4 -1

CHAPTER

Activity-Based
Costing
 4 -2

Objectives
1. Discuss the importance of unit
After studying this costs.
2. Describe functional-based costing
chapter, you should
approaches. be able to:
3. Explain why functional-based costing
approaches may produce distorted costs.
4. Explain how an activity-based costing system
works for product costing.
continued
 4 -3

Objectives
5. Provide a detailed description of how
activities can be grouped into homogeneous
sets to reduce the number of activity rates.
6. Describe activity-based customer and
supplier costing.
 4 -4
Unit cost is the total cost
associated with the units
produced divided by the
number of units produced.

Unit cost is used for--

Inventory valuation
Income determination
Providing input to a
variety of decisions
such as pricing, make or
buy, and accept or reject
special orders
 4 -5

Product cost is often defined as the

sum of direct materials, direct labor,
and manufacturing overhead. This
definition is required for external
financial reporting.
 4 -6

Cost measurement consists of

determining the dollar amounts of
direct materials, direct labor, and
overhead used in production.
 4 -7

The process of associating

the costs, once measured,
with the units produced is
called cost assignment.
 4 -8

Measurement Systems
Two possible measurement systems are
actual costing and normal costing.
Actual costing assigns the actual costs
of direct materials, direct labor, and
overhead to products.
Normal costing assigns the actual
costs of direct materials and direct
labor to products; however, overhead
cots are assigned to products using
predetermined rates.
 4 -9

Measurement Systems
A predetermined
overhead rate is a rate
based on estimated data.

Budgeted (estimated) cost

Estimated activity usage
 4 -10

Examples of Unit-Level Drivers

Units produced
Direct labor hours
Direct labor dollars
Machine-hours
Direct material dollars
 4 -11

Units
(of
driver) Theoretical
Practical
Expected actual

Normal

Time
 4 -12

Functional-Based Costing: Plantwide Rate

Overhead Costs

Assign Costs Direct Tracing

Plantwide Pool Stage One: Pool Formation

Assign Costs Unit-Level Driver

Products Stage Two: Costs Assigned

 4 -13

Belring, Inc.
Belring, Inc. produces two telephones: a
cordless and a regular model. The company
has the following actual and budgeted data:

.
Budgeted overhead $360,000
Expected activity (DLH) 100,000
Actual activity (DLH) 100,000
Actual overhead $380,000
 4 -14

Belring, Inc.
Predetermined Budgeted (estimated) cost
Overhead Rate =
Estimated activity usage
Predetermined $360,000
Overhead Rate =
100,000 DLH
Predetermined
Overhead Rate = $3.60 per DLH
 4 -15

The total overhead assigned

to actual production is
called applied overhead.

Overhead rate
Applied
= x
overhead
Actual activity
output
 4 -16

Belring, Inc.
Applied
= Overhead rate x Actual activity output
overhead

= $3.60 x 100,000 DLH

= $360,000
 4 -17
Per-Unit Cost
Belring, Inc.
Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
$3.60 x 10,000 36,000 ---
$3.60 x 90,000 --- 324,000
Total manufacturing costs $114,000 $1,062,000
Units produced  10,000  100,000
Unit cost $ 11.40 $ 10.62
 4 -18
Functional-Based Costing Department Rates
Overhead Costs

Allocation
Direct Tracing
Assign Costs Driver Tracing

Stage One: Pool

Department A Pool Formation Department B Pool

Assign Costs Unit-Level Drivers Assign Costs

Stage Two: Costs

Products Assigned
Products
 Departmental Data 4 -19

Belring, Inc.
Fabrication Assembly
Budgeted overhead $252,000 $108,000
Expected and actual usage (dlh):
Cordless 7,000 3,000
Regular 13,000 77,000
20,000 80,000
Expected and actual usage (mh.):
Cordless 4,000 1,000
Regular 36,000 9,000
40,000 10,000
 4 -20

