Managerial accounting tool for business decision making chapter 04

Know how companies identify the activity cost pools used in activity-based costing.. Allocates overhead using a single predetermined rate.Job order costing: Direct labor cost is assumed

Chapter 4-1

CHAPTER 4

Activity-Based Costing

Chapter

4-3

1 Recognize the difference between traditional

costing and activity based costing.

2 Identify the steps in the development of an

activity-based costing system.

3 Know how companies identify the activity cost

pools used in activity-based costing.

4 Know how companies identify and use cost

drivers in activity-based costing.

Study Objectives

Study Objectives

5 Understand the benefits and limitations of

activity-based costing.

6 Differentiate between value-added and

non-value-added activities.

7 Understand the value of using activity

levels in activity-based costing.

8 Apply activity-based costing to service

industries.

Study Objectives

Study Objectives

Determining the proper amount of

overhead to assign to each product, service or job.

Hard Part of Determining Product Costs is?

Hard Part of Determining Product Costs is?

Chapter

4-7

Traditional Costing and ABC

Traditional Costing and ABC

Allocates overhead using a single predetermined rate.

Job order costing: Direct labor cost is assumed

to be the relevant activity base.

Assumption was satisfactory when direct labor was a major portion of total manufacturing

costs.

There should be of a high correlation between direct labor costs and overhead costs.

Traditional Costing

Traditional Costing

Chapter

4-9

Allocates overhead using a single predetermined rate.

Process Costing : Machine hours is assumed

to be the relevant activity base.

Assumption was satisfactory when machine hours was a major portion of total

manufacturing costs.

There should be of a high correlation between machine hours and overhead costs.

Traditional Costing

Traditional Costing

SO 1: Recognize the differences between traditional costing and

activity-based costing.

Tremendous change in manufacturing and service industries.

Decrease in amount of direct labor usage.

Significant increase in total overhead costs.

May be inappropriate to use plant-wide predetermined overhead rates based on direct labor or machine hours when a lack of

correlation exists.

Complex manufacturing processes may require multiple allocation bases; this approach is called

Why Do Companies Need a New Approach?

Why Do Companies Need a New Approach?

Chapter

4-11

 Is another approach (other than traditional costing) to allocate manufacturing overhead.

 An overhead cost allocation system that allocates

overhead to multiple activity cost pools,

Activity : Any event, action, transaction, or work sequence that causes a cost to be incurred in

producing a product or providing a service.

Activity Cost Pool : The overhead cost attributed

to a distinct type of activity.

Examples:

Purchasing materials.

Setting up machines.

Cost Drivers : Any factors or activities that have

a direct cause-effect relationship with the

resources consumed.

ABC Definitions

ABC Definitions

Chapter

4-13

Products consume activities,

and Activities consume resources.

Activity-Based Costing

Activity-Based Costing

SO 1: Recognize the differences between traditional costing and

activity-based costing.

ABC allocates overhead costs in two stages:

Stage 1 : Overhead costs are allocated to activity

cost pools.

Stage 2 : The overhead costs allocated to the cost pools is assigned to products using cost drivers.

The more complex a product’s manufacturing

operation, the more activities and cost drivers

likely to be present.

Activity-Based Costing

Activity-Based Costing

Overhead Costs

Overhead Costs

ABC, thus, supplements – it does not replace – the traditional cost system.

Activity-Based Costing

Activity-Based Costing

SO 2 Identify the steps in the development of an activity-based system.

Atlas Company produces two automotive antitheft

devices:

The Boot: A high volume item with sales totaling 25,000 per year.

The Club: A low volume item with sales totaling 5,000 per year.

Each product requires 1 hour of direct labor

Total annual direct labor hours (DLH) 30,000 (25,000 + 5000).

Direct labor cost $12 per unit for each product.

Expected annual manufacturing overhead costs

$900,000

Direct materials cost:

The Boot - $40 per unit.

The Club - $30 per unit.

Activity-Based Costing

Activity-Based Costing

* Predetermined overhead rate: $900,000 ÷ 30,000 DLH = $30 per DLH Overhead = predetermined overhead rate times direct labor hours

($30 × 1 hr = $30)

Costing Under Traditional Costing

Costing Under Traditional Costing

SO 2 Identify the steps in the development of an activity-based system.

Illustration 4-10

Identify and classify the major activities and allocate manufacturing overhead costs

to the appropriate cost pools.

Identify the cost driver that has a strong correlation to the costs in the cost pool.

Compute the overhead rate for each pool.

Assign overhead costs for each cost pool to products using the overhead rates.

Four Steps of Activity-Based Costing

Four Steps of Activity-Based Costing

SO 3 Know how companies identify the activity cost pools

and use activity-based costing.

Illustration 4-4

Expected Use

of Cost Drivers

Activity Cost Pools Cost Drivers Per Activity

Setting up machines Number of setups 1,500

Inspecting Number of Inspections

2,000

Identify Cost Drivers

Identify Cost Drivers

Illustration 4-5

Activity Cost Pools OverheadPer Activity Overhead Rates

Setting up machines $300,000 1,500 setups $200 per setup

Machining 500,000 50,000 machine hrs $ 10 per mach hour Inspecting 100,000 2,000 inspections $ 50 per inspection Total $900,000

SO 4 Know how companies identify and use cost drivers in activity-based costing

Estimated Overhead Per Activity

= Activity-Based Overhead Rate Expected Use of Cost Drivers Per Activity

Expected Use of Costs to Products

Expected Use of Costs to Products

Illustration 4-8

The Boot The Club

Unit Product Costs Under Traditional

and ABC Costing Methods

Unit Product Costs Under Traditional

and ABC Costing Methods

Illustration 4-11

the low volume product (The Club The Club ) because:

Low volume products often require more special handling.

