CIA1004: Cost Accounting

Lecture 9 & 10: 15 & 22 May 2023

Chapter 5

Activity-Based
Costing and
Management

5-1
Learning Objective 5-1 – Compute product costs under a
traditional, volume-based product-costing system.

5-25-2
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

5-3
Traditional, Volume-Based Product-
Costing System
Mo d e I Mo d e I I Mo d e I I I
Direct mat erials $ 50.00 $ 90.00 $ 20.00
Direct lab o r 60.00 80.00 40.00
Man u f act u rin g o verh ead 99.00 132.00 66.00
To t al $ 209.00 $ 302.00 $ 126.00

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

5-4
Traditional, Volume-Based Product-
Costing System
Mode I Mode II Mode III
Units produced 10,000 20,000 4,000
Direct labor (hr/unit) 3 4 2
To tal hours 30,000 80,000 8,000

To tal hours required 118,000

Budgeted manufacturing overhead $3,894,000

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

Mode I Mode II Mode III

Direct labor (hr/unit) 3 4 2
Overhead rate per hour $ 33 $ 33 $ 33
Overhead per unit $ 99 $ 132 $ 66

5-5
Traditional, Volume-Based Product-
Costing System
With these product costs, Aerotech established target
selling prices (Cost × 125%).
Mode I Mode II Mode III
Direct materials $ 50.00 $ 90.00 $ 20.00
Direct labor 60.00 80.00 40.00
Manufacturing overhead 99.00 132.00 66.00
To tal $ 209.00 $ 302.00 $ 126.00

Mo d e I Mo d e I I Mo d e I I I
Co st p er u n it $ 209.00 $ 302.00 $ 126.00
Targ et sellin g p rice 261.25 377.50 157.50

209.00 x 1.25
5-6
Another example of Traditional,
Volume Based Costing System..
from the new 12th edn Text Book
Traditional, Volume-Based
Costing System (1 of 2)

5-8
Traditional, Volume-Based
Costing System (2 of 2)

5-9
 Traditional, Volume-Based
Product-Costing System – Target Selling Price
With these product costs, Dronze Inc. established target
selling prices (Cost × 120%).

496.00 x 1.20
5-10
Learning Objective 5-2 - Explain how an activity-based costing system
operates, including the use of a two-stage procedure for cost
assignment, the identification of activity cost pools, and the selection of
cost drivers.

5-11
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.

5-12
Learning Objective 5-3 – Explain the cost hierarchy concept,
including unit-level, batch-level, product-sustaining-level,
and facility-level costs.

5-13
 Activity Overhead Costs
must be Identification
Total budgeted cost = $4,896,000
done on of Activity
each unit Cost Pools
produced.
Activity
Cost
Pools

Unit- Batch- Product- Facility-

Level Level Sustaining- Level
Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,242,000 $210,000 $130,000 $2,300,000

Activity
Activities needed to support Activity required in order
performed
an entire product line for the production
on each
batch process to occur.
produced.
5-14
 Overhead Cost Pools
Product-Sustaining- Facility-
Unit-Level Batch-Level Level Level
Machinery Setup Engineering Facility
cost pool cost pool cost pool cost pool
$1,242,000 $210,000 $130,000 $2,300,000

Purchasing
cost pool 300,000

Material-Handling
cost pool $340,000

Quality-Assurance
cost pool $110,000

Packaging/Shipping
cost pool $264,000
5-15
Learning Objectives 5-4 – Compute product costs under an
activity-based costing system.

5-16
 Stage One – Machinery Cost Pool
Various overhead
Maintenance Lubrication
costs related
to machinery Depreciation Electricity

Computer Support Calibration

Activity
cost Machinery Cost Pool
pool Total budgeted cost = $1,242,000

5-17
Stage Two – Machinery Cost Pool
Budgeted Machinery Costs $1,242,000
=
Budgeted Machine Hours 230,000
= $5.40/hour

5-18
ABC Pool Cost Calculations –
First 4 Activities

5-19
ABC Pool Cost Calculations – Last
4 Activities

5-20
 Product Costs from ABC
These are the new product costs when ABC is used.

5-21
Learning Objective 5-5 – Explain why traditional, volume-
based costing systems tend to distort product costs.

5-22
 Distorted Product Costs
Both original and ABC target selling prices are based
on (Cost × 120%).

