MANAGEMENT ACCOUNTING
Don R. Hansen
Maryanne M. Mowen
Nabil S. Elias
David W. Senkow
Copyright 2001 Nelson Thomson Learning
Chapter 4-1
Chapter Four
Activity-Based Costing
Chapter 4-2
Learning Objectives

Discuss the importance of unit costs.

Describe functional-based costing
approaches.

Explain why functional-based costing
approaches may produce distorted costs.

Explain how an activity-based costing
system works.
Chapter 4-3
Learning Objectives (continued)

Provide a detailed description of how
activities can be grouped into homogeneous
sets to reduce the number of activity rates.

Describe the role of activity-based costing
for organizations with only one product,
homogeneous products, or a JIT structure.
Chapter 4-4
Unit Costs
The unit cost is the total cost associated with the units
produced divided by the number of units produced
Although the concept is simple, the practical reality of
the computation can be somewhat more complex
because of the following issues:
–
What is meant by “total cost”?
–
How do we measure the costs to be assigned?
–
How do we assign costs to the product?
Chapter 4-5
Unit Costs (continued)
Unit costs are important for:

inventory valuation

income determination

providing input to a variety of decisions such as
pricing, make or buy, and accept or reject special
orders
Chapter 4-6
Measurement Systems
Two possible measurement systems are
actual costing and normal costing.
Actual costing assigns the actual costs of direct
materials, direct labour, and overhead to products.
Normal costing assigns the actual costs of direct
materials and direct labour to products; however,
overhead cots are assigned to products using
predetermined rates.
Chapter 4-7
Activity Capacity Measures
Units (of driver)
Theoretical
Practical
Expected actual
Normal
Time
Chapter 4-8
Functional-Based Costing:
Plantwide Rate
Overhead Costs
Assign Costs
Plantwide Pool
Assign Costs
Products
Direct Tracing
Stage One: Pool Formation
Unit-Level Driver
Stage Two: Costs Assigned
Chapter 4-9
Belring, Inc.
Belring, Inc. produces two telephones: a cordless and
a regular model. The company has the following
actual and budgeted data:
Budgeted overhead
Expected activity (DLH)
Actual activity (DLH)
Actual overhead
Chapter 4-10
$360,000
100,000
100,000
$380,000
Belring, Inc. (continued)
Units produced
Prime costs
Direct labour hours
Cordless
Regular
10,000
100,000
$78,000
$738,000
10,000
90,000
Chapter 4-11
Belring, Inc. (continued)
Predetermined
Overhead Rate
=
Budgeted overhead  Expected activity
=
$360,000  100,000 DLH
=
$3.60 per DLH
Chapter 4-12
Belring, Inc. – Unit Cost Computation:
Plantwide Rate
Cordless
Regular
$ 78,000
$ 738,000
$3.60 x 10,000
36,000
---
$3.60 x 90,000
---
324,000
Total mfg. costs
$114,000
$1,062,000
Units produced
 10,000
 100,000
Unit cost
$ 11.40
=======
$
10.62
========
Prime costs
Overhead costs:
Chapter 4-13
Functional-Based Costing:
Departmental Rates
Overhead Costs
Assign Costs
Department A Pool
Stage One: Pool
Formation
Department B Pool
Assign Costs
Unit-Level
Drivers
Assign Costs
Products
Stage Two: Costs
Assigned
Products
Chapter 4-14
Belring, Inc. – Departmental Data
Fabrication
Budgeted OH
$252,000
=======
Expected and actual usage (DLH):
Cordless
7,000
Regular
13,000
20,000
=====
Expected and actual usage (MH):
Cordless
4,000
Regular
36,000
40,000
=====
Chapter 4-15
Assembly
$108,000
=======
3,000
77,000
80,000
=====
1,000
9,000
10,000
=====
Belring, Inc. – Departmental Rates
Overhead Rates:
Fabrication Rate
= Budgeted OH / Expected MH
= $252,000/40,000
= $6.30 per MH
Assembly Rate
= Budgeted OH / Expected DLH
= $108,000/80,000
= $1.35 per DLH
Chapter 4-16
Belring, Inc. – Unit Cost Computation:
Departmental Rate
Prime costs
Overhead costs:
($6.30 x 4,000) + ($1.35 x 3,000)
($6.30 x 36,000) + ($1.35 x 77,000)
Total mfg. costs
Units produced
Unit cost
Cordless
$ 78,000
Regular
$738,000
29,250
--$107,250
 10,000
$ 10.73
=======
--330,750
$1,068,750
 100,000
$
10.69
========
Chapter 4-17
Symptoms of an Outdated
Functional Cost System

