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Activity Based Costing-A Tool To Aid Decision Making
Activity Based Costing-A Tool To Aid Decision Making
The objective of
ABC is a
activity-based good supplement
costing is to to our traditional
cost system
I agree!
understand
overhead and the
profitability of
products and
customers.
Activity Based Costing (ABC)
Activity-Based Costing
Both
Both manufacturing
manufacturing There
There are
are aa number
number
and
and nonmanufacturing
nonmanufacturing of
of cost
cost pools
pools each
each ofof
costs
costs may
may be
be which
which is
is allocated
allocated
assigned
assigned to
to using
using aa unique
unique
products.
products. measure
measure of of activity.
activity.
Some
Some manufacturing
manufacturing
costs
costs may
may be
be excluded
excluded
from
from product
product
costs.
costs.
Allocation
Allocation bases
bases often
often Overhead
Overhead rates
rates may
may
differ
differ from
from be
be based
based on
on activity
activity
traditional
traditional costing
costing at
at capacity.
capacity.
systems.
systems.
How Costs are Treated Under Activity-
Based Costing
Activity
Activity Based
Based
Costing
Costing
Departmental
Departmental
Overhead
Overhead i ty
Rates
Rates ex
pl
o m
Plantwide f C
Plantwide o
Overhead
Overhead e l
v
Rate
Rate Le
Overhead Allocation
Plantwide Overhead Rate
Finishing Department
AA two
two stage
stage process
process is
is
Painting Department necessary
necessary because
because costs
costs
are
are allocated
allocated to
to departments
departments
Shipping Department and
and then
then to
to products.
products.
Departmental Overhead Rates
Stage Two:
Costs applied
to products
Products
Departmental Overhead Rates
Cost
Cost Objects
Objects Consumption
Consumption
(e.g.,
(e.g.,products
products Activities
Activities of
of Resources
Resources
and
andcustomers)
customers)
Cost
Cost
Designing an ABC System
Unit-Level Batch-Level
Activity Activity
Product-Level Customer-Level
Activity Organization- Activity
sustaining
Activity
Identifying Activity to Include
Production Department
Indirect factory wages $ 500,000
Factory equipment amortization 300,000
Factory utilities 120,000
Factory building lease 80,000 $ 1,000,000
Shipping costs traced to customer orders 40,000
General Administrative Department
Administrative wages and salaries 400,000
Office equipment amortization 50,000
Administrative building lease 60,000 510,000
Marketing Department
Marketing wages and salaries 250,000
Selling expenses 50,000 300,000
Total overhead costs $ 1,850,000
Activity-Based Costing at Classic Brass
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
First-Stage Allocation
Cost Objects:
Products, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Second-Stage Allocations
Cost Objects:
Unallocated
Products, Customer Orders, Customers
Assigning Costs to Activity Cost
Pools
Management at Classic Brass believes overhead should be
distributed as follows:
Activity Cost Pools
Customer Product Order Customer
Orders Design Size Relations Other Total
Production Department
Indirect factory wages 25% 40% 20% 10% 5% 100%
Factory equipment amortization 20% 0% 60% 0% 20% 100%
Factory utilities 0% 10% 50% 0% 40% 100%
Factory building lease 0% 0% 0% 0% 100% 100%
Shipping costs traced to customer order N/A
General Administrative Department
Administrative wages and salaries 15% 5% 10% 30% 40% 100%
Office equipment amortization 30% 0% 0% 25% 45% 100%
Administrative building lease 0% 0% 0% 0% 100% 100%
Marketing Department
Marketing wages and salaries 20% 10% 0% 60% 10% 100%
Selling expenses 10% 0% 0% 70% 20% 100%
Assigning Costs to Activity Cost
Pools
Using the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
First-Stage Allocation to Activity Cost Pools
Customer Product Order Customer
Orders Design Size Relations Other Total
Production Department
Indirect factory wages $ 125,000
Factory equipment amortization
Factory utilities
Factory building lease
General Administrative Department
Administrative wages and salaries
Office equipment amortization
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total
Indirect
Indirect factory
factory wages
wages $500,000
$500,000
Percent
Percent consumed
consumed byby customer
customer orders
orders 25%
25%
$125,000
$125,000
Assigning Costs to Activity Cost
Pools
Using the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
First-Stage Allocation to Activity Cost Pools
Customer Product Order Customer
Orders Design Size Relations Other Total
Production Department
Indirect factory wages $ 125,000
Factory equipment amortization 60,000
Factory utilities
Factory building lease
General Administrative Department
Administrative wages and salaries
Office equipment amortization
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total
Factory
Factory equipment
equipment amortization
amortization $300,000
$300,000
Percent
Percent consumed
consumed byby customer
customer orders
orders 20%
20%
$$ 60,000
60,000
Assigning Costs to Activity Cost
Pools
Using the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
First-Stage Allocation to Activity Cost Pools
Customer Product Order Customer
Orders Design Size Relations Other Total
Production Department
Indirect factory wages $ 125,000 $ 200,000 $ 100,000 $ 50,000 $ 25,000 $ 500,000
Factory equipment amortization 60,000 - 180,000 - 60,000 300,000
Factory utilities - 12,000 60,000 - 48,000 120,000
Factory building lease - - - - 80,000 80,000
General Administrative Department
Administrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000
Office equipment amortization 15,000 - - 12,500 22,500 50,000
Administrative building lease - - - - 60,000 60,000
Marketing Department
Marketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000
Selling expenses 5,000 - - 35,000 10,000 50,000
Total $ 315,000 $ 257,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000
Assigning Costs to Activity Cost
Pools
Using the total costs and percentage consumption of
overhead, costs are assigned to activity pools.
