 8,372,000$ (1,132,000)$ 7,240,000$

Less costs not assigned to products:Customer relations 3,080,000 Other 6 160 000Other 6,160,000 Total 9,240,000

Ne t operating loss (2,000,000)$


Prepare Management ReportsPrepare Management ReportsCustomer Margin Analysis

The first step in computing Acme Auto Parts’ customer margin is to gather its sales and direct cost data.

Acme AutoP tParts

Sales 29,200$ Direct costsDirect costs

Direct material 7,500 Direct labor 6 700Direct labor 6,700 Shipping 1,700



The second step is to incorporate Acme Auto Parts’ previously computed activity-based cost assignments.

Acme AutoParts

S l 29 200$Sales 29,200$ Direct costs

Direct material 7,500 Di t l b 6 700Direct labor 6,700 Shipping 1,700

ABC cost assignmentsC t d 5 424Customer orders 5,424 Product design 3,040 Order size 2,912 Customer relations 1 540


Customer relations 1,540


Th thi d t i t t A A t P t ’ t i fThe third step is to compute Acme Auto Parts’ customer margin of $384 by deducting all its direct and indirect costs from its sales.

Sales 29,200$ Direct costs

Acme Auto Parts

Direct costsDirect material 7,500$ Direct labor 6,700 Shipping 1 700Shipping 1,700 Customer orders 5,424 Product design 3,040 Order size 2,912 Customer relations 1,540 28,816

Customer margin 384$


Product Margins Computed Using the Traditional Cost SystemTraditional Cost System

The first step in computing product margins is togather each product’s sales and direct cost data.

SureStarts LongLifes TotalSales 31,300,000$ 18,700,000$ 50,000,000$ Direct costs

Direct material 9,000,000 6,000,000 15,000,000 Direct labor 7,000,000 5,000,000 12,000,000



The second step in computing product marginsis to compute the plantwide overhead rate.

Manufacturing Overhead Costs at Baxter Battery

Production DepartmentIndirect factory wages 6,000,000$ Factory equipment depreciation 3,500,000 Factory utilities 2,500,000 Factory building lease 2,000,000

Total manufacturing overhead 14,000,000$

Plantwide manufacturingoverhead rate

$14,000,000800,000 MH = $17.50 per machine-hour=

Machine-hoursSureStarts (800,000 @ 0.60 hours) 480,000 L Lif (400 000 @ 0 80 h ) 320 000


LongLifes (400,000 @ 0.80 hours) 320,000 Total machine-hours 800,000


The third step in computing product margins isallocate manufacturing overhead to each product.

M hi O h d O h dMachine Overhead Overhead Hours Rate Allocated

SureStarts 480,000 17.50$ 8,400,000$ L Lif 320 000 17 50 5 600 000LongLifes 320,000 17.50 5,600,000 Total overhead allocated to products 14,000,000$

480,000 hours × $17.50 per hour = $8,400,000



The fourth step is to actuallycompute the product margins.

Sales 31,300,000$ 18,700,000$ 50,000,000$ Cost of goods sold

SureStarts LongLifes Total

Direct materials 9,000,000$ 6,000,000$ 15,000,000$ Direct labor 7,000,000 5,000,000 12,000,000 Manufacturing overhead 8,400,000 24,400,000 5,600,000 16,600,000 14,000,000 41,000,000

Product margin 6,900,000$ 2,100,000 9,000,000 Selling and administrative 11,000,000 Se g a d ad st at e ,000,000

Ne t operating loss (2,000,000)$

Shipping expenses 3,000,000$ Marketing expenses 2,000,000 General administrative expenses 6,000,000

11 000 000$


11,000,000$

Differences Between ABC and Traditional Product CostsProduct Costs

SureStarts LongLifesProduct margins – traditional 6,900,000$ 2,100,000$Product margins traditional 6,900,000$ 2,100,000$ Product margins – ABC 8,372,000 (1,132,000) Change in reported margins 1,472,000$ (3,232,000)$

Th t diti l t Th t diti l tThe traditional costsystem overcosts the

SureStarts and reports

The traditional costsystem undercosts theLongLifes and reportsSureStarts and reports

a lower productmargin for this product.

