Chapter 5

Activity-Based
Costing and
Management

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Traditional, Volume-Based Product-
Costing System
Aerotech produces three complex printed
circuit boards referred to as Mode I, Mode II,
and Mode III.
The following information is obtained from
company records:

5-2
Traditional, Volume-Based Product-
Costing System

Additional information includes:

Manufacturing overhead is determined as follows

5-3
Traditional, Volume-Based Product-
Costing System

Budgeted manufacturing overhead $3,894,000

= $33 per hour
Budgeted direct-labor hours 118,000

5-4
Traditional, Volume-Based Product-
Costing System
With these product costs, Aerotech established
target selling prices (Cost 125%).

209.00 x 1.25
5-5
Activity Based Costing System
(ABC)
ABC systems follow a two-stage procedure to
assign overhead costs to products.

Stage One
Identify significant activities and assign overhead costs
to each activity in proportion to resources used.
Stage Two
Identify cost drivers appropriate to each activity and
allocate overhead to the products.

5-6
 Overhead Costs
Activity Total budgeted cost = $3,894,000
must be Identification
Identification
done on of
of Activity
Activity
each unit Activity Cost
Cost Pools
Pools
produced.
Cost
Pools
Product-
Unit- Batch- Sustaining- Facility-
Level Level Level Level

Machinery Setup Engineering Facility

cost pool cost pool cost pool cost pool
$1,212,600 $3,000 $700,000 $507,400

Activity Activities needed to support Activity required in order

performed an entire product line for the production
on each process to occur.
batch
produced.
5-7
 Product-
Unit- Batch- Sustaining- Facility-
Level Level Level Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,212,600 $3,000 $700,000 $507,400

Receiving/Inspection
cost pool $200,000

Material-Handling
cost pool $600,000

Quality-Assurance
cost pool $421,000

Packaging/Shipping
cost pool $250,000
5-8
 STAGE ONE

Various overhead
Maintenance Lubrication
costs related
to machinery Depreciation Electricity

Computer Support Calibration

Activity
cost Machinery Cost Pool
pool Total budgeted cost = $1,212,600

5-9
 STAGE TWO
Calculate Budgeted Machinery Costs = $1,212,600
the pool Budgeted Machine Hours 43,000
rate = $28.20/hour

Cost
Assignment

5-10
 STAGE ONE

Calculation of
total setup cost

Activity
cost Setup Cost Pool
pool Total budgeted cost = $3,000

5-11
 STAGE TWO
Calculate Budgeted Setup Costs = $3,000
the pool Planned Production Runs 15 runs
rate = $200 per run

Cost
Assignment

5-12
 STAGE ONE
Various overhead Engineering salaries Engineering software
costs related
to engineering Engineering supplies Depreciation

Activity
cost Engineering Cost Pool
pool Total budgeted cost = $700,000

5-13
 STAGE TWO
Allocate based Engineering Cost Pool
on engineering Total budgeted cost = $700,000
transactions

Cost
Assignment

5-14
 STAGE ONE
Various overhead Plant depr. Property taxes
costs related
Plant mgmt. Insurance
to general
operations Plant maint. Security

Activity
cost Facility Cost Pool
pool Total budgeted cost = $507,400

5-15
 STAGE TWO
Calculate Budgeted Facilities Cost = $507,400
the pool Budgeted Direct-Labor Hours 118,000
rate = $4.30/hour

Cost
Assignment

5-16
 Other Overhead Costs
Receiving and Inspection Cost Pool
Board Overhead % Units = Cost/Unit
Mode I $ 200,000 6% 10,000 = $ 1.20
Mode II 200,000 24% 20,000 = 2.40
Mode III 200,000 70% 4,000 = 35.00

Material-Handling Cost Pool

Board Overhead % Units = Cost/Unit
Mode I $ 600,000 7% 10,000 = $ 4.20
Mode II 600,000 30% 20,000 = 9.00
Mode III 600,000 63% 4,000 = 94.50

Quality-Assurance Cost Pool

Board Overhead % Units = Cost/Unit
Mode I $ 421,000 20% 10,000 = $ 8.42
Mode II 421,000 40% 20,000 = 8.42
Mode III 421,000 40% 4,000 = 42.10

