Activity-Based Costing
Chapter 8
Learning Objectives
1. Understand the potential effects of using reported product costs
for decision making.
2. Explain how a two-stage product costing system works.
3. Compare and contrast plantwide and department allocation
methods.
4. Explain how activity-based costing and a two-stage product
system are related.
5. Compute product costs using activity-based costing.
6. Compare activity-based product costing to traditional
department product costing methods.
7. Demonstrate the flow of costs through accounts using activitybased costing.
8. Apply activity-based costing to marketing and administrative
services.
8-2
8-3
Product Costs and Decision Making
L.O. 1 Understand the potential effects of using
reported product costs for decision making.
Remember Sammy’s Skis and Boards?
Units
Units Produced
Direct Labor Hours
Skis
500
4,000
Snowboards
150
900
Costs
Direct Material
Direct Labor
OH @$20/DLH
Total
$ 75,000
100,000
80,000
$ 255,000
$
$
15,000
22,500
18,000
55,500
Cost per unit
$
$
370
510
Total
650
4,900
$ 90,000
122,500
98,000
$ 310,500
Sammy is considering dropping snowboards.
Sammy’s Skis and Boards
Sammy’s costs without snowboards.
Cost Estimates
Direct Materials
Direct Labor
Original
$ 90,000
122,500
Skis Only
$ 75,000
100,000
Manufacturing Overhead
Utilities
Supplies
Supervision
Machine Depreciation
Plant depreciation
Miscellaneous
Total Overhead
Total costs
1,200
1,500
35,000
15,000
30,000
15,300
98,000
$ 310,500
1,000
1,300
35,000
10,000
30,000
15,300
92,600
$ 267,600
8-4
8-5
Sammy’s Skis and Boards
Look at overhead
Overhead
Utilities
Supplies
Supervision
Machine Depreciation
Plant depreciation
Miscellaneous
Total Overhead
Total
$ 1,200
1,500
35,000
15,000
30,000
15,300
$ 98,000
Skis Only
$ 1,000
1,000
35,000
10,000
30,000
15,300
$ 92,600
Sammy allocates $18,000 overhead to the Snowboards.
Only $5,400 of the overhead is avoided if Snowboards
are not produced.
Two-Stage Allocation Systems
L.O. 2. Explain how a two-stage product costing system works.
Stage One Allocate overhead costs to
departments.
Allocate department
Stage Two overhead costs to the
products or services.
8-6
8-7
Two-Stage Cost Allocation Continued
Cost Pool
Intermediate
Cost Pools
Cost
Allocation
Rule
Overhead
Department A
Direct Labor
Hours
Department B
Machine
Hours
8-8
Plantwide versus Department Allocation Method
L.O. 3 Compare and contrast plantwide and department allocation methods.
Plantwide Allocation Method
All overhead costs are recorded in one
cost pool and applied to products using
one overhead allocation rate.
One cost pool for the factory
One
allocation
rate
Products
Factory
Overhead
Costs
8-9
Department Allocation
Overhead costs traced to separate
departments and applied to products using a
department allocation rate.
One cost pool for each department
Assembly
Department
Overhead
Costs
Each
department
has an
allocation
rate
Products
Packaging
Department
Overhead
Costs
8-10
Cost Allocation: An Example
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter
J3MP
Number of units
Machine-hours
100,000
6,000
J5MP
40,000
30,000
Total
14,000
36,000
Cost Allocation: An Example
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter
J3MP
J5MP
Total
Number of units
Machine-hours
100,000
6,000
40,000
30,000
14,000
36,000
Direct material
Direct labor
Assembly
Packaging
$ 1,500,000
$ 2,400,000
$ 3,900,000
750,000
990,000
600,000
360,000
1,350,000
1,350,000
Direct labor total
$ 1,740,000
$
960,000
$ 2,700,000
Total direct cost
Overhead costs
Assembly
Packaging
$ 3,240,000
$ 3,360,000
$ 6,600,000
Total overhead
Total costs
$ 1,620,000
810,000
$ 2,430,000
$ 9,030,000
8-11
8-12
Cost Allocation: An Example Continued
Plantwide Cost Allocation
Port Arthur Manufacturing Facility
Third Quarter
J3MP
Units produced
J5MP
100,000
40,000
Direct material
$
15.00
$
60.00
Direct labor
Assembly
Packaging
$
7.50
9.90
$
15.00
9.00
Total
$
17.40
$
24.00
Direct costs
Applied overhead (@90% of direct labor cost)
$
32.40
15.66
$
84.00
21.60
Unit costs (direct material, direct labor and overhead)
$
48.06
$ 105.60
8-13
Two-Stage Cost Allocation Continued
Cost Pool
Overhead
Intermediate
Cost Pools
Assembly
Packaging
Cost
Allocation
Rule
Machine
Hours
Direct
Labor Cost
8-14
Cost Allocation: An Example Continued
Department Cost Allocation
Port Arthur Manufacturing Facility
Third Quarter
Units produced
100,000
Machine-hours per unit
0.06
Direct material
$ 15.00
$ 60.00
7.50
9.90
15.00
9.00
$ 17.40
$ 24.00
$ 32.40
$ 84.00
2.70
5.94
33.75
5.40
8.64
$ 39.15
$ 41.04
$ 123.15
Direct labor
Assembly
Packaging
Total
Direct costs
Applied overhead
Assembly (@$45 per machine hour)
Packaging (@60% of direct labor cost)
Total Overhead
Unit costs ( direct material, direct labor and overhead)
40,000
0.75
$
Choice of Cost Allocation Method
Which cost allocation method is appropriate?