LongLifes and reportsa higher product

margin for this product.


g p g p


There are three reasons why thereported product margins for the two

costing systems differ from one another.

Traditional costing allocates all manufacturingTraditional costing allocates all manufacturingoverhead to products. ABC costing only assignsmanufacturing overhead costs consumed bymanufacturing overhead costs consumed byproducts to those products.





Traditional costing allocates all manufacturingTraditional costing allocates all manufacturingoverhead costs using a volume-related allocationbase ABC costing also uses non-volume relatedbase. ABC costing also uses non volume relatedallocation bases.





Traditional costing disregards selling andadministrative expenses because they areassumed to be period expenses. ABC costingdirectly traces shipping costs to products andincludes nonmanufacturing overhead costs causedby products in the activity cost pools that areassigned to products.


Targeting Process ImprovementTargeting Process ImprovementActivity-based management is

d i j ti ith ABC tused in conjunction with ABC to identify areas that would benefit

from process improvementsfrom process improvements.

While the theory of constraints approach discussed in Chapter 1

is a powerful tool for targeting improvement efforts activity ratesimprovement efforts, activity rates can also provide valuable clues on

where to focus improvement efforts.p

Benchmarking Benchmarking can be used to compare activity cost can be used to compare activity cost information with worldinformation with world class standards of performanceclass standards of performance


information with worldinformation with world--class standards of performance class standards of performance achieved by other organizations.achieved by other organizations.

Activity Based Costing and External ReportingActivity-Based Costing and External Reporting

Most companies do not use ABCfor external reporting because . . .p g

1. External reports are less detailed than internal reports.

2. It may be difficult to make changes to the company’s accounting system.

3. ABC does not conform to GAAP.

4 Auditors may be suspect of the subjective allocation4. Auditors may be suspect of the subjective allocation process based on interviews with employees.


ABC LimitationsABC Limitations

Substantial resourcesSubstantial resources Resistance toResistance toSubstantial resourcesSubstantial resourcesrequired to implementrequired to implement

and maintain.and maintain.

Resistance toResistance tounfamiliar numbersunfamiliar numbers

and reports.and reports.and maintain.and maintain. and reports.and reports.

Desire to fullyDesire to fullyallocate all costsallocate all costs

to productsto products

PotentialPotentialmisinterpretation ofmisinterpretation ofunfamiliar numbersunfamiliar numbersto products.to products. unfamiliar numbers.unfamiliar numbers.

Does not conform toDoes not conform toDoes not conform toDoes not conform toGAAP. Two costingGAAP. Two costing

systems may be needed.systems may be needed.


systems may be needed.systems may be needed.

ABC Action AnalysisABC Action Analysis

Appendix 8A



(A di 8A)(A di 8A)(Appendix 8A)(Appendix 8A)

Prepare an action analysis Prepare an action analysis Prepare an action analysis Prepare an action analysis report using activityreport using activity--based based costing data and interpret costing data and interpret

the report. the report. the report. the report.


Appendix 8A: ABC Action AnalysisAppendix 8A: ABC Action Analysis

Conventional ABC analysis does not identify potentially relevant costs Anidentify potentially relevant costs. An

action analysis report helps because it:• Shows what costs have beenassigned to a cost object.assigned to a cost object.

• Indicates how difficult it would be todj t th t i tadjust those costs in response to

changes in the level of activity.


Appendix 8A: ABC Action Analysis

Constructing an action analysis report


Constructing an action analysis report begins with the first-stage allocation process.

