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Activity-Based Costing
Chapter 9
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
LO 9-1
LO 9-2
LO 9-3
LO 9-4
LO 9-5
LO 9-6
LO 9-7
LO 9-8
Understand the potential effects of using externally reported
product costs for decision making.
Explain how a two-stage product costing system works.
Compare and contrast plantwide and department
allocation methods.
Explain how activity-based costing and a two-stage product
system are related.
Compute product costs using activity-based costing.
Compare activity-based product costing to traditional
department product costing methods.
Demonstrate the flow of costs through accounts using
activity-based costing.
Apply activity-based costing to marketing and administrative
services.
9-3
LO
9-1
Product Costs and Decision
Making
LO 9-1 Understand the potential effects of using externally
reported product costs for decision making.
C-27s
10
2,000
C-20s
30
3,000
Total
40
5,000
Units produced
Direct labor-hours
Costs:
Direct materials
Direct labor
Manufacturing overhead
(@ 120%)
Total
$ 40,000
72,000
$ 36,000
78,000
$ 76,000
150,000
86,400
$198,400
93,600
$207,600
180,000
$406,000
Cost per unit
$ 19,840
$
6,920
Grange is considering dropping C-27s.
9-4
LO
9-1
Product Costs and Decision
Making
The accountant estimated that overhead
will be $163,800.
Original
Manufacturing overhead:
Utilities
Supplies
Training
Supervision
Machine depreciation
Plant depreciation
Miscellaneous
Total overhead
$
2,400
2,500
30,000
54,900
29,550
40,050
20,600
$180,000
C-20s only
$
1,800
1,300
15,600
54,900
29,550
40,050
20,600
$163,800
9-5
LO
9-1
Product Costs and Decision
Making
Direct materials
Direct labor
Manufacturing overhead
Total costs
Original
C-20s only
$ 76,000
150,000
180,000
$406,000
$ 36,000
78,000
163,800
$277,800
The cost per unit for the C-20s will
increase from $6,920 to $9,260.
9-6
LO
9-1
The Death Spiral
This is a process that begins by
attempting to increase price to
meet reported product cost.
This may result in demand for
even fewer units.
9-7
LO
9-2
Two-Stage Cost Allocation
LO 9-2 Explain how a two-stage product costing system works.
Allocate overhead costs to departments.
Allocate department overhead costs
to the products or services.
9-8
LO
9-2
Two-Stage Cost Allocation
Cost
pool
Overhead
Intermediate
cost pools
Department A
Department B
Cost
allocation rule
Direct labor
hours
Machine
hours
9-9
LO
9-2
Two-Stage Cost Allocation
Third Quarter – Production and Cost Data
J25P
J40X
Total
Number of units
Machine hours – Assembly
100,000
6,000
40,000
30,000
140,000
36,000
Direct materials
Direct labor – Assembly
Direct labor – Packaging
Total direct labor
Total direct cost
Overhead costs:
Assembly
Packaging
Total overhead
Total costs
$1,500,000
$ 750,000
990,000
$1,740,000
$3,240,000
$2,400,000
$ 600,000
360,000
$ 960,000
$3,360,000
$3,900,000
$1,350,000
1,350,000
$2,700,000
$6,600,000
$1,620,000
810,000
$2,430,000
$9,030,000
The cost system allocates manufacturing overhead
to products based on direct labor costs.
9-10
LO
9-2
Two-Stage Cost Allocation
Third Quarter – Unit Cost Report – One allocation rate
J25P
J40X
Units produced
100,000
40,000
Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct cost
Applied overhead
(@ 90% of direct labor costs)
$ 15.00
$ 60.00
$
7.50
9.90
$ 17.40
$ 32.40
$ 15.00
9.00
$ 24.00
$ 84.00
15.66
$ 48.06
21.60
$105.60
9-11
LO
9-2
Two-Stage Cost Allocation
Third Quarter – Unit Cost Report –Two Stage Allocation
J25P
J40X
Units produced
100,000
40,000
Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct cost
Applied overhead:
Assembly @ $45/machine hour
Packaging @ 60% of direct labor cost
Total overhead
Unit costs
$ 15.00
$ 60.00
$
7.50
9.90
$ 17.40
$ 32.40
$ 15.00
9.00
$ 24.00
$ 84.00
$
$ 33.75
5.40
$ 39.15
$123.15
2.70
5.94
$ 8.64
$ 41.04
9-12
LO
9-3
Plantwide versus
Department-Specific Rates
LO 9-3 Compare and contrast plantwide and
department allocation methods.
