4-1
ActivityBased
Costing and
Management
Prepared by
Douglas Cloud
Pepperdine University
4-2
Objectives
 Explain and illustrate the traditional method
reading
of calculatingAfter
average
coststhis
of products.
chapter, you should
 Explain why the traditional method does not
be able to:
adequately serve modern organizations.
 Explain how complexity and diversity are
important cost drivers.
 Explain and illustrate the activity-based
costing method of calculating average costs
of products.
Continued
4-3
Objectives
 Explain and illustrate activity-based
management.
 Prepare ABC-formatted income statements.
4-4
The Traditional Approach
A company makes two products, A and B, and
uses machine hours as its cost driver.
A
Machine hours per unit
B
Total
2
4
Total units
100,000
25,000
Total hours
200,000
100,000
Total overhead cost
300,000
$900,000
4-5
The Traditional Approach
The overhead rate is $3 ($900,000 ÷ 300,000),
and the allocations of overhead to products are:
Total hours
Rate
Total overhead
A
B
Total
200,000
100,000
300,000
x $3
x $3
x $3
$600,000 $300,000 $900,000
4-6
Activity-Based Costing Approach
Volume is one major driver, measured either
in output (units produced) or input (labor
hours, machine hours, etc.)
Accountants today recognize two other major
influences on cost, complexity and diversity of
operations.
ABC is concerned with resource consumption.
4-7
MultiBrick Cost Determination Data
MultiBrick makes 10,000,000
total bricks, but in a dozen
colors, four textures, and eight
sizes/shapes, a total of 384
possibilities. The firm mixes
and bakes 10 to 18 batches of
bricks per day. MultiBrick sells
to over 1,000 customers whose
orders typically include 15 to 20
different kinds of bricks.
4-8
MultiBrick Cost Determination Data
Total manufacturing overhead $800,000
Total output 10,000,000 bricks
Model A-42
Total production
6,000
Material cost per brick
$0.05
Direct labor cost per brick $0.06
Model A-88 Model C-11
4,000
100,000
$0.04
$0.03
$0.07
$0.04
Overhead rate = $800,000 ÷ 10,000,000 = $0.08 per brick
4-9
MultiBrick Cost Determination Data
Cost calculations:
Model A-42 Model A-88
Material cost per brick
$0.05
$0.04
Direct labor cost per brick 0.06
0.07
Overhead cost at $0.08
0.08
0.08
Total unit cost
$0.19
$0.19
Model C-11
$0.03
0.04
0.08
$0.15
4-10
Activity-Based Costing Terms
A cost object refers to whatever segment for
which you are estimating the cost.
Examples: Products, customers, geographical
areas, and channels of distribution
Cost drivers are activities that cause costs.
Examples: Sales, production, number of
products, and number of customers.
4-11
Activity-Based Costing Terms
Resource Driver refers to activities that drive resource
requirements, and therefore drive costs.
Examples: People, machinery, space, and
utilities
An activity driver relates resource-driving activities to
products, customers, geographical areas, or other
segments of interest.
4-12
MultiBrick Data for Illustration
Resource Driver
Setups
Baking time
Customer orders
Total cost
Total Amount
Rate
Costs in Pool
of Driver
$120,000 ÷ 10,000 setups = $12
600,000 ÷ 300,000 hours = $2
80,000 ÷ 5,000 orders = $16
$800,000
4-13
MultiBrick Data for Illustration
Activity Data per Year
Model A-42
Number of setups
150
baking time, hours
60
Number of customer orders
30
Model A-88
180
50
40
Model C-11
30
300
20
Costs, excluding overhead
Material cost per brick
$0.05
Direct labor cost per brick 0.06
$0.04
0.07
$0.03
0.04
4-14
MultiBrick Data for Illustration
ABC Analysis of Bricks
Model A-42 Model A-88 Model C-11
Material cost
$ 300
$ 160
360
280
4000
Setup-based
1,800
2,160
360
Baking time
120
100
600
Customer order based
480
640
320
$3,060
$3,340
$ 8,280
Divided by annual volume 6,000
4,000
100,000
$0.835
$ 0.083
Direct labor cost
$
3000
Overhead:
Total Cost
Average cost per brick
$ 0.51
4-15
Comparison of Traditional Costs and
Activity-Based Costs
Traditional Cost Approach:
Model A-42 Model A-88 Model C-11
Material cost
$ 300
$160
$ 3000
Direct labor cost
360
280
4000
Overhead
480
320
8,000
Total cost
$1,140
$760
$15,000
4-16
Comparison of Traditional Costs and
Activity-Based Costs
Activity-Based Cost Approach:
Model A-42 Model A-88 Model C-11
Material cost
$ 300
$ 160
$ 3000
360
280
4000
Overhead
2,400
2,900
1,280
Total cost
$3,060
$3,340
$8,280
Direct labor cost
4-17
Consumption Ratios
Consumption ratios is the resource utilized by a
given product divided by the total amount of the
resource available.