Similar products using
same resources
Plantwide
Allocation
Multiple products using
resources differently
Department
Allocation
8-15
Activity-Based Costing (ABC)
8-16
L.O. 4 Explain how activity-based costing and a
two-stage product system are related.
Activity-Based Costing
Costing method that first assigns costs to
activities and then allocate them to products
based on the products’ consumption of
activities.
Stage One
Assign costs to activities
Stage Two
Allocate costs to products based
on the use of each activity
ABC Continued
Activities
consume
resources
Products
consume
activities
8-17
8-18
Developing Activity-Based Costing
1. Identify the activities that consume
resources and assign costs to them.
2. Identify the cost driver(s) associated with
each activity.
3. Compute a cost rate per cost driver unit or
transaction.
4. Allocate costs to products by multiplying
the cost driver rate by the volume of cost
driver units consumed by the product.
8-19
Cost Drivers
Factors that cause or “drive” an activity’s costs.
Identified activity
Identified cost driver
Preparing cafeteria food
Number of students in the dorm
Taking customer orders
Number of orders
Setting up equipment
Number of set-ups
Purchasing materials
Number of purchase orders
Cost Allocation Pools
Plantwide
One pool
Department
As many pools
as departments
ABC
As many pools as
activities and cost
drivers identified
8-20
8-21
Cost Allocation Pools: ABC
Cost Flow Diagram: Activity-Based Costing System
Overhead
Assign costs to activities
Set-up
Allocate
costs to
products
based on
the use of
each
activity
Set-up
hours
Handle
Material
Machine
Production
runs
Products
Machine
hours
Pack &
Ship
Shipments
8-22
Cost Hierarchy
Classification of cost drivers into general levels
of activity; volume, batch, product and so on.
Hierarchy Level
Cost Example
Cost Driver Example
8-23
Cost Hierarchy
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 costs
Machine-hours
Number of units
8-24
Cost Hierarchy
Classification of cost drivers into general levels
of activity; volume, batch, product and so on.
Hierarchy Level
Example Costs
Cost Driver Examples
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor costs
Machine-hours
Number of units
Batch related
Set-up costs
Material handling
Shipping costs
Set-up hours
Production runs
Number of shipments
8-25
Cost Hierarchy
Classification of cost drivers into general levels
of activity; volume, batch, product and so on.
Hierarchy Level
Example Costs
Cost Driver Examples
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor costs
Machine-hours
Number of units
Batch related
Set-up costs
Material handling
Shipping costs
Set-up hours
Production runs
Number of shipments
Compliance costs
Design and
specification costs
Number of products
Product related
8-26
Cost Hierarchy
Classification of cost drivers into general levels
of activity; volume, batch, product and so on.
Hierarchy Level
Example Costs
Cost Driver Examples
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor costs
Machine-hours
Number of units
Batch related
Set-up costs
Material handling
Shipping costs
Set-up hours
Production runs
Number of shipments
Product related
Compliance costs
Design and
specification costs
Number of products
Facility related
General plant costs
Plant administration costs
Direct costs
Value added
8-27
ABC Example
L.O. 5 Compute product costs using activity-based costing.
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter
J3MP
Number of units
Machine-hours
J5MP
Total
100,000
6,000
40,000
30,000
14,000
36,000
Direct material
Direct labor
Assembly
Packaging
$ 1,500,000
$ 2,400,000
$ 3,900,000
750,000
990,000
600,000
360,000
1,350,000
1,350,000
Direct labor total
$ 1,740,000
$
960,000
$ 2,700,000
$ 3,240,000
$ 3,360,000
$ 6,600,000
Total direct cost
Overhead costs
Assembly
Packaging
Total overhead
Total costs
$ 1,620,000
810,000
$ 2,430,000
$ 9,030,000
ABC Example Continued
Step 1 Identify the activities
Department
Activity
Assembly
Machine set-up
Material handling
Product assembly
Packaging
Inspection and packing
Shipping
8-28
8-29
ABC Example Continued
Identify the cost drivers and the
Step 2 expected volume of each cost driver.
