CHAPTER 5 Activity-Based Costing and Management Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Traditional, Volume-Based Product-Costing System Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records: Production: Units Runs Mode I Mode II Mode III 10,000 1 run of 10,000 units 20,000 4 runs of 5,000 units 4,000 10 runs of 400 units 5-2 Traditional, Volume-Based Product-Costing System Direct materials Direct labor Manufacturing overhead Total $ $ Mode I 50.00 60.00 99.00 209.00 Mode II $ 90.00 80.00 132.00 $ 302.00 Mode III $ 20.00 40.00 66.00 $ 126.00 Additional information includes: Direct materials Direct labor (hr/board) Setup time (hr/run) Machine time (hr/board) $ Mode I 50.00 3 10 1 Mode II $ 90.00 4 10 1.25 Mode III $ 20.00 2 10 2 Manufacturing overhead is determined as follows 5-3 Traditional, Volume-Based Product-Costing System Mode I 10,000 3 30,000 Units produced Direct labor (hr/unit) Total hours Mode II 20,000 4 80,000 Total hours required 118,000 Budgeted manufacturing overhead Budgeted direct-labor hours $3,894,000 118,000 Mode I Direct labor (hr/unit) Overhead rate per hour Overhead per unit Mode III 4,000 2 8,000 $ $ = $33 per hour Mode II 3 33 99 $ $ Mode III 4 33 132 $ $ 2 33 66 5-4 Traditional, Volume-Based Product-Costing System With these product costs, Aerotech established target selling prices (Cost × 125%). Direct materials Direct labor Manufacturing overhead Total Cost per unit Target selling price $ $ $ Mode I Mode II Mode III 50.00 $ 90.00 $ 20.00 60.00 80.00 40.00 99.00 132.00 66.00 209.00 $ 302.00 $ 126.00 Mode I 209.00 261.25 Mode II $ 302.00 377.50 Mode III $ 126.00 157.50 209.00 x 1.25 5-5 Activity Based Costing System (ABC) ABC systems follow a two-stage procedure to assign overhead costs to products. Stage One Identify significant activities and assign overhead costs to each activity in proportion to resources used. Stage Two Identify cost drivers appropriate to each activity and allocate overhead to the products. 5-6 Overhead Costs Total budgeted cost = $3,894,000 Activity must be done on each unit produced. Activity Cost Pools UnitLevel BatchLevel ProductSustainingLevel Machinery cost pool $1,212,600 Setup cost pool $3,000 Engineering cost pool $700,000 Activity performed on each batch produced. Activities needed to support an entire product line Identification of Activity Cost Pools FacilityLevel Facility cost pool $507,400 Activity required in order for the production process to occur. 5-7 UnitLevel BatchLevel ProductSustainingLevel Machinery cost pool $1,212,600 Setup cost pool $3,000 Engineering cost pool $700,000 FacilityLevel Facility cost pool $507,400 Receiving/Inspection cost pool $200,000 Material-Handling cost pool $600,000 Quality-Assurance cost pool $421,000 Packaging/Shipping cost pool $250,000 5-8 STAGE ONE Various overhead costs related to machinery Activity cost pool Maintenance Lubrication Depreciation Electricity Computer Support Calibration Machinery Cost Pool Total budgeted cost = $1,212,600 5-9 STAGE TWO Calculate the pool rate Cost Assignment Budgeted Machinery Costs = $1,212,600 Budgeted Machine Hours 43,000 = $28.20/hour Mode I: $28.20 per hr. 1 hr. per unit $28.20 per unit Mode II: $28.20 per hr. 1.25 hr. per unit $35.25 per unit Mode III: $28.20 per hr. 2 hr. per unit $56.40 per unit 5-10 STAGE ONE Calculation of total setup cost Activity cost pool Total budgeted setup cost $20 per hour 10 hr. per setup $200 cost per setup 15 production runs $ 3,000 Total Setup Cost Pool Total budgeted cost = $3,000 5-11 STAGE TWO Calculate the pool rate Cost Assignment Budgeted Setup Costs Planned Production Runs Mode I: (1 Run) $200 per run 10,000 units per run = $.02 per unit = $3,000 15 runs = $200 per run Mode II: (4 Runs) $200 per run 5,000 units per run = $.04 per unit Mode III: (10 Runs) $200 per run 400 units per run = $.50 per unit 5-12 STAGE ONE Various overhead costs related to engineering Activity cost pool Engineering salaries Engineering software Engineering supplies Depreciation Engineering Cost Pool Total budgeted cost = $700,000 5-13 STAGE TWO Allocate based on engineering transactions Cost Assignment Engineering Cost Pool Total budgeted cost = $700,000 Mode I: 25% × $700,000 10,000 units = $17.50 per unit Mode II: 45% × $700,000 20,000 units = $15.75 per unit Mode III: 30% × $700,000 4,000 units = $52.50 per unit 5-14 STAGE ONE Various overhead costs related to general operations