Belring, Inc.
Applied
= ($6.30 x actual mh) + ($1.35 x actual dlh)
overhead

= ($6.30 x 40,000) + ($1.35 x 80,000)

= $252,000 + $108,000

= $360,000
 4 -21

Belring, Inc.
Per-Unit Cost: Departmental Rates

Cordless Regular
Prime costs $ 78,000 $ 738,000
Overhead costs:
($6.30 x 4,000) + ($1.35 x 3,000) 29,250 ---
($6.30 x 36,000) + (1.35 x 77,000) --- 330,750
Total manufacturing costs $107,250 $1,068,750
Units produced  10,000  100,000
Unit cost $ 10.73 $ 10.69
 4 -22

Symptoms of an Outdated
Functional Cost System
1. The outcome of bids is difficult to explain.
2. Competitors’ prices appear unrealistically low.
3. Products that are difficult to produce show high
profits.
4. Operational managers want to drop products that
appear profitable.
5. Profit margins are difficult to explain.
Continued
 4 -23

Symptoms of an Outdated
Functional Cost System
6. The company has a highly profitable niche all to
itself.
7. Customers do not complain about price increases.
8. The accounting department spends a lot of time
supplying cost data for special projects.
9. Some departments are using their own accounting
system.
10. Product costs change because of changes in
financial reporting regulations.
 4 -24

Non-unit activity drivers are

factors that measure the
consumption of non-unit
activities by products and other
cost objects.
 4 -25

Product diversity means that the

products consume overhead activities
in systematically different proportions.
 4 -26

Belring, Inc.
Product-Costing Data
Cordless Regular Total
Units produced per year 10,000 100,000 110,000
Prime costs $78,000 $738,000 $816,000
Direct labor hours 10,000 90,000 100,000
Machine hours 5,000 45,000 50,000
Production runs 20 10 30
Number of moves 60 30 90

Activity Usage
Measures
 4 -27

Belring, Inc.
Product-Costing Data
Activity Activity Cost
Setups $120,000
Material handling 60,000
Machining 100,000
Testing 80,000
Total $360,000

Overhead Activities
 4 -28

Belring, Inc.
Product Diversity: Consumption Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
a 20/30 (cordless) and 10/30 (regular)
 4 -29

Belring, Inc.
Product Diversity: Consumption Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
b 60/90 (cordless) and 30/90 (regular)
 4 -30

Belring, Inc.
Product Diversity: Consumption Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
c 5,000/50,000 (cordless) and 45,000/50,000 (regular)
 4 -31

Belring, Inc.
Product Diversity: Consumption Ratios
Overhead Cordless Regular Activity
Activity Phone Phone Driver
a a
Setups 0.67 0.33 Production runs
Material
b b
handling 0.67 0.33 Number of moves
c c
Machining 0.10 0.90 Machine hours
d d
Testing 0.10 0.90 Direct labor hours
d 10,000/100,000 (cordless) and 90,000/100,000 (regular)
 4 -32

Belring, Inc.
Activity Rates

Setup rate: $120,000/30 =$4,000 per run

Material-handling
rate: $60,000/90 = $666.67 per move
Machining rate: $100,000/50,000 = $2 per MH
Testing rate: $80,000/100,000 = $0.80 per DLH
 4 -33

Belring, Inc.
Activity Rates
Cordless
$4,000 Regular
$4,000
Prime costs $ 78,000
x
$667 $ 738,000
x
$667
Overhead costs: 20
x 10
x
$2 $2
Setups 60
x
80,000 30
x
40,000
$0.80 $0.80
Material handling 5,000
x
40,000 45,000
x
20,000
Machining 10,000
10,000 90,000
90,000
Testing 8,000 72,000
Total manufacturing costs $216,000 $ 960,000
Units produced  10,000  100,000
Unit cost (total costs/units) $ 21.60 $ 9.60
 4 -34

Belring, Inc.
Comparison of Unit Costs
Cordless Regular
Plantwide rate $11.40 $10.62
Departmental rate 10.73 10.69
Activity rate 21.60 9.60
 4 -35