5-23
Cost Distortion

5-24
 Two Key Points
A
A large
large proportion
proportion of of non-
non- Product
Product diversity
diversity
unit-level
unit-level activities
activities When
When thethe consumption
consumption
A
A unit-level
unit-level cost
cost driver,
driver, such
such ratios
ratios differ
differ widely
widely
as
as direct
direct labor,
labor, machine
machine
hours, between
between activities,
activities, no
no
hours, or
or throughput,
throughput, willwill
not
not be
be able
able to
to assign
assign the
the costs
costs
single
single cost
cost driver
driver will
will
of
of non-unit-level
non-unit-level activities
activities accurately
accurately assign
assign the
the
accurately.
accurately. resulting
resulting overhead
overhead costs.
costs.

5-25
Learning Objective 5-6 – Explain three criteria for selecting
cost drivers.

5-26
 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 Cost of Behavioral

Correlation Measurement Effects

5-27
Learning Objective 5-7 – Discuss several implementation
processes in activity-based costing, including data collection
and storyboarding.

5-28
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.
5-29
Learning Objective 5-8 – Explain the concepts of activity-
based management and two-dimensional activity-based
costing.

5-30
Activity-Based Management

The use of
ABC costing
information
to help
management
make decisions
5-31
Activity-Based Management (ABM)

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 .

5-32
 Two-Dimensional ABC and
Activity-Based Management (1 of 2)

Activities

5-33
Two-Dimensional ABC and Activity-
Based Management (2 of 2)
Cost Assignment View

Resource Costs

Activities

Cost Objects
5-34
 Two-Dimensional ABC and
Activity-Based Management – Process View
Cost Assignment View

Resource Costs
Process View
Activity Analysis Activity Evaluation

Root Activity Performance

Causes Triggers Activities Measures

Cost Objects
5-35
Elimination of Non-Value-Added Costs
Activities

Non-value-
added
activities
Unnecessary Necessary

Reduce or Continually Evaluate

Eliminate
and Improve 5-36
 Using ABM to Eliminate Non-Value-
Added Activities and Costs (1 of 2)
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root Causes, and
Triggers.

Inspect Rework
Specify Select Receive Produce
finished defective
parts vendor parts goods
goods products

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

5-37
Using ABM to Eliminate Non-Value-
Added Activities and Costs (2 of 2)

Inspection time Process time

Move time Storage time

Waiting time

5-38
Learning Objective 5-9 – Explain and execute a customer-
profitability analysis.

5-39
Customer Profitability Analysis (1 of
2)

Customer profitability analysis uses

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

5-40
Customer Profitability Analysis (2 of
2)
Requires
special
packaging
Orders
small Demands
quantities fast
service
A costly
customer
Often Orders
changes frequently
orders

5-41
 Customer Profitability Analysis
(Costs)
Cost
CostDrive
Drive
Customer-Related
Customer-Related Activities
Activities Cost
CostDriver
DriverBase
Base Rate
Rate
Order
Orderprocessing
processing Purchase
Purchaseorders
orders $$ 150
150
Sales
Sales contacts
contacts(phone
(phone calls,
calls,faxes,
faxes,etc.)
etc.) Contacts
Contacts 100
100
Sales
Sales visits
visits Visits
Visits 1,000
1,000
Shipment
Shipmentprocessing
processing Shipments
Shipments 200
200
Billing
Billing and
and collection
collection Invoices
Invoices 160
160
Design/engineering
Design/engineering change
change orders
orders Design
Design changes
changes 4,000
4,000
Special
Specialpackaging
packaging Units
Unitspackaged
packaged 40
40
Special
Specialhandling
handling Units
Unitshandled
handled 60
60

A company may use these customer

related costs to help determine the
profitability of each customer.

5-42
Customer Profitability Analysis
(Graph)
Customer Profitability
Cumulative Operating Income as a % of Total

125.0%

100.0%
Operating Income

75% of actual operating income

75.0%

50% of actual operating income

50.0%

25% of actual operating income

25.0%

0.0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

5-43
Learning Objective 5-10 – Understand and discuss how
activity-based costing and its variant time-driven activity-
based costing are used in service-industry organizations.

5-44 5
 ABC Costing in the Service
Industry
The overall objectives of ABC in service
firms are no different than they are in
manufacturing companies.
Identify the activities.
Create activity cost pools.
Identify activity cost drivers.
Follow similar steps discussed in chapter.

5-45
End Chapter 5

5-46
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