Packaging and Shipping Cost Pool

Board Overhead % Units = Cost/Unit
Mode I $ 250,000 4% 10,000 = $ 1.00
Mode II 250,000 30% 20,000 = 3.75
Mode III 250,000 66% 4,000 = 41.25
5-17
 Other Overhead Costs
Receiving and Inspection Cost Pool
Board Overhead % Units = Cost/Unit
Mode I $ 200,000 6% 10,000 = $ 1.20
Mode II 200,000 24% 20,000 = 2.40
Mode III 200,000 70% 4,000 = 35.00

Material-Handling Cost Pool

Board Overhead % Units = Cost/Unit
$14.82 Mode I $ 600,000 7% 10,000 = $ 4.20
Mode II 600,000 30% 20,000 = 9.00
Mode III 600,000 63% 4,000 = 94.50

Quality-Assurance Cost Pool

Board Overhead % Units = Cost/Unit
Mode I $ 421,000 20% 10,000 = $ 8.42
Mode II 421,000 40% 20,000 = 8.42
Mode III 421,000 40% 4,000 = 42.10

Packaging and Shipping Cost Pool

Board Overhead % Units = Cost/Unit
Mode I $ 250,000 4% 10,000 = $ 1.00
Mode II 250,000 30% 20,000 = 3.75
Mode III 250,000 66% 4,000 = 41.25
5-18
Product Cost from ABC
These are the new product costs when
Aerotech uses ABC.

5-19
Distorted Product Costs
Both original and ABC target selling prices
are based on (Cost 125%).

The selling price of Mode I and II are decreased,

while the selling price for Mode III is increased.
[$209.00 1.25] [$183.44 1.25]
5-20
 Distorted Product Costs
Can you identify any problems Aerotech is
likely to face as a result of this distortion?

Traditional costing understates the cost

of complex, low volume products.

5-21
Cost Drivers
A characteristic of an event or activity that
results in the incurrence of costs. In selecting
a cost driver, we must consider . . .

Degree of Behavioral
Correlation Effects

Cost of
Measurement

5-22
COLLECTING ABC DATA
INTERVIEWS AND PAPER TRAILS - The information
for ABC systems initially comes from interviews with
employees in the support departments and a review of each
departments records.

STORYBOARDING - A procedure used to develop a

detailed process flow chart, which visually represents activities
and the relationships among activities.

MULTIDISCIPLINARY ABC PROJECT TEAMS To

gather information from all facets of an organizations
operations, it is essential to involve personnel from a variety of
functional areas. A typical ABC project team includes
ACCOUNTING, FINANCE, PRODUCTION, OPERATIONS,
ENGINEERS, MARKETING, etc.
5-23
Activity-Based Management

The use of
ABC costing
information
to help
management
make decisions
5-24
Activity-Based Management
Activity-based costing establishes relationships
between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs.

5-25
Two-Dimensional ABC and Activity-
Based Management
Cost Assignment View

Resource
Resource costs
costs
Process View
Activity Analysis Activity Evaluation

Root
Root Activity
Activity Performance
Performance
Causes
Causes Triggers
Triggers Activities Measures
Measures

Cost
Cost Objects
Objects
5-26
Elimination of Non-Value-Added
Costs
Activities

Non-value-
added
activities
Unnecessary Necessary

Reduce or Continually Evaluate

Eliminate
and Improve 5-27
Using ABM to Eliminate Non-Value-
Added Activities and Costs
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root
Causes, and Triggers.
Inspect
Inspect Rework
Rework
Specify
Specify Select
Select Receive
Receive Produce
Produce finished
finished defective
defective
parts
parts vendor
vendor parts
parts goods
goods goods
goods products
products

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

5-28
Customer Profitability Analysis

Customer profitability analysis uses

activity-based costing to determine
the activities, costs, and profit associated
with serving particular customers.

5-29
Customer Profitability Analysis
Required
special
packaging

Orders Demand
small fast
quantities service

Often
Orders
changes
frequently
orders

A costly
5-30