Activity Based Costing
Activity Based Costing
Activity Based Costing
CHAPTER 4
ACTIVITY- BASED COSTING
Prepared by
Dan R. Ward
Suzanne P. Ward
University of Louisiana at Lafayette
Study Objectives
Differentiate between
value-added and
non-value-added
activities.
Study Objectives:
Continued
Apply activity-based
costing to service
industries.
PREVIEW OF CHAPTER 4
Traditional Costing and Activity-Based Costing
Traditional costing systems
The need for a new approach
Activity-based costing
Products
Expected Use
of Cost Drivers
Activity Cost Pools Cost Drivers Per Activity
Setting up machines Number of setups 1,500
Machining Machine hours 50,000
Inspecting Number of
Inspections 2,000
Unit Costs Under ABC:
Step 3: Compute Overhead Rates
Expected Use
Estimated of Cost Drivers Activity-Based
Activity Cost Pools Overhead Per Activity Overhead Rates
Setting up machines $300,000 1,500 setups $200 per setup
Machining 500,000 50,000 machine hrs. $ 10 per mach. hour
Inspecting 100,000 2,000 inspections $ 50 per inspection
Total $900,000
Unit Costs Under ABC:
Step 4: Assign Overhead Costs to Products
Part 1: Expected Use of Cost Driver Per Product
Expected Use
of Cost Drivers
per Product
Expected Use
Activity Cost of Cost Drivers
Pools Cost Driver Per Activity The Boot The Club
Setting up Number of
machines setups 1,500 setups 500 1,000
Machining Machine hours 50,000 hours 30,000 20,000
Inspecting Number of
inspections 2,000 inspections 500 1,500
Unit Costs Under ABC:
Step 4: Assign Overhead Costs to Products
Part 2: Assign Cost Pools to Products
The Boot
Expected Use of Activity-Based
Activity Cost Drivers X Overhead = Cost
Cost Pools per Product Rates Assigned
Setting up machines 500 $200 $100,000
Machining 30,000 10 300,000
Inspecting 500 50 25,000
Total costs assigned $425,000
Units produced 25,000
Overhead cost per unit $17
Unit Costs Under ABC:
Step 2: Assign Overhead Costs to Products
Part 2: Assign Cost Pools to Products
The Club
Expected Use of Activity-Based
Activity Cost Drivers X Overhead = Cost
Cost Pools per Product Rates Assigned
Setting up machines 1,000 $200 $200,000
Machining 20,000 10 200,000
Inspecting 1,500 50 75,000
Total costs assigned $475,000
Units produced 5,000
Overhead cost per unit $95
Comparison of Unit Costs
Traditional vs ABC
Overstated Understated
$13 $65
Activity-Based Costing:
A Closer Look
Study Objective 5
Unit-level activities:
Performed for each unit of production
Batch-level activities:
Performed for each batch of product
Product-level activities:
Performed in support of an entire product line, but
not always performed every time a new unit or
batch is produced
Facility-level activities:
Required to support or sustain an entire production
process
Hierarchy of Activity Levels
Four Levels Types of Activities Cost Drivers
Unit-Level Activities Machine-related: Machine Hours
Drilling, cutting, milling
Labor-related Direct labor hours/cost
Assembling, painting
Batch-Level Activities Equipment setups Number of setups/setup time
Purchase ordering Number of purchase orders
Inspection Number of inspections or
inspection time
Material handling Number of material moves
Product-Level Activities Product design Number of product designs
Engineering changes Number of changes
Facility-Level Activities Plant management Number of employees
salaries managed
Plant depreciation Square footage
Property taxes Square footage
Utilities Square footage
Activity-Based Costing
in Service Industries
Study Objective 8
Revenue $2,000,000
Direct labor $ 600,000
Overhead (expected) 1,200,000
Total Costs 1,800,000
Operating income $ 200,000
Estimated overhead
= Predetermined overhead rate
Direct labor cost
$1,200,000
= 200%
$600,000
Activity-Based Costing in Service
Industries:
ABC Costing Example
CHECK AND DOUBLECHECK, CPAs
Plano Molding Company Audit
Revenue $260,000
Less: Direct professional labor $ 70,000
Applied Overhead (200% x $70,000) 140,000 210,000
Operating Income $ 50,000
Activity-Based Costing in Service Industries:
ABC Costing Example
CHECK AND DOUBLECHECK, CPAs
Annual Overhead Budget
Expected Use
Activity Cost Estimated + of Cost Drivers = Activity-Based
Pools Cost Drivers Overhead Per Activity Overhead Rates
Secretarial support Direct Prof. hours $ 210,000 30,000 $7 per hour
Direct labor Fringe benefits Direct labor cost 240,000 $ 600,000 $0.40 per $1 labor
Printing and photocopying Working paper pages 20,000 20,000 $1 per page
Computer support CPU minutes 200,000 50,000 $4 per minute
Telephone and postage None (traced directly) 71,000 $ 71,000 Based on usage
Legal support Hours used 129,000 860 $150 per hour
Insurance Revenue billed 120,000 $2,000,000 $0.06 per $1 rev.
Recruiting and training Direct Prof. Hours __210,000 30,000 $7 per hour
$1,200,000
Activity-Based Costing in Service Industries:
ABC Costing Example
CHECK AND DOUBLECHECK, CPAs
Plano Molding Company Audit
Activity-
Based-
Activity Cost Actual Use Overhead
Pools Cost Drivers of Drivers Rates Cost Assigned
Secretarial support Direct Professional hours 3,800 $ 7.00 $ 26,600
Direct labor Fringe benefits Direct labor cost $ 70,000 $ 0.40 28,000
Printing and photocopying Working paper pages 1,800 $ 1.00 1,800
Computer support CPU minutes 8,600 $ 4.00 34,400
Telephone and postage None (traced directly) 8,700
Legal support Hours used 156 $150.00 23,400
Insurance Revenue billed $260,000 $ 0.06 15,600
Recruiting and training Direct Prof. Hours 3,800 $ 7.00 26,600
$165,100
Activity-Based Costing in Service
Industries: ABC Costing Example
CHECK AND DOUBLECHECK, CPAs
Sales Order
Received
Goods Manufactured
JIT Processing
Objective of JIT:
Eliminate all manufacturing inventories
Elements of JIT:
Dependable suppliers
Multi-skilled work force
Total quality control system
Benefits of JIT:
Reduced inventory
Enhanced product quality
Reduced rework and storage costs
Savings from improved flow of goods
Let’s Review
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