All overhead costs are recorded in one
cost pool and applied to products using
one overhead allocation rate.
9-13
LO
9-3
Plantwide versus
Department-Specific Rates
Overhead costs are traced to separate
departments and applied to products
using a department allocation rate.
9-14
LO
9-3
Choice of Allocation Methods
Similar products using
same resources
Plantwide
allocation
Multiple products using
resources differently
Department
allocation
9-15
LO
9-4
Activity-Based Costing (ABC)
LO 9-4 Explain how activity-based costing and
a two-stage product system are related.
ABC is a costing method that first assigns costs
to activities and then assigns them to products
based on the products’ consumption of activities.
Assign costs to activities.
Assign costs to products based
on the use of each activity
9-16
LO
9-4
Activity-Based Costing (ABC)
Products
consume
activities
Activities
consume
resources
9-17
LO
9-4
Developing Activity-Based Costs
Step 1: Identify the activities that consume resources
and assign costs to them.
Step 2: Identify the cost driver(s) associated with
each activity.
Step 3: Compute a cost rate per cost driver unit
or transaction.
Step 4: Assign costs to products by multiplying the
cost driver rate by the volume of cost driver
units consumed by the product.
9-18
LO
9-4
Cost Drivers
Cost drivers are factors that cause or “drive”
an activity’s costs.
Identified Activity
Identified Cost Driver
Setting up machines
Handling material
Machining
Packaging and shipping
?
9-19
LO
9-4
Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level
Cost Example
Cost Driver Example
9-20
LO
9-4
Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level
Volume related
Cost Example
Supplies
Lubricating oil
Machine repair
Cost Driver Example
Direct labor costs
Machine hours
Number of units
9-21
LO
9-4
Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level
Cost Example
Cost Driver Example
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor cost
Machine-hours
Number of units
Batch related
Setup costs
Material handling
Shipping costs
Setup hours
Production runs
Number of shipments
9-22
LO
9-4
Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level
Cost Example
Cost Driver Example
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor cost
Machine-hours
Number of units
Batch related
Setup costs
Material handling
Shipping costs
Setup hours
Production runs
Number of shipments
Product related
Compliance costs
Design and
specification costs
Number of products
9-23
LO
9-4
Cost Hierarchies
The cost hierarchy in any ABC system depends on
the cost category and its cost driver.
Hierarchy Level
Cost Example
Cost Driver Example
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor cost
Machine-hours
Number of units
Batch related
Setup costs
Material handling
Shipping costs
Setup hours
Production runs
Number of shipments
Product related
Compliance costs
Design and
specification costs
Number of products
Facility related
General plant costs
Plant admin. costs
Direct costs
Value added
9-24
LO
9-5
Activity-Based Costing
Illustrated
LO 9-5 Compute product costs using activity-based costing.
Third Quarter – Production and Cost Data
J25P
J40X
Total
Number of units
Machine hours – Assembly
100,000
6,000
40,000
30,000
140,000
36,000
Direct materials
Direct labor – Assembly
Direct labor – Packaging
Total direct labor
Total direct cost
Overhead costs:
Assembly
Packaging
Total overhead
Total costs
$1,500,000
$ 750,000
990,000
$1,740,000
$3,240,000
$2,400,000
$ 600,000
360,000
$ 960,000
$3,360,000
$3,900,000
$1,350,000
1,350,000
$2,700,000
$6,600,000
$1,620,000
810,000
$2,430,000
$9,030,000
9-25
LO
9-5
Activity-Based Costing Illustrated
Step 1: Identify the Activities
Assembly Department
Packaging Department
Setting up machines
Handling material
Product assembly
Inspection
Packing
Shipping
9-26
LO
9-5
Activity-Based Costing Illustrated
Step 2: Identify the Cost Drivers
Cost Driver Volume
Activity
Assembly building:
Assembling
