Cornerstones of cost management 3rd edition hansen mowen chapter 4

May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protecte

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© 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use

ACTIVITY-BASED COSTING

CHAPTER 4

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CHAPTER 4 OBJECTIVES

1 Describe the basics of plantwide and

departmental overhead costing

2 Explain why plantwide and departmental

overhead costing may not be accurate

3 Provide a detailed description of

activity-based product costing

4 Explain how ABC can be simplified

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EXHIBIT 4.1—UNIT-BASED PRODUCT

COSTING MODEL

LO-1

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UNIT-LEVEL PRODUCT COSTING

• Overhead costs are assigned to products

using predetermined overhead rates

Predetermined

overhead rate = Budgeted annual overhead

Budgeted annual driver level Applied overhead = Overhead rate  Actual driver usage

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• Unit level drivers: factors that measure the

demands placed on unit-level activities by products

• Unit level activities: activities performed each

and every time a unit of a product is produced

• Five most commonly used unit level drivers

• Units produced

• Direct labor hours

• Direct labor dollars

• Machine hours

• Direct material dollars

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• The difference between actual overhead

and applied overhead

• If actual overhead > applied overhead:

underapplied overhead

• If actual overhead < applied overhead:

overapplied overhead

Overhead Variances

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LO-1

Disposal of Variance

• If immaterial, assign to cost of goods sold

• If material, allocate among work-in-process

inventory, finished goods inventory, and cost of

goods sold

Overhead Variances

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Overhead Application: Departmental Rates

• Costs assigned to individual production

department, creating departmental overhead cost

pools

• Unit level drivers are used to compute

predetermined overhead rates for each department

• Overhead is assigned to products by multiplying

the departmental rates by the amount of the driver

used in the respective departments

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LIMITATIONS OF PLANTWIDE AND

DEPARTMENTAL RATES

Non-Unit-Related Overhead Costs

• Plantwide and department rates assume that a product’s

consumption of overhead is directly related to units

produced

• Some costs, however, such as setups cost a certain

amount no matter how many products are produced

• Other costs, such as engineering hours, may depend on

something entirely different, such as work orders, not

units

• Non-unit-based drivers are factors, other than the

number of units produced, that measure the demands

that cost objects place on activities

LO-2

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DEPARTMENTAL RATES

Product Diversity

• Even if there are significant non-unit

driven overhead costs, it will not cause

distorted costing if the products all

consume overhead in the same proportion

as unit-level driven overhead costs

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DEPARTMENTAL RATES

Product Diversity

• Products consume overhead activities in

different proportions

• Caused by differences in product size, complexity,

setup time, batch size, etc

• The proportion of each activity consumed by a

product is called the consumption ratio

LO-2

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DEPARTMENTAL RATES

• Two producing departments: molding and

Assembly

• Two products: race cars and robots

• Five times more race cars than robots are

produced making race cars a high-volume product

and robots a low-volume product

• The molds for robots are larger and more varied

than those for race cars

• Four types of overhead activities are performed:

setups, machining, inspection, and moving

batches

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EXHIBIT 4.2—PRODUCT-COSTING DATA

LO-2

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EXHIBIT 4.2—PRODUCT-COSTING DATA

(CONTINUED)

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EXHIBIT 4.3—UNIT PRODUCT COST:

PLANTWIDE AND DEPARTMENTAL RATES

LO-2

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DEPARTMENTAL RATES

Problems with Costing Accuracy

• The main problem with using either plantwide or

departmental rates is the assumption that machine

hours and/or direct labor hours drive or cause all

overhead costs

• Race cars, the high-volume product, use four times

the direct labor hours used by robots, the

low-volume product

• If a plantwide rate is used, the race cars will receive

four times more overhead cost than will the robots

• This might not be reasonable

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LO-2

DEPARTMENTAL RATES

• The data in Exhibit 4.2 suggest that a

significant portion of overhead costs is not

driven or caused by the units produced

• The high-volume product, race cars, uses three

times the number of setups of robots, about

2.33 times as many inspection hours, and only

one and one-half times as many moves

• Use of direct labor hours, a unit-based activity

driver, and a plantwide rate assigns four times

more overhead costs to the race cars than to

the robots

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DEPARTMENTAL RATES

Activity Rates: A Better Approach

• Instead of using a single pool or department pools

based on units, expand the number of pools and

rates and base them on activities

• The rates are based on causal factors that

measure consumption – both unit and non-unit

level activity drivers

• Costs are assigned to each product by multiplying

the activity rates by the amount consumed by each activity

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EXHIBIT 4.4—COMPARISON OF UNIT

COSTS

LO-2

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DEPARTMENTAL RATES

• The activity-based cost assignment follows

a cause-and-effect pattern of overhead

consumption and is therefore the most

accurate of the three costs

• In the presence of significant non-unit

overhead costs and product diversity,

using only unit-based activity drivers can

lead to one product subsidizing another

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LO-3

EXHIBIT 4.5—ACTIVITY BASED

COSTING MODEL

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EXHIBIT 4.6—DESIGN STEPS FOR AN

ABC SYSTEM

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ACTIVITY-BASED COSTING SYSTEM

attributes

• Activity inventory: a simple list of activities identified

• Activity attributes: nonfinancial and financial

information items that describe individual activities

• Activity dictionary: lists the activities in an organization along with desired attributes

• Primary activity: consumed by the final cost object

• Secondary activity: consumed by intermediate cost

objects

• Interviews, questionnaires, surveys, and observation

are means of gathering data for an ABC system

LO-3

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EXHIBIT 4.7—SAMPLE ACTIVITY

INVENTORY

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2 Assign the cost of resources to

activities

• The cost of an activity is the resources

consumed by that activity

• If a resource is exclusive to an activity, assign

100% of the cost to the activity

• If the resource is split between more than one

activity, determine a resource driver

• Resource drivers are factors that measure the consumption of resources by activities

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3 Assign the cost of secondary

activities to primary activities

• Treat the secondary activity like a resource from the previous step

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4 Identify cost objects and specify the

amount of each activity consumed by

them

• Assign costs consumed by more than one

activity in proportion to their usage of the

activity as measured by the activity driver

• Transaction drivers measure the number of times

an activity is performed

• Duration drivers measure the demands in terms of the amount of time it takes to perform an activity

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• A bill of activities specifies the product,

expected product quantity, activities, and

amount of each activity expected to be

consumed by each product

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5 Calculate primary activity rates

• Primary activity rates are computed by dividing

budgeted activity costs by practical activity

capacity

• Practical activity capacity is the activity output

that can be produced when the activity is

performed efficiently

LO-3

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