Activity-Based Costing and Management Chapter 5 Activity-Based Costing and Management

Learning Objective 1

Traditional, Volume-Based Product-Costing System Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records: Aerotech produces three circuit boards referred to as Mode I, Mode II and Mode III. 10,000 units of Mode I are produced in 1 run. 20,000 units of Mode II are produced in 4 runs of 5,000 units. And 4,000 units of Mode III are produced in 10 runs o f400 units. (LO1) Manufacturing overhead is determined as follows

Traditional, Volume-Based Product-Costing System Budgeted manufacturing overhead $3,894,000 Budgeted direct-labor hours 118,000 = $33 per hour Aerotech applies manufacturing overhead using a predetermined overhead rate based on direct-labor hours. The total direct labor hours was estimated to be 118,000. The budgeted manufacturing overhead cost was estimated at $3,894,000. The estimated cost is divided by the estimated hours resulting in a predetermined overhead rate of $33 per hour. The overhead per unit is calculated by multiplying the direct labor hours per unit times the predetermined overhead rate per hour. (LO1)

Traditional, Volume-Based Product-Costing System With these product costs, Aerotech established target selling prices (Cost × 125%). Now that Aerotech is estimated the production cost per unit, the target selling price can be set. The company’s pricing policy has been to set a target price for each grill equal to 125 percent of the full product cost. The estimated unit cost is multiplied by 1.25 to arrive at the target selling price. (LO1) 209.00 x 1.25

Learning Objective 2

Activity Based Costing System (ABC) ABC systems follow a two-stage procedure to assign overhead costs to products. Stage One Identify significant activities and assign overhead costs to each activity in proportion to resources used. Stage Two Identify cost drivers appropriate to each activity and allocate overhead to the products. Activity-based costing (ABC) systems follow a two-stage procedure to assign overhead costs to products. (LO2) Assigning Overhead to product costs is a difficult process. Lets begin by identifying our major activities. The first stage identifies significant activities in the production process and assigns overhead costs to each activity in accordance with the cost of the organization’s resources used by the activity. The overhead costs assigned to each activity comprise an activity cost pool. (LO2) Overhead assigned to activities are called “activities cost pools.” After assigning overhead costs to activity cost pools in stage one, cost drivers appropriate for each cost pool are identified in stage two. Then the overhead costs are allocated from each activity cost pool to each product line in proportion to the amount of the cost driver consumed by the product line.

Learning Objective 4

STAGE ONE Machinery Cost Pool Various overhead costs related to machinery Maintenance Depreciation Computer Support Lubrication Electricity Calibration Activity cost pool Aerotech estimated the costs of maintenance, lubrication, depreciation, electricity, computer support and calibration. These costs are added together. The sum is the machinery cost pool budgeted cost. (LO4) Machinery Cost Pool Total budgeted cost = $1,212,600

STAGE TWO Calculate the pool rate Cost Assignment Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour = = Cost Assignment Aerotech selected machine hours for the cost driver, since a product that uses more machine hours should bear a larger share of machine-related costs. The budgeted machinery costs are divided by the budgeted number of machine hours to arrive at the machinery cost pool rate. Then, for each circuit board, the machinery cost pool rate is multiplied by the number of machine hours per board. (LO4)

STAGE ONE Setup Cost Pool Calculation of total setup cost Activity The budgeted cost for the setup cost pool is determined by multiplying the setup cost per hour by the number of hours required per setup then multiplying that by the number of production runs. (LO4) Setup Cost Pool Total budgeted cost = $3,000

STAGE TWO Calculate the pool rate Cost Assignment Budgeted Setup Costs $3,000 Planned Production Runs 15 runs $200 per run = = Cost Assignment The budgeted setup costs are divided by the planned production runs to arrive at the setup cost pool rate. Then, for each circuit board, the setup cost pool rate is divided by the number of units per run to arrive at the setup cost per unit. (LO4)

STAGE ONE Engineering Cost Pool Various overhead costs related to engineering Engineering salaries Engineering software Engineering supplies Depreciation Activity cost pool Engineering Cost Pool Total budgeted cost = $700,000 Aerotech estimated the costs of engineering salaries, supplies, software and depreciation. These costs are added together. The sum is the engineering cost pool budgeted cost. (LO4)

STAGE TWO Engineering Cost Pool Allocate based on engineering Total budgeted cost = $700,000 Allocate based on engineering transactions Cost Assignment The engineering department has estimated that 25% of its time is spent on Mode I, 45% on Mode II and 30% spent on Mode III. For each board, the percentage of engineering time is multiplied by the budgeted engineering cost then divided by the number of units to be produced. The result is the engineering cost per unit. (LO4)

STAGE ONE Facility Cost Pool Total budgeted cost = $507,400 Various overhead costs related to general operations Plant depr. Property taxes Plant mgmt. Insurance Plant maint. Security Activity cost pool Facility Cost Pool Total budgeted cost = $507,400 Aerotech estimated the costs of plant depreciation, management salaries, maintenance, property taxes, insurance and security. These costs are added together. The sum is the facility cost pool budgeted cost. (LO4)

STAGE TWO Calculate the pool rate Cost Assignment Budgeted Facilities Cost $507,400 Budgeted Direct-Labor Hours 118,000 $4.30/hour = = Cost Assignment Aerotech has selected to use direct labor hours as the cost driver for facilities cost. The budgeted facilities cost is divided by the budgeted direct labor hours to arrive at the facilities cost per hour. The facilities cost per unit is calculated by multiplying the facilities cost per hour by the number of direct labor hours required per board. (LO4)

Other Overhead Costs $14.82 The cost per unit for each of these batch level costs is added together for each board. (LO4)

These are the new product costs when Aerotech uses ABC. Product Cost from ABC These are the new product costs when Aerotech uses ABC. Now Aerotech has new product costs for each board. It is the sum of the costs for direct materials, direct labor, machinery, setup, engineering, facilities and costs accumulated as other costs. (LO4)

Learning Objective 5

Distorted Product Costs Both original and ABC target selling prices are based on (Cost × 125%). Using the existing target pricing policy, the unit cost based on ABC costing is multiplied by 1.25 to arrive at the ABC target selling price. Under ABC costing, the selling price for Mode I and Mode II boards has decreased, but the selling price for the Mode III board has increased significantly. (LO5) The selling price of Mode I and II are reduced and the selling price for Mode III is increased. [$209.00 × 1.25] [$183.44 × 1.25]

Learning Objective 3, 6 – 11 can be found in the text book

End of Chapter 5 This is my kind of cost pool!