Activity Based Costing

Handi Brata
Universitas Tanjungpura
Unit Cost

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
Slide 2
 Product Cost

Product cost is often defined as the sum of

direct materials, direct labor, and
manufacturing overhead. This definition is
required for external financial reporting.

Product Cost = DM + DL + OH

Slide 3
Cost Assignment

The process of associating the costs,

once measured, with the units
produced is called cost assignment.

Cost Assignment Systems

Functional Based Activity Based

Costing Costing (ABC)

Plantwide Departmental
Rate Rate

Slide 4
 Basic Concepts

Manufacturing costs are assigned

A predetermined
to product:
overhead rate is a rate
❖ Direct material direct tracing based on estimated data.

❖ Direct Labor direct tracing

❖ Overhead Driver tracing &

Allocations (using predetermined
OH Rate)

Slide 5
Functional Based Costing

Common unit level cost drivers:

• Units produced
• Direct material costs
• Direct labor costs
• Direct labor hours
• Machine-hours

Overhead costs are allocated using:

❖ Plantwide Rate, or
❖ Departmental Rate
Slide 6
 Plantwide Rate

Overhead Costs

Assign Costs Direct Tracing

Plantwide Pool Stage One: Pool Formation

Assign Costs

Stage Two: Costs Assigned

Products
Applied OH = OH rate X Actual cost driver
Slide 7
 Examples

Belring, Inc.

Belring, Inc. produces two hand

phones: a smartphone and a regular
model. The company has the following
actual and budgeted data:

Budgeted overhead $360,000

Expected activity (DLH) 100,000
Actual activity (DLH) 110,000
Actual overhead $380,000

Slide 8
 Belring’s Production Data

Smartphone Regular
Prime costs $ 78,000 $ 738,000
Direct Labor Hours 10,000 95,000
Units produced 10,000 100,000

Slide 9
 Calculate Applied Overhead

The total overhead assigned to actual

production is called applied overhead.

Actual
2 Applied Overhead x
= cost
overhead rate
driver

Slide 10
 Unit Cost Calculation

Smartphone Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
$3.60 x 10,000 36,000 ---
$3.60 x 95,000 --- 342,000
Total manufacturing costs $114,000 $1,080,000
Units produced ÷ 10,000 ÷ 100,000
Unit cost $ 11.40 $ 10.80

Slide 11
 Departmental Rates

Overhead Costs

Allocation
Assign Costs Driver Tracing
Direct Tracing

Stage One: Pool

Department A Pool Formation Department B Pool

Assign Costs Unit-Level Drivers Assign Costs

Stage Two: Costs

Products Assigned
Products

Slide 12
 Departmental Data
Belring, Inc.
Fabrication Assembly
Budgeted overhead $252,000 $108,000
Expected and actual usage (dlh):
Smartphone 7,000 3,000
Regular 18,000 77,000
25,000 80,000
Expected and actual usage (mh.):
Smartphone 4,000 1,000
Regular 36,000 9,000
40,000 10,000
Slide 13
 Departmental Rates

Applied
overhead

Slide 14
 Calculation Applied Overhead

Each product should go through 2 departments:

Fabrication and Assembly.

Applied Overhead Overhead

= +
overhead (Fabrication) (Assembly)

Applied
= ($6.30 x actual MH) + ($1.35 x actual DLH)
overhead

Slide 15
 Unit Cost: Departmental Rates

Smartphone Regular
Prime costs $ 78,000 $ 738,000
Overhead costs: ($6.30 x 4,000) + ($1.35 x 3,000) 29,250
---
($6.30 x 36,000) + (1.35 x 77,000) --- 330,750
Total manufacturing costs$107,250 $1,068,750
Units produced ÷ 10,000 ÷ 100,000
Unit cost $ 10.73 $ 10.69

Slide 16
 ABC: Two-Stage Assignment

Cost of Resources

Driver Driver
Assign Costs
Tracing Tracing

Activities

Driver
Assign Costs
Tracing

Products

Slide 17
 Product-Costing Data
Smartphone Regular Total
Units produced per year 10,000 100,000110,000
Activity Usage

Prime costs $78,000$738,000 $816,000

Measures

Direct labor hours 10,000 95,000 105,000

Machine hours 5,000 45,000 50,000
Production runs 20 10 30
Number of moves 60 30 90

Activity Activity Cost

Setups $120,000
Overhead Material handling 60,000
Activities Machining 100,000
Testing 80,000
Total $360,000
Slide 18
 Activity Rates

Setup rate: $120,000/30 = $4,000 per run

Material-handling rate: $60,000/90 = $666.67 per move
Machining rate: $100,000/50,000 = $2 per MH
Testing rate: $80,000/105,000 = $0.76 per DLH

Slide 19
 ABC Calculation

Smartphone Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
Setups 80,000 40,000

$4,000 x 20 $4,000 x 10

Slide 20
 ABC Calculation

Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
Setups 80,000 40,000
Material handling 40,000 20,000

$667 x 60 $667 x 30

Slide 21
 ABC Calculation

Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
Setups 80,000 40,000
Material handling 40,000 20,000
Machining 10,000 90,000

$2 x 5,000 $2 x 45,000

Slide 22
 ABC Calculation

Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
Setups 80,000 40,000
Material handling 40,000 20,000
Machining 10,000 90,000
Testing 7,600 68,400

$0.76 x 10,000 $0.76 x 90,000

Slide 23
 ABC Calculation

Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
Setups 80,000 40,000
Material handling 40,000 20,000
Machining 10,000 90,000
Testing 7,600 68,400
Total manufacturing costs$215,600 $ 956,400
Units produced ÷ 10,000 ÷ 100,000
Unit cost (total costs/units) $ 21.56 $ 9.56

Slide 24
 Comparison of Unit Costs

Cordless Regular
Plantwide rate $11.40 $10.80
Departmental rate 10.73 10.69
Activity rate 21.56 9.56

ABC shows more realistic unit costs

Slide 25
 Cost Distortions

When a unit-level approach is used to assign

non-unit-level costs (overhead), cost information can be
distorted.

Proportional
application assigns 9
times as much
overhead to Regular
phones.

Should we assume that

regular phones will use
9 times more overhead
costs than cordless
phones?

Slide 26
 Sources of cost distortions

Non-unit activity drivers are factors

that measure the consumption of
non-unit activities by products and
other cost objects.

❖ A large proportion of non-unit-level

activities
A unit level cost drivers, such as DMC, DLH, MH, will
not be able to assign the cost of non-unit-level
activities accurately

❖ Product diversity
Product diversity means that the products consume
overhead activities in systematically different
proportions.

Slide 27
Thanks for
Listening

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