CPAR (GPA REVIEW SCHOOL OF THE PHILIPPINES Mantle MAS 8602 MANAGEMENT ADVISORY SERVICES ACTIVITY BASED COSTING SYSTEM [BROAD AVERAGING OR “PEANUT-BUTTER COSTING - describes 2 costing approach that ses broad averages for assigning (or spreading, 2s in spreading peanut butter) te cast of resoures uniformly to cost objects when the India products or services, infact, use those resources in non-uniform ways. ‘Product undercostng ~ product consumes a high level of resources buts reported ‘tm have alow cost per unit. ‘Product overcosting- a product consumes alow level of resources but is reported to have a high cost per unt, Prodict-cost cross subsidization i a company undercosts one of ts products, Teil overcast atleast one of ts other products COSTING SYSTEM REFINEMENT - making changes toa simple costing system that reduces the use of broad averages for assigning the cost of resources to cost objets and provides better measurement of the costs of verhicad resources used by diferent cost objec, ‘An actinty-based approach refines a costing system by focusing on individual activites as the fundamental cost objects. I uses the cost ofthese actives 2s the bass for assigning costs ‘to other cost objects such as products or services. [ACTIVITY BASED COSTING (ABC) SYSTEM ~ alocates overhead to multiple actity cost oaks and assigns the activity cost posto products by means of cost drives. (Cost driver ~ a factor that causes @ change in the cost poo for a particular activity. Teis used 25 a basis for cost allocation; any factor or actity that has 2 direct cause-effect relationship ‘Activity - any event, action, transaction, or work sequence that incurs costs when producing a Product or providing a sence. ‘Activity Cost Pool - 2 “bucket” in which costs are accumulated that relate toa single activity" measure in the ABC System ‘aave-sooms Across ~ acviies that are necessary (non-elimnable) to produce the products 3 ‘Now-Vawwe ADDING ACTIIES ~ activites that do not make the product or service more ‘valuable to the customer BENEFITS OF ABC: 1. ABC leads to more cost pooks 2. ‘ABC leads to ennancad control over overhead ensts 3. ABC leads to better management decisions FOUR DECISIONS FOR WHICH ABC INFORMATION 1S USEFUL: 1. pricing and product max decisions, 2. cost reduction and proces improvement decisions, 3. product design decisions, nd 4. decisions for planing and managing activites, | |MAS 8602 ACTIVITY BASED COSTING Page 20813 LIMITATIONS OF ABC: 1. ABC can be expensive 2. Some arbitrary alocations continue WHEN TO SWITCH TO ABC - The presence of one or more ofthe following factors indicates ‘ABC asthe superior costing system: 1. Product ines diffe greatly in volume and manufacturing complexity 2 Product lines are numerous, diverse, and require fering degrees of support services. 3. Overhead costs constitute 2 significant portion of total costs The manufacturing process oF the number of products has changed significantly. 5. Production or marketing managers ae ignoring data provided by the existing system. HIERARCY OF ACTIVITY LEVELS 1. Unit-evel Activites ~ are performed each time a unit is produced. 21 Batch-level Activites ~ performed each time a batch is handled or processed, regardless of how many units are inthe batch. 3. Product-level Activites - relate to spedic products and typically must be carred out regardless of how many batches are run or units of product are produced or sol, 4. Cstomerlevel actives - relate to spetic customers 5. Organizaton-sustaining activites - carted out regardless of which customers are served, \hich products are produced, how many batces are run, or how many units are made. ‘STEPS FOR IMPLEMENTING ACTIVITY-BASED COSTING: 41. Define activites, activity cost pools, and activity measures. 2. Assign overhead costs to actuity cost pools. 3. Calevete activity rates, 4. Assign overhead costs to cost objects using the activity rates and actly measures. 