Setting up machines
Handling material
Packaging building:
Inspecting and packing
Shipping
Cost Driver
Machine-hours
Setup hours
Production runs
J25P
J40X
Total
6,000 30,000 36,000
40
400
440
8
40
48
Direct labor hours 60,000 22,800 82,800
No. of shipments
100
200
300
9-27
LO
9-5
Activity-Based Costing Illustrated
Step 3: Compute the Cost Driver Rates
Building and Activity
Assembly building:
Assembling
Setting up machines
Handling material
Total assembly overhead
Packaging building:
Inspecting and packing
Shipping
Total packaging overhead
Total overhead
Overhead
Cost
Cost Driver
Volume
Cost Driver
Rate
$1,080,000 ÷ 36,000 machine hour =
396,000 ÷ 440 hours
=
144,000 ÷
48 runs
=
$1,620,000
$ 30/machine hour
$ 900/setup hour
$3,000/run
$ 414,000 ÷82,800 direct labor hr =
396,000 ÷ 300 shipments
=
$ 810,000
$ 5/direct labor hour
$ 1,320/shipment
$2,430,000
9-28
LO
9-5
Activity-Based Costing Illustrated
Step 4: Assign Costs Using ABC
Overhead
J25P
J40X
Assembly building:
Assembling @ $30/machine hour
Machine setup @ $900/setup hour
Handling material @ $3,000/run
$180,000
36,000
24,000
$ 900,000
360,000
120,000
Packaging building:
Inspection and packaging @ $5/direct labor hour
Shipping @ $1,320/ shipment
Total ABC overhead
300,000
132,000
$672,000
114,000
264,000
$1,758,000
9-29
LO
9-5
Cost Flow Diagram – ABC
System
Direct
costs
Manufacturing
overhead
Directly
assigned
Assembly building
Assembling
Machine
hours
Setup
Setup
hours
J25P
Packaging building
Handling
material
Inspecting/
packaging
Direct
LH
Runs
Shipping
Shipments
J40X
9-30
LO
9-5
Activity Based Costing –
Illustrated
Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct costs
Overhead:
Assembly building:
Assembling @ $30 per machine hour
Machine setup @ $900 per setup hour
Handling material @ $3,000 per run
Package building:
Inspecting and packing @ $5 per direct labor hour
Shipping @ $1,320 per shipment
Total ABC overhead
Total ABC cost
Number of units
Unit cost
J25P
J40X
$1,500,000
$2,400,000
$ 750,000
990,000
$1,740,000
$3,240,000
$ 600,000
360,000
$ 960,000
$3,360,000
$ 180,000
36,000
24,000
$ 900,000
360,000
120,000
300,000
132,000
$ 672,000
$3,912,000
100,000
$
39.12
114,000
264,000
$1,758,000
$5,118,000
40,000
$ 127.95
9-31
LO
9-6
Unit Costs Compared
LO 9-6 Compare activity-based product costing to
traditional department product costing methods.
Comparison of Reported Unit Product Costs
Plantwide rate
Department (building) rate
Activity-based costing
J25P
J40X
$48.06
$41.04
$39.12
$105.60
$123.15
$127.95
9-32
LO
9-7
Cost Flows through Accounts
LO 9-7 Demonstrate the flow of costs through
accounts using activity-based costing.
Let’s see ABC cost flow for the Assembly Department.
It's T-account time!
9-33
LO
9-7
Direct Materials Costs
Materials Inventory
1,500,000
2,400,000
Assembly WIP J25P
DM 1,500,000
Assembly WIP J40X
DM 2,400,000
9-34
LO
9-7
Direct Labor Costs
Wages Payable
750,000
600,000
Assembly WIP J25P
DM 1,500,000
DL
750,000
Assembly WIP J40X
DM 2,400,000
DL
600,000
9-35
LO
9-7
Overhead Costs
Assembling
1,080,000 180,000
900,000
Setting Up
396,000
36,000
360,000
Handling Material
144,000
24,000
120,000
Assembly WIP J25P
DM 1,500,000
DL
750,000
OH
240,000
Assembly WIP J40X
DM 2,400,000
600,000
DL
1,380,000
OH
9-36
LO
9-7
Transfer from Assembly to
Packaging
Assembly WIP J25P
DM 1,500,000 2,490,000
DL
750,000
OH
240,000
Packaging WIP J25P
2,490,000
Assembly WIP J40X
DM 2,400,000 4,380,000
DL
600,000
Packaging WIP J40X
4,380,000
1,380,000
OH
9-37
LO
9-8
ABC Costing in Administration
LO 9-8 Apply activity-based costing to marketing
and administrative services.
Step 1: Identify the activities that consume resources.
Step 2: Identify the cost driver associated with each activity.
Step 3: Compute a cost rate per cost driver for each unit
or transaction.
Step 4: Assign costs to the marketing or administration
activity by multiplying the cost driver rate by the
volume of cost driver units consumed for that activity.
9-38
End of Chapter 9
9-39