Since MultiBrick is producing a total of 10,000,000
bricks, the consumption ratio of each model is:
Model A-42: 6,000 bricks ÷ 10,000,000 = 0.06%
Model A-88: 4,000 bricks ÷ 10,000,000 = 0.04%
Model C-11: 100,000 bricks ÷ 10,000,000 = 1.00%
4-18
Consumption Ratios
Model A-42: 150 setups ÷ 10,000 total = 1.50%
Model A-88: 180 setups ÷ 10,000 total = 1.80%
Model C-11: 30 setups ÷ 10,000 total = 0.30%
Model A-42: 60 hours ÷ 300,000 total = 0.0200%
Model A-88: 50 hours ÷ 300,000 total = 0.0167%
Model C-11: 300 hours ÷ 300,000 total = 0.1000%
Model A-42: 30 orders ÷ 5,000 total = 0.60%
Model A-88: 40 orders ÷ 5,000 total = 0.80%
Model C-11: 20 orders ÷ 5,000 total = 0.40%
4-19
Who Uses ABC?
Primary Objective
•
•
•
•
•
Productive/Service Costing
Process Analysis
Performance Management
Profitability Assessment
Value-Based Management
58%
51%
49%
38%
18%
4-20
Who Uses ABC?
Industry
•
•
•
•
Public Sector
Service
Manufacturing
Consulting
40%
24%
24%
11%
4-21
Kinds of Variability
1. Unit level activities
2. Batch level activities
3. Sustaining activities
4. Facility-sustaining or
company-sustaining activities
4-22
Types of Activities (continued)
Unit level activities are those performed each
time a unit is produced or sold.
Examples: Materials, components, drilling and
welding
4-23
Types of Activities (continued)
Batch level activities are those that a company
performs when it makes a group of units,
regardless of how many units are in the batch.
Example:
Machine setups
4-24
Types of Activities (continued)
Sustaining activities arise because a company
does particular types of business, or maintains
a particular product or service.
Examples: Advertising devoted to the product,
engineering and development related
to the product.
4-25
Types of Activities (continued)
Facility-sustaining or company-sustaining
activities and costs relate to an entire plant,
office, or company as a whole.
Example: Rent of the corporate headquarters
building
4-26
ABC and Ethics
Because some costs are on the
borderline between being direct
or indirect to a product or line,
managerial accountants must use
some judgment in assigning costs
to products. Whenever decisions
involve judgment, the potential
for an ethical conflict exists.
4-27
Activity-Based Management
(ABM)
Activity-Based
Management (ABM)
is using information
about activities to
manage many aspects
of an organization,
rather than simply
managing costs.
4-28
Activity-Based Management
(ABM)
Re-engineering describes the development of new
ways to perform existing activities and ways to
stop performing non-value-adding activities.
Benchmarking is the practice of comparing your
company with some of the industry leaders.
Process value analysis (PVA) uses activity analysis
to manage costs. PVA focuses on manufacturing
processes and seeks to reduce or optimize the
activities performed within a process.
4-29
Process Value Analysis (PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Value-added: An operation that actually changes
the physical aspects of the part.
Examples: Turning, milling, and drilling
4-30
Process Value Analysis (PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Non-Value-added, but necessary: An
operation/activity that does not change the
physical aspects of the part, but is necessary in
order to do so.
Examples: Setup time and inspecting
4-31
Process Value Analysis (PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Non-Value-added, and unnecessary: An activity
that does not changes the physical aspects of the
part and is not necessary for value added
operations to be performed.
Examples: Queue time
4-32
ABC/ABM and World-Class
Manufacturing
ABC is most beneficial for
companies with a great
deal of complexity and
diversity in their products
and operations.
4-33
ABC/ABM Analysis and
Income Reporting
Patterson Homewares, Inc.
Income Statement for 20X2, in thousands
Sales
Unit-level variable costs
Unit-level C/M
Batch-level variable costs
Batch-level C/M
Product-sustaining costs
Product margin
Facility-sustaining costs
Income
Flooring
$300.4
190.1
$110.3
9.6
$100.7
89.2
$ 11.5
Tile
$503.5
161.1
$342.4
26.4
$316.0
56.7
$259.3
Carpet
$623.3
249.3
$374.0
52.8
$321.2
73.7
$247.5
Total
$1,427.2
600.5
$ 826.7
88.8
$ 737.9
219.6
$ 518.3
220.5
$ 297.8
4-34
Chapter 4
The End
4-35