In addition to computing an overall activityIn addition to computing an overall activity rate for each activity cost pool, an activity

rate is computed for each type of overheadrate is computed for each type of overhead cost that is consumed supporting a given

activity.activity. Let’s revisit the stage-one allocations

f th B t B tt C lfrom the Baxter Battery Company example that we discussed earlier.


Appendix 8A: ABC Action AnalysisAppendix 8A: ABC Action Analysis


$1,800,000 10,000 orders = $180 per orderOther entries in the table are computed similarly.

$180 per order 4 000 orders = $720 000


$180 per order × 4,000 orders = $720,000Other entries in the table are computed similarly.

$180 d 6 000 d $1 080 000


$180 per order × 6,000 orders = $1,080,000Other entries in the table are computed similarly.

Appendix 8A: ABC Action AnalysisNext, label each cost using an ease of adjustment

Appendix 8A: ABC Action Analysisg j

code:• Green costs adjust more or less automatically toGreen costs adjust more or less automatically tochanges in activity level without any action bymanagers.

• Yellow costs can be adjusted to changes in activitylevel, but it would require management action tolevel, but it would require management action torealize the change in cost.

• Red costs can be adjusted to changes in activity• Red costs can be adjusted to changes in activitylevel only with a great deal of difficulty and withmanagement intervention.


a age e e e o


S l 18 700 000$

Action Analysis of LongLife Batteries


Sales 18,700,000$

Green costsDirect materials 6,000,000$ Shipping costs 1 000 000 7 000 000Shipping costs 1,000,000 7,000,000

Green margin 11,700,000$

Yellow costsDirect labor 5,000,000 Indirect factory wages 3,360,000 Factory utilities 850,000 Administrative wages and salaries 1,280,000 Office equipment depreciation 252,000 q p p ,Marketing wages and salaries 420,000 Selling expenses 60,000 11,222,000

Yellow margin 478,000$

Red costsFactory equipment depreciation 1,610,000 Factory building lease - Administrative building lease - 1,610,000


Red margin (1,132,000)$

Using a Modified Form of Activity-Based Costing to Determine Product Costs forCosting to Determine Product Costs for

External Reports

Appendix 8B



(A di 8B)(A di 8B)(Appendix 8B)(Appendix 8B)

Use activityUse activity based costing based costing Use activityUse activity--based costing based costing techniques to compute unit techniques to compute unit product costs for external product costs for external

reports. reports. reports. reports.


Appendix 8BAppendix 8B

A modified form of activity-basedA modified form of activity basedcosting can be used to develop product

costs for external financial reportscosts for external financial reports.

ABC product costs:• Include organization sustaining costs• Include organization-sustaining costs

and unused capacity costs.• Exclude nonmanufacturing costs evenExclude nonmanufacturing costs even

if they are caused by the products.



Simmons’ Industries provides the following informationfor the company as a whole and for its only two

products deluxe and standard hedge trimmersproducts—deluxe and standard hedge trimmers.

Total estimated manufacturing overhead 1,800,000$ Total estimated direct labor hours 400,000

Deluxe StandardDirect materials cost per unit 38.00$ 28.00$ pDirect labor cost per unit 24.00$ 12.00$ Direct labor hours per unit 2.0 1.0 Units produced 100,000 200,000



Assuming that Simmons’ traditional cost system relies Assuming that Simmons’ traditional cost system relies on one predetermined plantwide overhead rate withon one predetermined plantwide overhead rate withon one predetermined plantwide overhead rate with on one predetermined plantwide overhead rate with

direct labordirect labor--hours (DLHs) as the allocation base, then hours (DLHs) as the allocation base, then its plantwide overhead rate is computed as follows:its plantwide overhead rate is computed as follows:its plantwide overhead rate is computed as follows:its plantwide overhead rate is computed as follows:

Predeterminedh d t = $4.50 per DLH= $1,800,000

400 000 DLHoverhead rate $4.50 per DLH400,000 DLHs



Simmons’ traditional cost system wouldreport unit product costs as follows:

