Chapter 5

Activity-Based Costing
and Management

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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:

Mode I Mode II Mode III

Production:
Units 10,000 20,000 4,000
Runs 1 run of 10,000 4 runs of 10 runs of
units 5,000 units 400 units

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

Additional information includes:

Mode I Mode II Mode III
Direct materials $ 50.00 $ 90.00 $ 20.00
Direct labor (hr/board) 3 4 2
Setup time (hr/run) 10 10 10
Machine time (hr/board) 1 1.25 2

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
Re c e ivin g a n d In s pe c t ion Cos t P ool
Board Ove rh e ad × % ÷ U n its = Cos t/Un it
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

Mat eria l-Han dlin g Co s t P ool

Board Ove rh e ad × % ÷ U n its = Cos t/U n it
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

Qu alit y-As s u ra n c e Co s t P ool

Board Ove rh e ad × % ÷ U n its = Cos t/U n it
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

P a c ka gin g a n d Sh ippin g Cos t P o o l

Board Ove rh e ad × % ÷ Un its = Cos t/U n it
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
Re c e ivin g a n d In s pe c t ion Cos t P ool
Board Ove rh e ad × % ÷ U n its = Cos t/Un it
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

Mat e rial-Han dlin g Cos t P o ol

Board Ove rh e ad × % ÷ Un its = Cos t/Un it
$14.82 Mode I
Mode II
$ 600,000
600,000
×
×
7%
30%
÷
÷
10,000
20,000
= $
=
4.20
9.00
Mode III 600,000 × 63% ÷ 4,000 = 94.50

Qu alit y-As s u ra n c e Co s t P ool

Board Ove rh e ad × % ÷ U n its = Cos t/U n it
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

P a c ka gin g a n d Sh ippin g Cos t P o ol

Board Ove rh e ad × % ÷ U n its = Cos t/U n it
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
department’s 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 organization’s
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 customer
5-30