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Activity Based Costing: A Tool to Aid Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee Chapter.

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Presentation on theme: "Activity Based Costing: A Tool to Aid Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee Chapter."— Presentation transcript:

1 Activity Based Costing: A Tool to Aid Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee Chapter

2 Direct Materials Direct Materials Direct Labor Direct Labor Mfg. Overhead Mfg. Overhead Work-in- Process Work-in- Process Finished Goods Finished Goods Cost-of Goods Sold Cost-of Goods Sold Cost Measurement Cost Accumulation Cost Assignment Goal: Accurately costed products.

3 Actual Costing System Normal Costing System Standard Costing System Measuring Costs Actual DM Actual DL Actual MOH Actual DM Actual DL Estimated MOH Standard DM Standard DL Standard MOH

4 Cost Accounting Systems Product Costs Job-Order CostingProcess Costing Total/Unit Cost

5 Assigning Manufacturing Costs Functional Based Costing Activity Based Costing

6 Activity Based Costing (ABC) ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed costs. ABC is a good supplement to our traditional cost system I agree!

7 Overhead rates may be based on activity at capacity. Overhead rates may be based on activity at capacity. Activity Based Costing (ABC) Both manufacturing and nonmanufacturing costs may be assigned to products. Both manufacturing and nonmanufacturing costs may be assigned to products. Some manufacturing costs may be excluded from product costs. Some manufacturing costs may be excluded from product costs. A number of cost pools each allocated to a product or cost object. A number of cost pools each allocated to a product or cost object. Allocation bases often differ from traditional costing systems. Allocation bases often differ from traditional costing systems.

8 How Costs are Treated Under Activity-Based Costing Level of Complexity Overhead Allocation Plantwide Overhead Rate Plantwide Overhead Rate Departmental Overhead Rates Departmental Overhead Rates Activity Based Costing Activity Based Costing

9 Functional Based (Traditional) Costing

10 Department 1 Department 1 Department 2 Department 2 Department 3 Department 3 Cost pools Indirect Labor Indirect Labor Indirect Materials Indirect Materials Other Overhead Other Overhead Stage One: Costs assigned to pools Departmental Overhead Rates Products Products Stage Two: Costs applied to products Departmental Allocation Bases Direct Labor Hours Machine Hours Raw Materials Cost

11 Peanut-butter costing describes a cost approach that uniformly assigns (spreads or smooths out) the cost of resources to cost objects.

12 Resources Functions Products Efficiency Analysis Performance Analysis Functional-Based Management Model Cost View Operational View

13 The problem with this approach is that individual products, services, etc., may use those resources in a nonuniform way. The end result is that some products will be overcosted while others will be undercosted.

14 Refining a Cost System Reclassify indirect costs as direct costs. Define more cost pools. Identify cost drivers. Use Activity-Based Costing.

15 Resources Activities Products & Customers Driver Analysis Performance Analysis Activity-Based Management Model Cost View Operational View

16 Designing an ABC System Cost Objects (e.g., products and customers) Cost Objects (e.g., products and customers) ActivitiesActivities Consumption of Resources Consumption CostCost

17 Designing an ABC System 1.Identify and define activities and activity cost pools. 2.Whenever possible, directly trace costs to activities and cost objects. 3.Assign costs to activity cost pools. 4.Calculate activity rates.

18 Designing an ABC System 5.Assign costs to cost objects using the activity rates and activity measures. 6.Prepare management reports.

19 Identify and Define Activities and Activity Cost Pools

20 Step #1:Identify and Define Activities and Activity Cost Pools Activity Cost Pool An Activity Cost Pool is a bucket in which costs are accumulated that relate to a single activity measure in the ABC system. $ $ $ $ $ $

21 Activity Levels (Step #1) Activity Levels Product Level Customer Level Unit Level Batch Level Organization-Sustaining Level

22 At Classic Brass, the ABC team, selected the following activity cost pools and activity measures: Step #1: Identify and Define Activities and Activity Cost Pools Step #1 For Classic Brass

23 Step #1:Identify and Define Activities and Activity Cost Pools Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. Product Designs - assigned all costs of resources consumed by designing products. Order Size - assigned all costs of resources consumed as a consequence of the number of units produced.

24 Step #1:Identify and Define Activities and Activity Cost Pools Customer Relations – assigned all costs associated with maintaining relations with customers. Other – assigned all overhead costs that are not associated with the other cost pools.

25 Whenever Possible, Directly Trace Overhead Costs to Activities and Cost Objects.

26 The overhead costs at Classic Brass Exhibit 8-2

27 Assign Costs to Activity Cost Pools

28 The overhead costs at Classic Brass Exhibit 8-2

29 Assign Costs to Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. ** Not included because they are directly traced to customer orders.

30 Indirect factory wages $500,000 Percent consumed by customer orders 25% $125,000 Indirect factory wages $500,000 Percent consumed by customer orders 25% $125,000 Assign Costs to Activity Cost Pools

31 Factory equipment depreciation $300,000 Percent consumed by customer orders 20% $ 60,000 Factory equipment depreciation $300,000 Percent consumed by customer orders 20% $ 60,000 Assign Costs to Activity Cost Pools

32

33 Calculate the Activity Rates

34 At Classic Brass, the ABC team, selected the following activity cost pools and activity measures: Step #1: Identify and Define Activities and Activity Cost Pools Activity Cost Pools For Classic Brass

35 Calculate Activity Rates The ABC team determines that Classic Brass will have these total activities for each activity cost pool... 1,000 customer orders 1,000 customer orders 200 new designs 200 new designs 20,000 machine-hours 20,000 machine-hours 100 customer relations activities 100 customer relations activities Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.

36 Calculate Activity Rates ÷

37 Traced Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Overhead Costs Cost Objects: Products, Customer Orders, Customers Cost Objects: Products, Customer Orders, Customers Activity-Based Costing at Classic Brass

38 Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Overhead Costs Cost Objects: Products, Customer Orders, Customers Cost Objects: Products, Customer Orders, Customers Activity-Based Costing at Classic Brass OrderSizeOrderSizeCustomerOrdersCustomerOrdersProductDesignProductDesignCustomerRelationsCustomerRelationsOtherOther First-Stage Allocation

39 Activity-Based Costing at Classic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Overhead Costs Cost Objects: Products, Customer Orders, Customers Cost Objects: Products, Customer Orders, Customers Activity-Based Costing at Classic Brass OrderSizeOrderSizeCustomerOrdersCustomerOrdersProductDesignProductDesignCustomerRelationsCustomerRelationsOtherOther First-Stage Allocation Second-Stage Allocations $/MH $/Order $/Design $/Customer Unallocated

40 Assign Costs to Cost Objects

41 Assigning Costs to Cost Objects Lets take a look at how our system works for just one customer – Windward Yachts. Standard Stanchions (no design required) units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours. 3. Selling price is $34 each. 4. Direct materials total $2, Direct labor totals $1, Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours. 3. Selling price is $650 each. 4. Direct materials total $ Direct labor totals $ Shipping costs total $25.

42 Standard Stanchions (no design required) units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours. 3. Selling price is $34 each. 4. Direct materials total $2, Direct labor totals $1, Shipping costs total $180.

43 Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours. 3. Selling price is $650 each. 4. Direct materials total $ Direct labor totals $ Shipping costs total $25.

44 Prepare Management Reports

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46

47 Product Margins Traditional Cost Accounting System Predetermined manufacturing overhead rate $1,000,000 20,000 MH = $50/MH= 400 units x 0.5 MH/unit x $50/MH = $10,000


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