First-Stage Allocation to Activity Cost Pools
Customer Product Order Customer
Orders Design Size Relations Other Total
Production Department
Indirect factory wages $ 125,000 $ 200,000 $ 100,000 $ 50,000 $ 25,000 $ 500,000
Factory equipment amortization 60,000 - 180,000 - 60,000 300,000
Factory utilities - 12,000 60,000 - 48,000 120,000
Factory building lease - - - - 80,000 80,000
General These costs
Administrative should
Department
Administrative wages and salaries
be cross-added to 60,000 This number
20,000 40,000 should
120,000 then
160,000 400,000
Office equipment amortization 15,000 - - 12,500 22,500 50,000
getbuilding
Administrative the total
lease - -
equal the
-
total of
-
the 60,000 60,000
Marketing Department individual overhead item
Marketing wages and salaries 50,000 25,000 to be- allocated
150,000 25,000 250,000
Selling expenses 5,000 - - 35,000 10,000 50,000
Total $ 315,000 $ 257,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000
Computation of Activity Rates
Let’s take a look at how our system works for just one
customer - Windward Yachts.
– Windward ordered two products - Stanchions and
Customer Compass Housings.
– The details are outlined on the following slide.
Assigning Costs to Cost Objects
Standard
Standard Stanchions
Stanchions (no (no design
design required)
required)
1.
1. 400
400 units
units ordered
ordered withwith 22 separate
separate orders.
orders.
2.
2. Each
Each stanchion
stanchion required
required 0.5
0.5 machine-hours
machine-hours ..
3.
3. Selling
Selling price
price isis $34
$34 each.
each.
4.
4. Direct
Direct materials
materials total
total $2,110.
$2,110.
5.
5. Direct
Direct labour
labour totals
totals $1,850.
$1,850.
6.
6. Shipping
Shipping costs
costs total
total $180.
$180.
Custom
Custom Compass
Compass HousingHousing (requires
(requires new
new design)
design)
1.
1. One
One order
order during
during the the year.
year.
2.
2. Each
Each housing
housing required
required 44 machine-hours
machine-hours ..
3.
3. Selling
Selling price
price isis $650
$650 each.
each.
4.
4. Direct
Direct materials
materials total
total $13.
$13.
5.
5. Direct
Direct labour
labour totals
totals $50.
$50.
6.
6. Shipping
Shipping costs
costs total
total $25.
$25.
Assigning Costs to Cost Objects
400
400 units
units xx 0.5
0.5 MH/unit
MH/unit xx $50/MH
$50/MH == $10,000
$10,000
Product Margins
11 units
units xx 4.0
4.0 MH/unit
MH/unit xx $50/MH
$50/MH == $200
$200
Difference Between ABC and
Traditional Product Costs
Computation
Computationof ofthe
theActivity
ActivityRates
Rates
Customer
Customer Product
Product Customer
Customer
Orders
Orders Design
Design Order
OrderSize
Size Relations
Relations Other
Other
Costs
Costsfrom
fromfirst-
first-
stage
stageallocation
allocation $$ 315,000
315,000 $$ 257,000
257,000 $$ 380,000
380,000 $$ 367,500
367,500 $$ 490,500
490,500
Total
Totalactivity
activity ÷ 1,000
1,000 ÷ 200200 ÷ 20,000
20,000 ÷ 100100 N/A
N/A
Cost
Costper
perunit
unit
of
ofactivity
activity $$ 315
315 $$ 1,285
1,285 $$ 19
19 $$ 3,675
3,675
Simplified Approach to ABC
Standard Stanchions:
Sales $ 13,600
Costs:
Direct materials $ 2,110
Direct labour 1,850
Shipping costs 180
Customer orders (2) 630
Product design -
Order size (200) 3,800 8,570
Product margin $ 5,030
22 orders
orders @
@ $315
$315 per
per order
order
Simplified Approach to ABC
11 design
design @
@ $1,285
$1,285 per
per design
design
Simplified Approach to ABC