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Activity-Based Costing

Learn about the benefits of activity-based costing, how to reduce cost pools, and use homogenous cost pools effectively. Explore concepts like direct tracing, overhead allocation, and the limitations of unit-based costing. Case study of Goodmark Company's product costing data.

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Activity-Based Costing

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  1. Activity-Based Costing Prepared by Douglas Cloud Pepperdine University

  2. Objectives 1. Discuss the limitations of using only unit-based drivers to assign costs. 2. Provide a detailed description of activity-based product costing. 3. Explain how homogenous cost pools can be used to reduce the number of activity rates. 4. Describe activity-based system concepts including an ABC relational database and ABC software. After studying this chapter, you should be able to:

  3. Functional-Based ProductCosting Model Direct Tracing Driver Tracing Allocation Direct Tracing Direct Tracing Plant/Departmental Cost Pools Unit-Based Driver Direct Materials Direct Labor Overhead PRODUCTS

  4. Goodmark Company—An Example Goodmark Company produces two products: scented and regular birthday cards.

  5. Scented Cards Regular Cards Total Unit produced per year 20,000 200,000 -- Prime costs $160,000 $1,500,000 $1,660,000 Direct labor hours 20,000 160,000 180,000 Number of setups 60 40 100 Machine hours 10,000 80,000 90,000 Inspection hours 2,000 16,000 18,000 Number of moves 180 120 300 Goodmark Company—An Example Product Costing Data

  6. Goodmark Company—An Example Product Costing Data Departmental Data Cutting Dept. Printing Dept. Total Direct labor hours: Scented cards 10,000 10,000 20,000 Regular cards 150,00010,000160,000 Total 160,000 20,000 180,000 Machine hours: Scented cards 2,000 8,000 10,000 Regular cads 8,00072,000 80,000 Total 10,000 80,000 90,000 Continued

  7. Departmental Data Cutting Dept. Printing Dept. Total Overhead costs: Setting up equipment $120,000 $120,000 $240,000 Moving materials 60,000 60,000 120,000 Machining 20,000 180,000 200,000 Inspecting products 16,000 144,000 160,000 Total $216,000 $504,000 $720,000

  8. Total overhead cost Direct labor hours Plantwide rate = $720,000 180,000 DLH = $4 per direct labor hour = Goodmark Company—An Example Plantwide Overhead Rate

  9. Dept. overhead cost Cutting Dept. DLH Cutting Department rate = $216,000 160,000 DLH = $1.35 per dlh = Goodmark Company—An Example Departmental Rates

  10. Dept. overhead cost Printing Dept. MH Printing Department rate = $504,000 80,000 MH = $6.30 per mh = Goodmark Company—An Example Departmental Rates

  11. Goodmark Company—An Example Unit Cost Computation: Plantwide Rates Scented Cards Regular Cards Prime costs $160,000 $1,500,000 Overhead costs: $4.00 x 20,000 80,000 $4.00 x 160,000 640,000 Total manufacturing costs $240,000 $2,140,000 Units of production ÷ 20,000 ÷ 200,000 Unit cost $ 12.00 $ 10.70

  12. Goodmark Company—An Example Unit Cost Computation: Departmental Rates Scented Cards Regular Cards Prime costs $160,000 $1,500,000 Overhead costs: [($1.35 x 10,000) + ($6.30 x 8,000)] 63,900 [($2.35 x 150,000) + ($6.30 x 72,000)] 656,100 Total manufacturing costs $223,900 $2,156,100 Units of production ÷ 20,000 ÷ 200,000 Unit cost $ 11.20 $ 10.78 * * * Rounded to nearest cent

  13. The Inadequacy of Plantwide and Departmental Rates There are at least two major factors that can impair the ability of the unit-based plantwide and departmental rates to assign overhead costs accurately: (1) the proportion of nonunit-related overhead costs to total overhead costs is large, and (2) the degree of product diversity is great.

  14. Goodmark Company—An Example Product Diversity: Consumption Ratios Overhead Activity Scented Cards Regular Cards Activity Drivers Setups 0.60 0.40 Production runs Moving materials 0.60 0.40 Number of moves Machining 0.11 0.89 Machine hours Inspection 0.11 0.89 Inspection hours a a b b c* c* d* d* a b c d 60/100 (scented) and 40/100 (regular) 180/300 (scented) and 120/300 (regular) 10,000/90,000 (scented) and 80,000/90,000 (regular) 2,000/18,000 (scented) and 16,000/18,000 (regular) *rounded

  15. Goodmark Company—An Example Unit Cost Computation: Activity Rates Scented Cards Regular Cards Prime costs $160,000 $1,500,000 Overhead costs: Setting up: $2,400 x 60 144,000 $2,400 x 40 96,000 Machining: $2.20 x 10,000 22,200 $2.20 x 80,000 177,600 Continued

  16. Rounded Scented Cards Regular Cards Overhead costs(cont’d): Inspecting: $8.89 x 2,000 17,780 $8.89 x 16,000 142,240 Moving materials: $400 x 180 72,000 $400 x 120 48,000 Total manufacturing costs $415,980 $1,963,840 Units of production ÷ 20,000 ÷ 200,000 Unit cost $ 20.80 $ 9.82

  17. Activity-Based Costing Model Costs assigned using driver tracing and direct tracing Activities Costs assigned using activity drivers Products Cost of Resources

  18. Design Steps for an Activity-Based Costing System 1. Identify, define, and classify activities and key attributes. 2. Assign the cost of resources to activities. 3. Assign the cost of secondary activities to primary activities. 4. Identify cost objects and specify the amount of each activity consumed by specific cost objects. 5. Calculate primary activity rates. 6. Assign activity costs to cost objects.