The outcome of bids is difficult to explain.

Competitors’ prices appear unrealistically low.

Products that are difficult to produce show high
profits.

Operational managers want to drop products that
appear profitable.

Profit margins are difficult to explain.
Chapter 4-18
Symptoms of an Outdated Functional
Cost System (continued)

The company has a highly profitable niche all to itself.

Customers do not complain about price increases.

The accounting department spends a lot of time supplying
cost data for special projects.

Some departments are using their own accounting system.

Product costs change because of changes in financial
reporting regulations.
Chapter 4-19
Belring, Inc. – Activity Usage
Cordless
Regular
Total
10,000
100,000
110,000
$78,000
$738,000
$816,000
10,000
90,000
100,000
5,000
45,000
50,000
Production runs
20
10
30
Number of moves
60
30
90
Units produced per year
Prime costs
Direct labour hours
Machine hours
Chapter 4-20
Belring, Inc. – Additional OH Cost Data
Activity
Setups
Material handling
Machining
Testing
Total
Activity Cost
$120,000
60,000
100,000
80,000
$360,000
=======
Chapter 4-21
ABC: Two-Stage Assignment
Cost Of Resources
Direct Tracing
Assign Costs
Activities
Driver Tracing
Assign Costs
Products
Chapter 4-22
Driver tracing
Belring, Inc. – Activity Rates
Activity rates are computed below:
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
Chapter 4-23
Belring, Inc. – Activity-Based Costing
Unit Cost Computation
Prime costs
Overhead costs:
Setups
Material handling
Machining
Testing
Total mfg. costs
Units produced
Unit cost
Cordless
$ 78,000
Regular
$ 738,000
80,000
40,000
10,000
8,000
$216,000
 10,000
$ 21.60
40,000
20,000
90,000
72,000
$ 960,000
 100,000
$
9.60
=====
Chapter 4-24
=====
Comparison of Unit Costs
Plantwide rate
Departmental rate
Activity rate
Cordless
$11.40
10.73
21.60
Chapter 4-25
Regular
$10.62
10.69
9.60
Activity Categories
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 labour
activities are also unit-level activities, even though
they are not overhead costs.
Chapter 4-26
Activity Categories (continued)
Batch-level Activities are those that are performed each
time a batch of products is produced.
Examples:
Setups, inspections, production scheduling, and
material handling.
Chapter 4-27
Activity Categories (continued)
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, and expediting.
Chapter 4-28
Activity Categories (continued)
Facility-level Activities are those that
sustain a factory's general
manufacturing processes.
Examples:
Plant management,
landscaping, maintenance,
security, property taxes, and
plant depreciation.
Chapter 4-29
When To Use An ABC System
Measurement Cost
Cost
Error Costs
Optimal Cost Level
Low
High
Level of Accuracy
Chapter 4-30
Comparison of JIT with
Traditional Manufacturing
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
JIT
Pull-through system
Insignificant inventories
Small supplier base
Long-term supplier contracts
Cellular structure
Multiskilled labour
Decentralized services
High employee involvement
Facilitating management style
Total quality control
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Traditional
Push-through system
Significant inventories
Large supplier base
Short-term supplier contracts
Departmental structure
Specialized labour
Centralized services
Low employee involvement
Supervisory management style
Acceptable quality level
Chapter 4-31
End of Chapter 4
Chapter 4-32