5. Prepare management reports. arrcises: 11 Various types of activities at Ning Corporation, a manufacturing Company, ae sted below ‘Assembling components Receiving shipments. Providing eecricy 1. Designing modiications Setup. Cutting parts ‘Searing weriglace. 1 Caroting machines Organizing nodvetor. {Contoing inventay, Regunen: ‘Cassfy each aohity as a unitievel cas, producyprocessdevel cost, bettevel cost, of ‘orgerizatona/ecity evel cost act. 2. Weng Office Equipment Corporation marufacures two types of fling cabinets—Deluxe and ‘Executve—and 2ppies manuiacturing overhead to al unis at the rate of P8O per machine hou. Production information folows. SoReaMET ee Dawe — Beecutve Drec-materal cost Pao PES Directed cost 25 3 Budgeted volume (units) 16,000 30,000 ‘The controler, who is studying the use of activty-based costing, has determined that the fir’s cverneaad can be identities vith thrae actives: menufacuring setups, machine pc, rd pec ig Detaon msner f tr toe rs, et vg are the actties’ three respective cost dvr, elo.MAS 8602 ACTIVITY BASED COSTING Page 312 Deine Executive Total Setups 100 Cy 160 Machine hours 32,000 45,000 77,000 ‘Outgoing shipments 200 150 350 ‘The fim’s total overbead of 6,160,000 is subdivided as follows: manufacturing setups, 1,344,000; machine processing, P3,636,000; and product shipping, P1,120,000. ‘RequmneD: 11 Compute the unit manufacturing cost of Deluxe and Executive fling cabinets by using the companys curent overead costing procedures. 2. Compute the unit manufacturing cast of Deluxe and Executive fling cabinets by using _actvty-based costing, 3. Is the cost ofthe Dele fling cabinet overstated or understated (Le, distorted) by the use of machine hours to allocate total manufacturing overhead to production? By how much? 4. Calculate the aggregate amount by which the Deluxe cabinet Ine is undercosted by the company current traditional verhead casting procedures. Then calculate the aggre amount Whe aoa system eons te Exe cabinet 5. Assume thatthe curent sling price ofa Deluxe fling cabinet is P270 and the ‘marketing manager is contemplating a P30 discount to stimulate volume. ts tis discount advisable? '3. The following data are forthe two products produoed by Aplan Company. Product A Product B Direct materials PIAS per unt P24 per unit Direct labor hours 0.3 DUM per unt 1.6 DLH per unit Machine hours OHH perunit| —.2.MH per unit Batches 125 batthes 225 batches Volune 10,000 units 2,000 units Engineering modifications A2modifcations 58 modifications Number of customers ‘500 customers 400 customers Market price 20 per unit 120 per unit Ze comoanys rect bor rats 20 pr dct aor bur (DL. atonal INomaton Costs Driver Indirect manufacturing: Engineering support 24,500 Engineering moditions Bedtricty 36/000 Machine hours Setup costs 52,500 Batches Nonmanufactusing: Customer sevice 81,000 Number of customers Reaunen: 1. Compute the manufcuring cost per unt using the plant wide overhead rte based on irc lobe hours. Wat the goss proftper unt? 2. How much gross profit is generated by each customer of Product A using the plant-wide cvernad rate? How much gross prof 's generated by each austomer of Produ B using the pantie overhead rte? What I te cost of prong customer Sorvino each ‘asicme? What infomation s provid by hs comperson? 3. Determine the manufacturing os per unt of each produc Be using ABC. What the goss promt per unt? : 4. How much rss profit i generat) each customer of Product A using ABC? How much gos prof ic geneated by eat customer of Produc 8 ung ABC? Is te gross profit per customer adequate? 5. Which method of preheating ches beter lformatin to managers ofthis company? Elin wy.