Deluxe StandardDi t t i l t it 38 00$ 28 00$Direct materials cost per unit 38.00$ 28.00$ Direct labor cost per unit 24.00 12.00 Manufacturing overhead per unit 9.00 4.50 Unit product cost 71.00$ 44.50$

2.0 DLH × $4.50 per DLH

1 0 DLH × $4 50 per DLH


1.0 DLH × $4.50 per DLH


The ABC project team at Simmons hasdeveloped the following basic information.g

Estimated O h d

Activity and Activity MeasuresOverhead

Cost Deluxe Standard Total

Direct labor support (DLHs) 900 000$ 200 000 200 000 400 000

Expected Activity

Direct labor support (DLHs) 900,000$ 200,000 200,000 400,000 Machine setups (setups) 600,000 400 100 500 Parts administration (part types) 300,000 200 100 300 Total manufacturing overhead 1 800 000$Total manufacturing overhead 1,800,000$



We can calculate the following activity rates:

Activity and Activity Measures

Estimated Overhead

Cost

Total Expected Activity Activity RateActivity and Activity Measures Cost Activity

Direct labor support (DLHs) 900,000$ ÷ 400,000 = 2.25$ per DLHMachine setups (setups) 600,000 ÷ 500 = 1,200$ per setupParts administration (part types) 300,000 ÷ 300 = 1,000$ per part type

Activity Rate

Parts administration (part types) 300,000 300 1,000$ per part typeTotal manufacturing overhead 1,800,000$

Using the new activity rates, let’s assign overheadto the two products based upon expected activity.


Appendix 8BAppendix 8BDeluxe Product

Activity and Activity MeasuresExpected Activity

Activity Rate

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$Amount

Direct labor support (DLHs) 200,000 2.25$ 450,000$ Machine setups (setups) 400 × 1,200$ = 480,000 Parts administration (part types) 200 × 1,000$ = 200,000 T t l h d t i d 1 130 000$Total overhead cost assigned 1,130,000$

Standard Product

Activity and Activity MeasuresExpected Activity

Activity Rate Amount

Standard Product

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$ Machine setups (setups) 100 × 1,200$ = 120,000 Parts administration (part types) 100 × 1 000$ = 100 000


Parts administration (part types) 100 × 1,000$ = 100,000 Total overhead cost assigned 670,000$


Activity-based unit product costs for both product lines

Premium StandardDirect materials cost per unit 38.00$ 28.00$ Direct labor cost per unit 24 00 12 00Direct labor cost per unit 24.00 12.00 Manufacturing overhead per unit 11.30 3.35 Unit product cost 73.30$ 43.35$



Activity-based unit product costs for both product lines

Premium StandardDirect materials cost per unit 38.00$ 28.00$ Direct labor cost per unit 24 00 12 00Direct labor cost per unit 24.00 12.00 Manufacturing overhead per unit 11.30 3.35 Unit product cost 73.30$ 43.35$

$1,130,000 ÷ 100,000 units

$670,000 ÷ 200,000 units


Appendix 8BAppendix 8BComparing the two approaches

Deluxe Standard Deluxe StandardActivity-Based Costing Traditional Costing

Direct material 38.00$ 28.00$ 38.00$ 28.00$ Direct labor 24.00 12.00 24.00 12.00 Manufacturing overhead 11 30 3 35 9 00 4 50Manufacturing overhead 11.30 3.35 9.00 4.50 Unit product cost 73.30$ 43.35$ 71.00$ 44.50$

Note that the unit product cost of a Standard unitNote that the unit product cost of a Standard unitdecreased from $44.50 to $43.35 . . . . .decreased from $44.50 to $43.35 . . . . .

. . . . . while the unit cost of a Deluxe unit increased from . . . . . while the unit cost of a Deluxe unit increased from $71 00 to $73 30$71 00 to $73 30


$71.00 to $73.30.$71.00 to $73.30.

End of Chapter 8End of Chapter 8


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