  19. Activity-Based Costing A primary activity is an activity that is consumed by a final cost object such as a product or customer. A secondary activity is one that is consumed by intermediate cost objects such as primary activities, materials, or other secondary activities.

  20. Activity Dictionary: Cardiology Ward Activity Description Activity Name Activity Type Cost Object(s) Activity Driver Supervising Scheduling, Secondary Activities Percentage nurse coordinating, within time nurses and performance department spend on evaluation each activity Treating Administering Primary Patient types Number of patients medicine and treatments changing dressings Continued

  21. Activity Description Activity Name Activity Type Cost Object(s) Activity Driver Providing Bathing, Primary Patient types Labor hours hygienic care changing bedding and clothes, walking patients Responding to Answering Primary Patient types Number of patient calls, counseling, requests requests providing snacks, etc. Monitoring Monitoring Primary Patient types Monitoring patients vital signs hours and posting patient information

  22. Cardiology Ward Example (Cont’d) ActivitySupervisorNurses Supervising nurses 100 % 0 % Treating patients 0 25 Providing hygienic care 0 20 Responding to requests 0 40 Monitoring patients 0 15 Percentage of Time for Each Activity

  23. Cardiology Ward Example (Cont’d) Unbundling of General Ledger Costs —Chart of Accounts View Supervising $ 50,000 Supplies 40,600 Uniforms 8,200 Salaries 300,000 Computer 1,200 Monitor 80,000 Total $480,000

  24. Unbundling of General Ledger Costs —ABC View Cardiology Ward Example (Cont’d) Supervising nurses $ 52,280 Treating patients 90,000 Providing hygienic care 76,600 Responding to requests 133,200 Monitoring patients 127,920 Total $480,000

  25. Cardiology Ward Example (Cont’d) Treating patients $103,070 Providing hygienic care 87,056 Responding to requests 154,112 Monitoring patients 135,762 Assignment of Secondary Activity Costs to Primary Activities $90,000 + (0.25 x $52,280) $76,600 + (0.20 x $52,280) $133,200 + (0.40 x $52,280) $127,920 + (0.15 x $52,280)

  26. Cardiology Ward Example (Cont’d) Treating patients: $103,070/30,000 = $3.44 per treatment Providing hygienic care: $87,056/16,000 = $5.44 per hour of care Responding to requests: $154,112/80,000 = $1.93 per request Monitoring patients: $135,762/200,000 = $0.68 per monitoring hour Rate Calculations

  27. Cardiology Ward Example (Cont’d) Bill of Activities Activity Intensive ActivityDriverNormalIntermediateCareTotal Production (output) Patient days 10,000 5,000 3,000 Treating patients Treatments 5,000 10,000 15,000 30,000 Providing hygienic care Hygienic hours 5,000 2,500 8,500 16,000 Responding to requests Requests 30,000 40,000 10,000 80,000 Monitoring patients Monitoring hours 20,000 60,000 120,000 200,000

  28. Cardiology Ward Example (Cont’d) Assigning Cost: Final Cost Objects Normal Treating patients: $3.44 x 5,000 $ 17,200 Providing hygientic care: $5.44 x 5,000 27,200 Responding to requests: $1.93 x 30,000 57,900 Monitoring patients: $0.68 x 20,000 13,600 Total cost $115,900 Units ÷ 10,000 Nursing cost per patient day $ 11.59

  29. Cardiology Ward Example (Cont’d) Assigning Cost: Final Cost Objects Intermediate Treating patients: $3.44 x 10,000 $ 34,400 Providing hygientic care: $5.44 x 2,500 13,600 Responding to requests: $1.93 x 40,000 77,200 Monitoring patients: $0.68 x 60,000 40,800 Total cost $166,000 Units ÷ 5,000 Nursing cost per patient day $ 33.20

  30. Cardiology Ward Example (Cont’d) Assigning Cost: Final Cost Objects Intensive Care Treating patients: $3.44 x 15,000 $ 51,600 Providing hygientic care: $5.44 x 8,500 46,240 Responding to requests: $1.93 x 10,000 19,300 Monitoring patients: $0.68 x 120,000 81,600 Total cost $198,740 Units ÷ 3,000 Nursing cost per patient day $ 66.25

  31. Activity-Level Classification Unit-level activitiesare 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.

  32. Activity-Level Classification Batch-level activitiesare those that are performed each time a batch of products is produced. Examples:Setups, inspections, purchasing, and material handling.

  33. Activity-Level Classification Product-level (sustaining) activities are those activities performed that enable the various products of a company to be produced. These activities and their costs tend to increase as the number of different products increases. Examples:Engineering changes, developing product-testing procedures, introducing new products, and expediting goods.

  34. Activity-Level Classification Facility-level activities are those that sustain a factory's general manufacturing processes. Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.

  35. A A A A A 1 2 3 4 5 ProcessLevel Filter Activity P P P P 1 2 3 4 To activity filter Activities Classification and Homogeneous Sets Processed –classified activities

  36. Unit Level Batch Level Product Level Facility Level Driver Filter Driver Filter Driver Filter Set 1 Set 2 Set 3 Set 4 Set 5 Set 6 Set 7 From processed-classification activities Activity Level Filter Level-Classification activities Homogenous sets

  37. ABC Database An ABC database is the collected data sets that are organized and interrelated for use by an organization’s activity-based costing information system. A data set is a grouping of logically related data.

  38. End of Chapter

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