(MAS 8602 ACTIVITY BASED COSTING Page of 13 ‘4. Medtech, Inc. manufactures two types of medical devices, Medform and Proce, and apples ‘overhead on the basis of drectdabor hours. Anticipated overhead and direclabor time for the ‘upcoming accounting period are P710,000 and 20,000 hours, respectively, Information about the ‘company’s products follows. Medtorm: Estimated production volume, 2,500 units Direct material cost, P30 per unit Direct labor per uni, 3 hours at P25 per hour Proce: Estimated production volume, 3,125 unis Direct- material cost, P45 per unit Direct labor per un, 4 hours at PaS per hour ‘Meditech’s overhead of P710,000 can be identified with three major activites: order processing (P 120,000), machine processing (PS00,000), and product inspection (PG0,000). These activites ‘are driven by number of orders processed, machine hours worked, and Inspection hours, respectively, Data relevant to these activites foow. Orders Machine Hours Inspection Proaessed Word = Hows Medform 350 23,000 4,000 Proce! 250 2700 = 31,000 Total 600 50/00 15,000 Management is very concemed about decning proftabilty despite @ healthy increase in sles volume. The decrease in income is especially puzzing because the company recently undertook '8- massive piant renovation during which new, highly automated machinery was instaled— ‘machinery tat was expected to produce significant operating efiiencies. Requnsp: 11. Assuming use of directlebor hours to apply overhead to production, compute the unit ‘manufacturing coss ofthe Medform and Procs products Ifthe expected manufacturing volume is attained. 2. Assuming use of actvty-based costing, compute the unit menufacturing costs of the “Medform and Procel praducts ithe expected manufacturing volume is attained. 3. Meditec’sseling prices are based heavily on cost 2. By using drec-labor hour as an applcalion base, which product is overcasted and which product is undercsted? Calculate the amount ofthe cost distortion for each product i. Is it possible that overcosting and undercnsting (Le, cost distortion) and the subsequent determination of seling prices are consibutng to the company’s profit ‘woes? Explain 5. Super Coo Inc. manufactures cooling units for commercial buidiags. The price and cost of ‘00ds sold for each unit are as follows: Price '40}500 per unit Cast of goods sold 25.500) Gress profit 1P15.000 per unit {In addon, the company incurs seling and administrative expenses of P160,400. The company ‘Wishes to assign these costs tots three major customers, Glles Unversity, Blagest Arena, and [NE Hospital. These expenses are related to kre major nonmanufactring activites: customer server, project bidding, and engineering sipport. The engineering support Is in the form of engineering changes that are placed by the|customer to change the design of a product. The ‘activity cnst pool and acy bases with these activites are:MAS 8602 ACTIVITY BASED COSTING Page 50 18 Actity Act Base ‘customer service 66,500 Number of service requests Project bing 34500 Number of bids Engineering support 58409 Number of customer design changes Tota costs Bes00 ‘Acthvy-base usage and unit volume information forthe thre customers is as follows: Gooner Bonestena — NEosnkal ta Number of service requests 0 3 6 190 Number of bids 4 2 a 6 Number of customer design changes 75 2% 35 135 10 15 30 Unit volume 5 RequneD: “L_ Determine the acti rates fr each ofthe three nonmanufacturing activity pools. 350,790; 40 2. Determine the actly costs allocated to the three customers, using the activity rates in (1), 62000 32250 46.150 3. Construct customer profeabiltyrepets forthe three customers, using the actvty costs in (@), The reports should disclose the gross proft and income from operations associated with each customer, oft (es) = (7000) 17 780: 173880 4, Construct customer proftablty reports for the three customers, using the traditional ‘costing system where the company. allocates non-manufacturing costs using the un Volume, The reports should dscose the gross profit and income from operations, associated with each customer. n-manufctunng ct par unt = FICOAY30 ants = EE2AEE2 Poh = 42287; 9514200 2 cous siasesT ne Ccutamer serve Prmsoo P2250 PASTS Pree ong 10500 ‘00 15000 Enginserng support mst Tonirenmanfecuingest “Bzo = EBM a cous BIGGEST ne resprofe(untsx P1500) P7500 -«PAsOOND FL, 000 Nowmandacurogcts aon) ats] ‘Open cae eo am fase 4 cous sicsEst ne romprote (ints xPt5a00) P7500 Pisj000 225,000 Nonmaructring cts Goisxrsa667) = ae Shay a Opesing nce ma WINDING-UP: THEORY 4. An accounting system that coletsfnansal and operating data on the basis ofthe undertying, ‘ature and exten ofthe eos erivers a. Direct costing. & Cyeletime costing. . Actvy-based costing 4. Variable costing 2. The resource uted by a given product cided by the total amount ofthe resource Te weon C by of avalabe is 1 Actuty iver. & Costobjct 1b Coneumption rat, Sustaining activity. 