Assigning overhead using ABC will usually increase the cost per unit of low volume products.

Results of Using ABC

Results of Using ABC

SO 4 Know how companies identify and use cost drivers

in activity-based costing

More accurate product costing through:

Use of more cost pools to assign overhead costs.

Enhanced control over overhead costs.

Better management decisions.

Benefits of Activity-Based Costing

Benefits of Activity-Based Costing

Chapter

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Can be expensive to use (Cost/Benefit) Some arbitrary allocations continue.

SO 5 Understand the benefits and limitations of activity-based costing

Limitations of Activity-Based Costing

Limitations of Activity-Based Costing

Products differ greatly in volume/manufacturing

complexity.

Products lines are:

Numerous.

Diverse.

Require different degrees of support services.

Overhead costs are a significant portion of total costs Significant change in manufacturing process or number

of products.

Managers ignore data from existing system and instead

Use ABC When One or More of the

Following Exist:

Use ABC When One or More of the

Following Exist:

Chapter

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Activity-based costing (ABC):

system.

An extension of ABC from a product costing system to a management function

that focuses on reducing costs and improving processes and decision making.

A refinement of ABC used in ABM classifies activities as either value-added

or non-value-added.

Activity-Based Management (ABM)

Activity-Based Management (ABM)

Chapter

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An activity that increases the worth

of a product or service such as:

Machining Legal research services Assembly Delivering packages

Painting Packaging

Value- Added Activities

Value- Added Activities

SO 5 Understand the benefits and limitations of activity-based costing

An activity that adds cost to, or increases the

time spent on, a product/service

Manufacturing Company Service Company Repair of machines Taking appointments

Storage of inventory Reception

Moving of raw materials, Bookkeeping/billing

assemblies, and Traveling

finished goods Ordering supplies

Building maintenance

Inspections

Non-Value Activities

Non-Value Activities

production process.

Classification of Activity Levels

Classification of Activity Levels

Hierarchy of Activity Levels

Hierarchy of Activity Levels

each service provided.

General approach is to identify activities, cost pools, and cost drivers

Labeling of activities as value-added or value-added

non-Reduction of non-value-added activities.

Activity-Based Costing In Service

Major Difficulty of Implementing ABC

Major Difficulty of Implementing ABC

Condensed Budget of Service Company

under Traditional Costing

Condensed Budget of Service Company

under Traditional Costing

CHECK AND DOUBLECHECK, CPAs

Plano Molding Company Audit

Chapter

4-41

CHECK AND DOUBLECHECK, CPAs

Annual Overhead Budget

Expected

Insurance

$1,200,000

Activity-Based Costing Budget

Activity-Based Costing Budget

Illustration 4-16

SO 8 Apply activity-based costing to service industries.

CHECK AND DOUBLECHECK, CPAs Plano Molding Company Audit

$165,100

Assigning Overhead in a Service Company

Assigning Overhead in a Service Company

$260,000 Expenses

Comparison of Traditional and ABC

Comparison of Traditional and ABC

Illustration 4-18

SO 8 Apply activity-based costing to service industries.

Recognize the difference between traditional and

activity-based costing.

Traditional system allocates overhead to products using

predetermined unit-based output rate.

ABC allocates overhead to activity cost pools and assigns cost to products using cost drivers.

Identify the steps in the development of an

activity-based costing system.

Step 1: Identify the major activities and allocate the overhead costs to cost pools.

Step 2: Identify the cost driver highly correlated to the cost pool.

Step 3: Compute the overhead rate per cost driver.

Review

Review

Chapter

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Know how companies identify cost pools used in ABC.

Analyze each operation or process, document and time every task, action, or transaction.

Know how companies identify and use cost drivers in ABC.

Cost drivers identified for assigning activity cost pools must:

Accurately measure the consumption of the activity.

Have related data easily available.

Understand the benefits and limitations of ABC:

Benefits:

Enhanced control over overhead costs.

Better management decisions.

Differentiate between value-added and non-value-added activities.

Value-added activities increase the worth of a product or service Non-value-added activities add cost to, or increase the time spent

on, a product or service without increasing its market value.

Understand the value of using activity levels in ABC.

Activities may be classified as:

Chapter

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Apply ABC to service industries.

Same objective – improved costing of services provided.

The general approach to costing is also the same:

A processing system dedicated to

products, or parts arrive as they are needed, thereby reducing the amount

of inventory

Just-in-Time

Just-in-Time

Objective of JIT:

Eliminate all manufacturing inventories

Elements of JIT:

Dependable suppliers

Multi-skilled work force.

Total quality control system.

Benefits of JIT:

Reduced inventory.

Enhanced product quality.

Reduced rework and storage costs.

Just-in-Time

Just-in-Time

ALL ABOUT YOU

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Chapter

4-53

ALL ABOUT YOU

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ALL ABOUT YOU

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