Chapter 5

Activity-Based
Costing and
Management

McGraw-Hill/Irwin Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 1
Compute product costs under a traditional,
volume-based product-costing system.

5-2
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:

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

Additional information includes:

Manufacturing overhead is determined as follows

5-4
Traditional, Volume-Based Product-
Costing System

Budgeted manufacturing overhead $3,894,000

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

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

209.00 x 1.25
5-6
Learning Objective 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.

5-7
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.

5-8
Learning Objective 3
Explain the concept of cost levels, including unit-level, batch-
level, product-sustaining-level, and facility-level costs.

5-9
 Overhead Costs
Total budgeted cost = $3,894,000 Identification
Identification
Activity
of
of Activity
Activity
must be
done on Activity Cost
Cost Pools
Pools
each unit Cost
produced. 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. 5-10
 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
5-11
Learning Objectives 3 &
4
Learning Objective 3. Explain the concept of cost
levels, including unit-level, batch-level, product-
sustaining-level, and facility-level costs.

Learning Objective 4. Compute product costs under

an activity-based costing system.

5-12
 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

5-13
 STAGE TWO
Calculate Budgeted Machinery Costs = $1,212,600
the pool Budgeted Machine Hours 43,000
rate = $28.20/hour

Cost
Assignment

5-14
 STAGE ONE

Calculation of
total setup cost

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

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

Cost
Assignment

5-16
 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

5-17
 STAGE TWO
Allocate based Engineering Cost Pool
on engineering Total budgeted cost = $700,000
transactions

Cost
Assignment

5-18
 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

5-19
 STAGE TWO
Calculate Budgeted Facilities Cost = $507,400
the pool Budgeted Direct-Labor Hours 118,000
rate = $4.30/hour

Cost
Assignment

5-20
 Other Overhead Costs
ReceivingandInspectionCostPool
Board Overhead % Units = Cost/Unit
ModeI $200,000 6% 10,000 = $1.20
ModeII 200,000 24% 20,000 = 2.40
ModeIII 200,000 70% 4,000 = 35.00

MaterialHandlingCostPool
Board Overhead % Units = Cost/Unit
ModeI $600,000 7% 10,000 = $4.20
ModeII 600,000 30% 20,000 = 9.00
ModeIII 600,000 63% 4,000 = 94.50

QualityAssuranceCostPool
Board Overhead % Units = Cost/Unit
ModeI $421,000 20% 10,000 = $8.42
ModeII 421,000 40% 20,000 = 8.42
ModeIII 421,000 40% 4,000 = 42.10

PackagingandShippingCostPool
Board Overhead % Units = Cost/Unit
ModeI $250,000 4% 10,000 = $1.00
ModeII 250,000 30% 20,000 = 3.75
ModeIII 250,000 66% 4,000 = 41.25
5-21
 Other Overhead Costs
ReceivingandInspectionCostPool
Board Overhead % Units = Cost/Unit
ModeI $200,000 6% 10,000 = $1.20
ModeII 200,000 24% 20,000 = 2.40
ModeIII 200,000 70% 4,000 = 35.00

MaterialHandlingCostPool
Board Overhead % Units = Cost/Unit
$14.82 ModeI $600,000 7% 10,000 = $4.20
ModeII 600,000 30% 20,000 = 9.00
ModeIII 600,000 63% 4,000 = 94.50

QualityAssuranceCostPool
Board Overhead % Units = Cost/Unit
ModeI $421,000 20% 10,000 = $8.42
ModeII 421,000 40% 20,000 = 8.42
ModeIII 421,000 40% 4,000 = 42.10

PackagingandShippingCostPool
Board Overhead % Units = Cost/Unit
ModeI $250,000 4% 10,000 = $1.00
ModeII 250,000 30% 20,000 = 3.75
ModeIII 250,000 66% 4,000 = 41.25
5-22
Product Cost from ABC
These are the new product costs when
Aerotech uses ABC.

5-23
Learning Objective 5
Explain why traditional, volume-based costing
systems tend to distort product costs.

5-24
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]
5-25
 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.

5-26
Two Key Points

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

5-27
Learning Objective 6
Explain three criteria for selecting cost drivers.

5-28
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

5-29
Learning Objective 7
Discuss several key issues in activity-based costing,
including data collection and storyboarding.

5-30
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.
5-31
Learning Objective 8
Explain the concepts of activity-based
management and two-dimensional ABC.

5-32
Activity-Based Management

The use of
ABC costing
information
to help
management
make decisions
5-33
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.

5-34
Two-Dimensional ABC and Activity-
Based Management

Activities

5-35
Two-Dimensional ABC and Activity-
Based Management
Cost Assignment View

Resource
Resource costs
costs

Activities

Cost
Cost Objects
Objects
5-36
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
5-37
Elimination of Non-Value-Added
Costs
Activities

Non-value-added activities

Unnecessary Necessary

Reduce or Continually Evaluate

Eliminate
and Improve 5-38
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.

5-39
Using ABM to Eliminate Non-Value-
Added Activities and Costs

Process time

Inspection time Storage time

Move time Waiting time

5-40
Learning Objective 9
Explain and execute a customer-profitability analysis.

5-41
Customer Profitability Analysis

Customer profitability analysis uses

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

5-42
Customer Profitability Analysis
Required
special
packaging
Orders Demand
small fast
quantities service

Often
Orders
changes
frequently
orders

A costly
customer 5-43
Customer Profitability Analysis

A
A company
company maymay use
use these
these customer
customer
related
related costs
costs to
to help
help determine
determine the
the
profitability
profitability of
of each
each customer.
customer.

5-44
Customer Profitability Analysis
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

5-45
End of Chapter 5
This is
my kind of cost
pool!

5-46