3, Which of he flowing statements e tive? ‘The tracional approach to costing uses many diferent cost divers.‘Mas 9602 ACTIVITY BASED COSTING Page Gof 13 1b. Costs that are indirect to products are by definition traceable directly to products. | Costs that ae indirect o products are traceable to some activity: : 6. Allofthe above statements are tue 4, Mass customization can be achieved through the use of 2. Actviy-based costing, ‘c.Flexble merufacuring eystems. . justin-time inventory 4d. allot the above. 5. Prooess value analysis ie a Key component of acvty-besed management tat links product costing and fa Reduction ofthe numberof cost pools. . Contnueus improvement Accumulation of heteragenoous cot pools. 4. Overhead rates hased on broad averages. 16. Anaperoach to developing new ways to perform existing acthiis is called a.” Process value analysis, © Caveat analysis, b. Reengineering 4. Benchmarking. 7. Ain)__method fist races cost to & department and then to products. a dreceosing ‘e tadtional costing ‘absorption costing ‘actity-based costing 8. A(n)________ mth fret aves costs o acts and then to products. a creacartng ‘© taditonal costing i, absomniion costeg actviy-based costing {8 Uniformly assigning the costs of resoursas t cost objects when those resources. are actully ‘used ina non-urdorm way is caled fs overcosting & peamt-buter costing, '. undercostra. 4. department costing, 10. An objective af actuty-based management is to 2 ernate ths rrajty ef centralized active: in on orgazation Bb Teduse or aiminate ror-velue-aaded actives incurted to make a product or provide 8 . P378 & 25200 4. P530 ‘22. Whats the nit cost of Product 8? Pe40 b. P6800 2. 25200 . Peat (QUESTIONS 23 THRU 28 ARE BASED ON THE FOLLOWING INFORMATION. ‘Acton Company has two products: A and 8. The annual production and sales of Product A is 800, Units and of Prodt Bis 500 uns. The company has tadtonally used direct labor-hours asthe ‘basis for applying all manufacturing overhead to products. Product A requires 0.3 direct labor hours ‘er unit and Product B requires 0.2 direct labor hours per unit. The total estimated overtead for next period is 92,023. ‘The company Is considering switching to en setwty-based costing system for the purpose of ‘computing unl product costs for extemal reports. The new actvty-based costing system would have ‘ree overhead activity cost pools-Actviy 2, Activty 2, and General Factory-with estimated ‘overhead costs and expected activity 2s folows: Expected Actuty ‘Activity Cost Poot ‘Coats Product Product” Total eit 1 Pigs? 500 ‘600 100 ‘cavity 2 64 800, 2.500 ‘00 31900 General Factory P12 738 "240 10 340 “Tetal Pezioza (ote: The General Factory atvly cost poo's costs ae allocated on the basis of rect labor hours.) 23, The predetermined overhead rate under the tredtional costing system is closest to: a P3746, P2160. PAST, ‘4. P270.68. 24. The overhead cost per unt of Product 6 under the traditional costing systems closest to: a P5413, P79, © P43, 4. P2863, 25. The predetermined overheed rate (le. activity rate) for Activity 1 under the actviy-based costing system is cosas to a P2BS7, b. PI3a7, & P8388. P2415. 26. The overhead cost per unk of Product A under the actvity-based costing system is closest to: a. Pa6.7 b. P7079, ce PB120. a PIT 24 ‘THEORIES PROBLEMS LB] ea c/a O/T Als 8 Le [ope . 2 6/2 6]2. c]s cle. cls. 6 20 [2 A[2A 3. C/s. 0] 23. 8/30) a 8 [se 0 Ze] 8 [a0 4 C/i4. 8 [240] AHO [SAC 40 [iA [28 A 38]. 8 [a6 [35 A] 4%. D 5D [as A [25.8 6.8 /16.A [26 636. 8146, 0 6A [36 A [2A 7 |W7.6 [27.8 [37 c/a, D 7.8 [a7.A 8D [18 C [ax [3a 0a C 30 [18 8 3.¢ [8 8/8 A; CLOA 3A |. C 10.8 [20A [30.0] 40. C [50.8 10. 8 [20