Activity cost pool Plant depr. Property taxes Plant mgmt. Insurance Plant maint. Security Facility Cost Pool Total budgeted cost = $507,400 5-15 STAGE TWO Calculate the pool rate Cost Assignment Budgeted Facilities Cost = $507,400 Budgeted Direct-Labor Hours 118,000 = $4.30/hour Mode I: $4.30 per hr. × 3 hr. per unit $12.90 per unit Mode II: $4.30 per hr. × 4 hr. per unit $17.20 per unit Mode III: $4.30 per hr. × 2 hr. per unit $8.60 per unit 5-16 Other Overhead Costs Receiving and Inspection Cost Pool Board Overhead Mode I $ 200,000 Mode II 200,000 Mode III 200,000 × × × × % 6% 24% 70% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 1.20 = 2.40 = 35.00 Material-Handling Cost Pool Board Overhead Mode I $ 600,000 Mode II 600,000 Mode III 600,000 × × × × % 7% 30% 63% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 4.20 = 9.00 = 94.50 Quality-Assurance Cost Pool Board Overhead Mode I $ 421,000 Mode II 421,000 Mode III 421,000 × × × × % 20% 40% 40% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 8.42 = 8.42 = 42.10 Packaging and Shipping Cost Pool Board Overhead Mode I $ 250,000 Mode II 250,000 Mode III 250,000 × × × × % 4% 30% 66% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 1.00 = 3.75 = 41.25 5-17 Other Overhead Costs Receiving and Inspection Cost Pool Board Overhead Mode I $ 200,000 Mode II 200,000 Mode III 200,000 × × × × % 6% 24% 70% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 1.20 = 2.40 = 35.00 Material-Handling Cost Pool Board Overhead Mode I $ 600,000 Mode II 600,000 Mode III 600,000 $14.82 × × × × % 7% 30% 63% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 4.20 = 9.00 = 94.50 Quality-Assurance Cost Pool Board Overhead Mode I $ 421,000 Mode II 421,000 Mode III 421,000 × × × × % 20% 40% 40% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 8.42 = 8.42 = 42.10 Packaging and Shipping Cost Pool Board Overhead Mode I $ 250,000 Mode II 250,000 Mode III 250,000 × × × × % 4% 30% 66% ÷ ÷ ÷ ÷ Units 10,000 20,000 4,000 = Cost/Unit = $ 1.00 = 3.75 = 41.25 5-18 Product Cost from ABC These are the new product costs when Aerotech uses ABC. Mode I Direct materials $ 50.00 Direct labor 60.00 Machinery 28.20 Setup 0.02 Engineering 17.50 Facilities 12.90 Other 14.82 Total $ 183.44 Mode II $ 90.00 80.00 35.25 0.04 15.75 17.20 23.57 $ 261.81 Mode III $ 20.00 40.00 56.40 0.50 52.50 8.60 212.85 $ 390.85 5-19 Distorted Product Costs Both original and ABC target selling prices are based on (Cost × 125%). Traditional costing ABC costing Original target selling price ABC target selling price Mode I $ 209.00 183.44 Mode II $ 302.00 261.81 Mode III $ 126.00 390.85 261.25 229.30 377.50 327.26 157.50 488.56 The selling price of Mode I and II are decreased, while the selling price for Mode III is increased. [$209.00 × 1.25] [$183.44 × 1.25] 5-20 Distorted Product Costs Can you identify any problems Aerotech is likely to face as a result of this distortion? Mode I Traditional costing $ 209.00 ABC costing 183.44 Cost distortion per unit 25.56 Units produced 10,000 Total cost distortion 255,600 Mode II $ 302.00 261.81 40.19 20,000 803,800 Mode III $ 126.00 390.85 (264.85) 4,000 (1,059,400) Traditional costing understates the cost of complex, low volume products. 5-21 Two Key Points A large proportion of non-unitlevel activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately. Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs. 5-22 Activity-Based Management The use of ABC costing information to help management make decisions 5-23 Activity-Based Management Activity-based costing establishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based management focuses on managing activities to reduce costs. 5-24 Two-Dimensional ABC and Activity-Based Management Activities 5-25 Two-Dimensional ABC and Activity-Based Management Cost Assignment View Resource costs Activities Cost Objects 5-26 Two-Dimensional ABC and Activity-Based Management Cost Assignment View Resource costs Process View Activity Analysis Root Causes Activity Triggers Activity Evaluation Activities Performance Measures Cost Objects 5-27 Elimination of Non-Value-Added Costs Activities Non-valueadded activities Unnecessary Necessary Reduce or Eliminate Continually Evaluate and Improve 5-28 Using ABM to Eliminate Non-Value-Added Activities and Costs Process time Inspection time Move time Storage time Waiting time 5-29 End of Chapter 5 This is my kind of cost pool! 5-30