Week 3 ActivityBased Costing

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Week 3 - Activity-Based Costing

• Chapter 4

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Learning Objectives

• Discuss the importance of unit costs.
• Define actual and normal costing and explain why
  normal costing is preferred.
• Describe traditional costing approaches.
• Explain why traditional costing approaches may
  produce distorted costs.
• Explain how an activity-based cost system can
  produce more accurate product costs.

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Learning Objectives (Continued)

• Provide a detailed description of how activities
  are identified and classified so that homogeneous
  cost pools can be formed.
• Describe the role of activity-based costing in a
  JIT environment.

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Cost Assignment and Cost Measurement (Again)
Issue One
Issue Two
How to measure costs?
How to assign costs?
Used for financial reporting
Used for effective decision making
Unit Cost
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Conventional Product Costing
Direct Materials
Multiproducts
Multiproducts
Traceable
Direct Labour
Unit Cost for Finished Goods
Mfg. Process (Work in Process)
Overhead to be Assigned
Problem

Predetermined Overhead Budgeted Manufacturing
Costs/
Single Activity Base
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Two Approaches to ProductCosting
Issue One
Issue Two
How to measure costs?
How to assign costs?
Job Order Cost System
Unit Cost
Process Cost System
Both Approaches are Used for Service and
Manufacturing Firms. Try to Identify Some
Examples!
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Cost Assignment Objective
Actual Costing
Normal Costing
What is Normal Costing?
Job order (Actual)
Job order (Normal)
Unit Cost Objective
Process (Actual)
Process (Normal)
Some manufacturing settings may need to use a
blend of job and process costing. Job order
procedures could be used to assign material costs
while a process approach may be used to assign
conversion costs. The blending of the two
methods is known as operational accounting.
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Belring, Inc.
Belring, Inc. produces two telephones cordless
and regular. It had the following actual
budgeted data
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Unit-Cost Computation Plantwide Rate
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Departmental Data
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Unit Cost Computation Departmental Rates
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Symptoms of an Outdated 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.

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Symptoms of an Outdated 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 on
  special projects.
• Some departments are using their own accounting
  system.
• Product costs change because of changes in
  financial reporting regulations.

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More Product Costing Data for Belring, Inc.
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More Accurate Cost Allocations with
Activity-based Costing
Direct Materials
Multiproducts
Multiproducts
Traceable
Direct Labour
Unit Cost for Finished Goods
Mfg. Process (Work in Process)
Overhead to be Assigned
Solution

Various indirect cost pools are allocated to
products by using a number of activity bases that
bear a cause and effect relationship
between activities and cost incurred.
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Types of Activities

• Unit Related Activities
• Batch Related Activities
• Product Related Activities
• Facility Related Activities

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First-Stage ProcedureActivity-Based Costing
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Unit Cost Computation Activity-Based Costing
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The ABC Model
Indirect Cost Pool

Resource Drivers
1st Stage Allocation
Activity Centre B
Activity Centre C
Activity Centre D
2nd Stage Allocation
Activity Drivers
Product 1 Product 2
Product 3
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An ABC Example
Assume the following activity costs were incurred
in the manufacturing of three products 1.
Writing Test Programs 200,000 2. Making
Circuit Boards 120,000 3. Setting-up
Insert Machine 175,000 4. Inserting
Components 100,000 5. Providing Space
50,000 6. Utility Cost
130,000
Total 775,000
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An ABC Example (Continued)
Operational Data
Product
Product Product Possible Drivers Line
1 Line 2 Line 3 Units produced
100,000 200,000
150,000 Number of orders 200
300 600
Number of tests 500
200 1,000 Machine
hours 5,000
6,000 4,000 Products/models
150 50
200 Square feet of space
5,000 7,000 6,000
Direct labour hours 2,000
3,500 2,250

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The ABC Model
775,000
Resource Drivers
1st Stage Allocation (complete)
Writing Prog. Making /Ins.
Set-ups
Space/Util. 200,000 220,000
175,00
180,000
Products Machine hours
Orders Square feet
2nd Stage Allocation
Activity Drivers
Product Product
Product Line 1
Line 2 Line 2
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An ABC Example (Continued)
Cost Driver Activity
Pool Pool Level Amount
Driver Rate
Writing Prog. Products 200,000 400
products 500/product Making/Ins. Units
220,000 15,000 M. H.
14.67/M. H. Set-up Batch
175,000 1,100 orders
159.09/order Space/Util. Facility
180,000 18,000 sq. feet 10/sq. foot
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Unit Cost Calculation with ABC
Cost Product Product
Product Pool Line 1
Line 2 Line 3 Total
Writing Prog. 75,000 25,000
100,000 200,000 Making/Ins. 73,350
88,020 58,630
220,000 Set-up 31,818
47,727 95,455 175,000 Space/Util.
50,000 70,000
60,000 180,000 Total
230,168 230,747 314,085
775,000
Unit Cost Product Line 1 230,168/100,000 units
2.30/unit U nit Cost Product Line 2
230,747/200,000 units 1.15/unit Unit Cost
Product Line 3 314,085/150,000 units
2.09/unit
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Unit Overhead Cost Using Conventional Methods
Predetermined Overhead Rate Using Direct Labour
Hours Overhead Rate 775,000/7,750 hours
100/direct labour
hour Unit Cost Product Line 1 (2,000 dlh x 100)
200,000/100,000

2.00 Unit Cost Product Line 2 (3,500 dlh x
100) 350,000/200,000

1.75 Unit Cost Product Line 3 (2,250 dlh x
100) 225,000/150,000

1.50
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Comparison of ABC and Conventional Costing
Unit Cost ABC Unit Cost Conventional
Product Line 1 2.30
2.00 Product Line 2 1.15
1.75 Product Line 3
2.09 1.50
Rule-of-thumb Conventional cost accounting
tends to over-cost high
volume products and under-cost low volume
items. (Please note
implications for product line 2.)
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Unit Cost Comparisons
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Activity Identification and Classification

• Activities consume resources to satisfy customers
• Activities can be listed in an inventory
• Activities have the same level attribute when
  they are performed at the same general level
• Activities have the same driver attribute when
  can use the same driver to assign costs to a cost
  object.

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JIT Compared with Traditional Manufacturing

• Lower Inventories
• Manufacturing Cells (More Tracing of Costs)
• Multiskilled Labour
• Extensive Reliance on TQM
• Decentralization of Services
• Extensive Use of Flexible Manufacturing Systems
  (FMS)
• Facilitating Management Style
• Total Quality Control

Error Costs
Optimal Cost Level
High
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Numerical Questions from the Back of Chapter 4

• E4-1
• E4-11
• P4-3
• P4-9

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Question E4-11

• Please go to your text to read this question.

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Question P4-3

• Please go to your text to read this question.

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Question P4-9

• Please go to your text to read this question.

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The End