Chapter 4 Activity-Based Costing COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license.

Study Objectives Describe the basics of plantwide and departmental overhead costing. Explain why plantwide and departmental overhead costing may not be accurate. Provide a detailed description of activity-based product costing. Explain how the activity-based costing systems can be simplified.

Functional-Based Product Costing Model 1.

Functional-Based Product Costing 1. Overhead costs are assigned to products using predetermined overhead rates.

Overhead Application: Plantwide Rates 1.

Overhead Variances 1. Overapplied overhead Underapplied overhead Applied overhead > actual overhead Underapplied overhead Applied overhead < actual overhead Disposition of overhead variances Immaterial: assign to cost of goods sold Material: allocate among inventories and cost of goods sold

Overhead Application: Plantwide Rates 1.

Overhead Application: Departmental Rates 1.

Overhead Application: Departmental Rates 1.

Limitations of Plantwide and Departmental Rates 2. Non-Unit-Related Costs The use of either plantwide or departmental rates assumes that the number of units produced causes overhead costs to increase Some overhead costs are not driven by the number of units produced Product Diversity Products consume overhead activities in different proportions

Limitations of Plantwide and Departmental Rates 2.

Unit Cost Based on Plantwide and Departmental Rates 2. This schedule uses the data from exhibit 4-2 to determine unit cost using a single plantwide overhead rate based on direct labor hours. This schedule uses the data from exhibit 4-2 to determine unit cost using department overhead rates based on labor (cutting) and machine (printing) hours.

Limitations of Plantwide and Departmental Rates 2. Application of overhead using unit-based drivers may be inappropriate if Multiple products are produced Product diversity exists Non-unit-level overhead is a significant percentage of production costs

Limitations of Plantwide and Departmental Rates 2. 4 Activities: Setup Cost $240,000 Qty 100 Machining Cost $200,000 Qty 90,000 Inspecting Cost $160,000 Qty 18,000 Moving materials Cost $120,000 Qty 300

Design Steps for an ABC System 3. Identify, define, and classify activities and key attributes Activity inventory – a list of identified activities Activity definition – financial and nonfinancial descriptions of the activities Activity classification – primary and secondary Activity dictionary – activity name, description, driver, and cost objects

Design Steps for an ABC System 3. Assign the cost of resources to the activities Cost of performing each activity Use both direct and indirect tracing General ledger costs are unbundled and reassigned

Design Steps for an ABC System 3. Assign the cost of secondary activities To those activities that consume their output Total cost of the secondary activity is the sum of the direct and assigned costs

Design Steps for an ABC System 3. Identify cost objects and specify the amount of each activity consumed by specific cost objects Cost objects are identified Activity drivers are used to measure the demands placed on activities. Transaction drivers – measure demand by quantity of events Duration drivers – measure demand by elapsed time

Design Steps for an ABC System 3. Calculate primary activity rates Assign activity costs to cost objects Multiply activity rate by activity measure

Reducing the Size and Complexity of an ABC System 4. Approximately Relevant ABC Systems Use only the most expensive activities for ABC assignment. Assign using cause-and-effect drivers All other activity costs are added to cost pools of the expensive activities

Reducing the Size and Complexity of an ABC System 4. Time-Driven ABC System Overcomes the drawback of traditional ABC systems: few people report idle or unused time Managers estimate practical capacity as a percentage of theoretical capacity Determine a per-time-unit rate Determine the time required for one unit of activity Multiply rate by time

End Chapter 4