Activity
Cost Driver
Assembly
Machine set-up
Material handling
Product assembly
Cost Driver Volume
J3MP
Set-up hours
Production runs
Machine hours
J5MP
Total
40
8
6,000
400
40
30,000
440
48
36,000
60,000
100
22,800
200
82,800
300
Packaging
Inspection and packing
Shipping
Direct labor hours
Number of shipments
ABC Example Continued
8-30
Step 3 Compute the Cost Driver Rates
Overhead Cost Data
Port Arthur Manufacturing Facility
Third Quarter
Building and Activity
Overhead
Cost
Cost Driver
Volume
Cost Driver
Rate
Assembly
Machine set-up
Material handling
Product assembly
Total assembly
$
396,000
144,000
1,080,000
$ 1,620,000
440 hours
48 runs
36,000 mh
$900 per set-up hour
$3,000 per run
$30 per machine hour
$
82,800 dlh
300 shipments
$5 per direct labor hour
$1,320 per shipment
Packaging
Inspection and packing
Shipping
Total packaging
Total overhead
$
414,000
396,000
810,000
$ 2,430,000
8-31
ABC Example Continued
Step 4 Allocate costs to products
Overhead
J3MP
J5MP
Assembly
Machine set-up @ $900 per set-up hour
Material handling at $3,000 per run
Product assemby @ $30 per machine hour
$
36,000
24,000
180,000
$ 360,000
120,000
900,000
300,000
132,000
114,000
264,000
672,000
$1,758,000
Packaging
Inspection and packing @ $5 per direct labor hour
Shipping @ $1,320 per shipment
Total ABC Overhead
$
8-32
ABC Example Continued
Direct Costs
Direct material
Direct labor
Assembly
Packaging
Direct labor total
Total direct cost
J3MP
$ 1,500,000
J5MP
$ 2,400,000
750,000
990,000
$ 1,740,000
$ 3,240,000
600,000
360,000
$ 960,000
$ 3,360,000
$
36,000
24,000
180,000
$ 360,000
120,000
900,000
300,000
132,000
672,000
114,000
264,000
$ 1,758,000
Total ABC Cost
$ 3,912,000
$ 5,118,000
Number of units
100,000
40,000
Overhead
Assembly
Machine set-up @ $900 per set-up hour
Material handling at $3,000 per run
Product assembly @ $30 per setup hour
Packaging
Inspection and packing @ $5 per direct labor hour
Shipping @ $1,320 per shipment
Total ABC Overhead
Unit costs
$
$
39.12
$
127.95
8-33
Cost Flow Diagram
Cost Flow Diagram
Activity-Based Costing System
Port Arthur Manufacturing Facility
Direct costs
Overhead costs
Assembly
Assemble
Handle
Material
J3MP
Packaging
Set-up
Inspect &
Pack
J5MP
Ship
8-34
Product Cost Methods: A Comparison
L.O. 6 Compare activity-based product costing to traditional
department product costing methods.
Comparison of Reported Unit Product Costs
J3MP
J5MP
Plantwide rate
$ 48.06
$ 105.60
Department rate
$ 41.04
$ 123.15
Activity-based costing
$ 39.12
$ 127.95
Overhead Costs using ABC
L.O. 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
8-35
8-36
Direct Material Costs
Assembly WIP
DM
Material Inventory
J3MP
1,500,000
1,500,000
2,400,000
Assembly WIP
DM
2,400,000
J5MP
8-37
Direct Labor Costs
Assembly WIP
Wages Payable
DM
1,500,000
DL
750,000
J3MP
750,000
600,000
Assembly WIP
DM
DL
2,400,000
600,000
J5MP
8-38
Overhead Costs
Assembling
Assembly WIP
180,000
900,000
Setting up Machines
DM
J3MP
1,500,000
DL
750,000
OH
240,000
36,000
Assembly WIP
360,000
Handling Material
DM
DL
24,000
120,000
2,400,000
OH
600,000
1,380,000
J5MP
8-39
Transfer from Assembly to Packaging
Assembly WIP
DM
1,500,000
DL
750,000
OH
240,000
2,490,000
Assembly WIP
DM
2,400,000
DL
OH
600,000
1,380,000
J3MP
J5MP
4,380,000
Packaging WIP
J3MP
2,490,000
Packaging WIP
4,380,000
J5MP
ABC in Administration
8-40
L.O. 8 Apply activity-based costing to marketing and administrative services.
The same four-step process
1.
Identify the activities that consume resources.
2.
Identify the cost driver associated with each
activity.
3.
Compute a cost rate per cost driver for each
unit or transaction.
4.
Allocate costs to the marketing or administration
activity by multiplying the cost driver rate by the
volume of cost driver units consumed by that
activity.
8-41
Chapter 8