ABC: Two-Stage Assignment

Cost of Resources

Driver Driver
Assign Costs
Tracing Tracing

Activities

Driver
Assign Costs
Tracing

Products
 4 -36

A secondary activity is
A primary activity is one
one that is consumed by
that is consumed by a
other primary and
product or customer.
secondary activities.
 4 -37

Resource drivers are

factors that measure the
consumption of
resources by activities.
 4 -38

Activity Activity Activity Cost Activity

name Description Type Object(s) Driver

Supervising Scheduling, Secondary Activities within Total labor

employees coordinating and department time for each
evaluating activity
performance
Processing Sorting, keying, Primary Credit cards Number of
transactions and verifying transactions

Preparing Reviewing, Primary Credit cards Number of

statements printing., stuffing, statements
and mailing
Answering Answering, Primary Credit cards Number of
questions logging, reviewing calls
database, and
making call backs
Providing Accessing accounts Primary Credit cards , Number of
automatic withdrawing funds checking and teller
tellers saving accounts transactions
 4 -39

Classification of Activities

Unit-level activities are those that are performed each

time a unit is produced.
Examples: Power and machine hours are used
each time a unit is produced. Direct
materials and direct labor activities are
also unit-level activities, even though
they are not overhead costs.
 4 -40

Classification of Activities

Batch-level activities are those that are performed

each time a batch of products is produced.
Examples: Setups, inspections, production
scheduling, and material handling.
 4 -41

Classification of Activities
Product-level (sustaining) activities are those that are
performed as needed to support the various products
produced by a company. These activities consume inputs that
develop products or allow products to be produced and sold.
Examples: Engineering changes, process engineering, and
expediting.
 4 -42

Classification of Activities

Facility-level activities are those that sustain a

factory's general manufacturing processes.

Examples: Plant management, landscaping,

maintenance, security, property
taxes, and plant depreciation.
 4 -43

A1 A2 A3 A4 A5

Activit
y Level
Filter

Unit Level Batch Level Product Level Facility Level

Driver Driver Driver

Filter Filter Filter

Set 1 Set 2 Set 3 Set 4 Set 5 Set 6 Set 7

 4 -44

Customer
Costing versus
Product Costing
 4 -45

Example
Large Customer Ten Smaller Customers
(50% of sales) (50% of sales)

Units purchased 500,000 500,000

Orders placed 2 200
Number of sales calls 10 210
Manufacturing cost $3,000,000 $3,000,000
Order-filling costs
allocated $202,000 $202,000
Sales-force costs
allocated $110,000 $110,000
 4 -46

Example

The purchasing manager uses two suppliers,

Murray Inc. and Plata Associates, as the source of
two machine parts: Part A1 and Part B2.

Activity Costs
Repairing products $800,000
Expending products 200,000
 4 -47

Example
Murray Inc. Plata Associates
Part A 1 Part B2 Part A 1 Part B2
Unit purchase price $20 $52 $24 $56
Units purchased 80,000 40,000 10,000 10,000
Failed units 1,600 380 10 10
Late shipments 60 40 0 0

Repair rate = $800,000 ÷ 2,000 = $400 per failed part

Expediting rate = $200,000 ÷ 100 = $2,000 per late
(1,600 + 380 + 10 + 10)
delivery
60 + 40
 4 -48

Example
Murray Inc. Plata Associates
Part A 1 Part B2 Part A 1 Part B2
Purchase cost $1,600,000 $2,080,000 $240,000 $560,000
Repairing products 640,000 152,000 4,000 4,000
Expediting products 120,000 80,000
Total costs $2,360,000 $2,312,000 $244,000 $564,000
Units ÷ 80,000 ÷ 40,000 ÷ 10,000 ÷ 10,000
Total unit cost $ 29.50 $ 57.80 $ 24.40 $ 56.40
 4 -49

Chapter Four

The End