Chapter 5
Activity-Based Costing
Undercosting and Overcosting
• Consider the costing of a bill for four
friends who go for dinner.
• Each diner orders separate entrees,
desserts, and drinks.
• Bill details are as follows:
Emma
James
Jessica
Matthew
Total
Entrée
$11
20
15
14
$60
Dessert
$0
8
4
4
$16
Drinks
$4
14
8
6
$32
Total
$15
42
27
24
$108
Average
$15
$4
$8
$27
Over- and Undercosting
• Overcosting – a product consumes a low
level of resources (costs) but is allocated
high costs per unit
• Undercosting – a product consumes a high
level of resources (costs) but is allocated
low costs per unit
Plastim Corporation
• Manufactures lenses for rear taillights of
automobiles
• Makes two types of lenses for Giovanni Motors
– A complex lens, CL5
– A simple lens, S3
• Processes at Plastim include:
– Design products
– Manufacture lenses
– Distribute lenses
Some Basic Data at Plastim
• Simple S3 lenses – 60,000 units (sales) budgeted
for 2010
– Uses 30,000 DLH’s
– Sells for $63 each
– Competitor has offered this product for $53 to Giovanni
• Complex CL5 lenses – 15,000 units (sales)
budgeted for 2010
– Uses 9,750 DLH’s
– Sells for $137 each
– No price pressure exists
Product Costing at Plastim
• To guide pricing and cost-management decisions,
Plastim assigns all costs (both mfg. and non-mfg.)
to its products
• Plastim’s simple costing system traces direct
materials and direct labor costs to products (CL5
and S3 lenses)
• All other costs in the value chain are allocated to
products using a single overhead rate using DLH
as the allocation base
Overview of Plastim’s Simple Costing System
Allocation Rate per DLH (Step 5)
Budgeted
indirect-cost
rate
=
=
Budgeted total costs in
indirect-cost pool
Budgeted total quantity
of cost-allocation base
$2,385,000
39,750 direct
manufacturing labor-hours
$60 per direct
=
manufacturing labor-hour
Allocation of Indirect Costs to
Products (Step 6)
• Plastim expects to use 30,000 total direct
manufacturing labor-hours to make the
60,000 S3 lenses, and
• 9,750 total direct manufacturing laborhours to make the 15,000 CL5 lenses.
• Thus, indirect costs of $1,800,000 are
allocated to the simple lens, and
• $585,000 are allocated to the complex lens.
Plastim’s Product Costs Using Simple Costing
Product Profitability Using Simple Costing
60,000
Simple Lenses (S3)
Total
Per Unit
Revenues
Costs
Operating
Income
Profit margin
percentage
15,000
Complex Lenses (CL5)
Total
Per Unit
Total
$3,780,000
$63.00
$2,055,000
$137.00
$5,835,000
3,525,000
58.75
1,455,000
97.00
4,980,000
$ 255,000
$
4.25
6.75%
$
600,000
$
40.00
29.20%
$
855,000
Guidelines for Refining a Cost System
• Direct-cost tracing - categorize as many of the
overall costs as direct costs (as economically
feasible)
• Divide indirect-cost pool into several
homogeneous groups (pools) with cause-andeffect relationships between the cost driver and
indirect cost
• Define cost-allocation bases (cost drivers) for each
cost pool using cause-and-effect criterion
Activity-Based Costing Systems
Assignment to
Other Cost
Objects
Fundamental
Cost Objects
Activities
Costs of
Activities
Costs of:
* Products
* Services
* Customers
Plastim's ABC System - Activities
a. Design products and processes
b. Set up molding machines to ensure that the molds
are properly held in place and parts are properly aligned
before manufacturing starts
c. Operate molding machines to manufacture lenses
d. Clean and maintain the molds after lenses are
manufactured
e. Prepare batches of finished lenses for shipment
f. Distribute lenses to customers
g. Administer and manage all processes at Plastim
Setup Data For Products
Quantity of lenses
produced
Number of lenses
produced per batch
Number of batches
Setup time per
batch
Total setup-hours
Simple
S3 Lens
Complex
CL5 Lens
60,000
15,000
240
50
250
300
2 hours
5 hours
500
hours
1,500 hours
Total
2,000 hours
Alternative Allocation Rates For
Setup Cost to Products
• Of the $2,385,000 in the total indirect-cost
pool, Plastim identifies the total costs of setups
to be $300,000.
• Of the $60 total rate per direct manufacturing
labor-hour, the setup cost per direct
manufacturing labor-hour amounts to $7.54717
($300,000/39,750 total direct manufacturing
labor-hours).
• The setup cost per setup-hour equals $150
($300,000 / 2,000 total setup-hours).
Allocation of Setup Costs to
Products
Simple
S3 Lens
Setup cost allocated using
direct manufacturing
Complex
CL5 Lens
Total
$ 226,415
$
73,585
$
300,000
$
$ 225,000
$
300,000
labor-hours:
$7.54717 X 30,000;
$7.54717 X 9,750
Setup cost allocated using
setup-hours:
$150 X 500;
$150 X 1,500
75,000
Cost Hierarchies
• A cost hierarchy defines each activity cost pool as
falling into one of four categories
• The four categories in ABC systems are as follows:
–
–
–
–
Unit-level (output-level) costs
Batch-level costs
Product-sustaining-level costs
Facility-sustaining-level costs
Definitions
• Unit-level – activities undertaken for every part
made (machining operations)
• Batch-level – activity is related to a group of units
produced (setup, move material)
• Product-sustaining – activity supports individual
products regardless of the number of units or
batches produced
• Facility-sustaining – activities that support the
organization as a whole. Assigned costs cannot be
traced to any particular product (administrative
costs, building rent, landscaping services)
Overview of Plastim’s ABC System
Direct Costs Using ABC Costing
Description
Cost
Hierarchy
Category
60,000
15,000
Simple Lenses (S3)
Complex Lenses (CL5)
Total
Per Unit
Total
Total
Per Unit
Direct
Materials
Output unitlevel
$1,125,000
$18.75
$675,000
$45.00
$1,800,000
Direct
Manuf.
Labor
Output unitlevel
600,000
10.00
195,000
13.00
795,000
Mold
cleaning &
Batch-level
maintenance
$
120,000
$
2.00
$
150,000
$
10.00
$
Total direct
costs
$1,845,000
$
30.75
$
1,020,000
$
68.00
$ 2,865,000
270,000
Activity-Cost Rates for Plastim’s Indirect Costs Pools
Plastim’s Product Costs Using ABC
Plastim: Simple & ABC Compared
Activity-Based Management
• A method of management that used ABC as
an integral part in critical decision-making
situations, including:
– Pricing and product-mix decisions
– Cost reduction and process improvement
decisions
– Design decisions
– Planning and managing activities