4 -1 Activity-Based Costing CHAPTER

Discuss the importance of unit costs. 2.Describe functional-based costing approaches. 3.Explain why functional-based costing approaches may produce distorted costs. 4.Explain how an activity-based costing system works for product costing. ObjectivesObjectives After studying this chapter, you should be able to: continuedcontinued

Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates. 6.Describe activity-based customer and supplier costing. ObjectivesObjectives

4 -4 Unit cost is the total cost associated with the units produced divided by the number of units produced. Inventory valuation Income determination Providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders Unit cost is used for--

4 -5 Product cost is often defined as the sum of direct materials, direct labor, and manufacturing overhead. This definition is required for external financial reporting.

4 -6 Cost measurement consists of determining the dollar amounts of direct materials, direct labor, and overhead used in production.

4 -7 The process of associating the costs, once measured, with the units produced is called cost assignment.

4 -8 Two possible measurement systems are actual costing and normal costing. Measurement Systems Actual costing assigns the actual costs of direct materials, direct labor, and overhead to products. Normal costing assigns the actual costs of direct materials and direct labor to products; however, overhead cots are assigned to products using predetermined rates.

4 -9 Measurement Systems A predetermined overhead rate is a rate based on estimated data. Budgeted (estimated) cost Estimated activity usage

4 -10 Examples of Unit-Level Drivers Units produced Direct labor hours Direct labor dollars Machine-hours Direct material dollars

4 -11 Units (of driver) Time Theoretical Practical Normal Expected actual

4 -12 Functional-Based Costing: Plantwide Rate Overhead Costs Assign Costs Plantwide Pool Assign Costs Products Direct Tracing Stage One: Pool Formation Unit-Level Driver Stage Two: Costs Assigned

4 -13 Belring, Inc. Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following actual and budgeted data:. Budgeted overhead$360,000 Expected activity (DLH)100,000 Actual activity (DLH)100,000 Actual overhead$380,000

4 -14 Predetermined Overhead Rate = Belring, Inc. Budgeted (estimated) cost Estimated activity usage Predetermined Overhead Rate = $360, ,000 DLH Predetermined Overhead Rate = $3.60 per DLH

4 -15 The total overhead assigned to actual production is called applied overhead. Applied overhead = Overhead rate x Actual activity output

4 -16 Belring, Inc. Applied overhead = Overhead rate x Actual activity output = $3.60 x 100,000 DLH = $360,000

4 -17 CordlessRegular Prime costs$ 78,000$ 738,000 Overhead costs: $3.60 x 10,00036, $3.60 x 90, ,000 Total manufacturing costs$114,000$1,062,000 Units produced  10,000  100,000 Unit cost $ 11.40$ Belring, Inc. Per-Unit Cost

4 -18 Overhead Costs Assign Costs ProductsProducts Stage One: Pool Formation Unit-Level Drivers Stage Two: Costs Assigned Functional-Based Costing Department Rates Department A Pool Department B Pool Allocation Direct Tracing Driver Tracing

4 -19 Budgeted overhead$252,000$108,000 Departmental Data Belring, Inc. FabricationAssembly Expected and actual usage (dlh): Cordless7,0003,000 Regular 13,000 77,000 20,00080,000 Expected and actual usage (mh.): Cordless4,0001,000 Regular36,0009,000 40,00010,000

4 -20 Belring, Inc. Applied overhead = ($6.30 x actual mh) + ($1.35 x actual dlh) = ($6.30 x 40,000) + ($1.35 x 80,000) = $360,000 = $252,000 + $108,000

4 -21 Belring, Inc. Per-Unit Cost: Departmental Rates CordlessRegular Prime costs$ 78,000$ 738,000 Overhead costs: ($6.30 x 4,000) + ($1.35 x 3,000)29, ($6.30 x 36,000) + (1.35 x 77,000) ,750 Total manufacturing costs$107,250$1,068,750 Units produced  10,000  100,000 Unit cost $ 10.73$ 10.69

4 -22 Symptoms of an Outdated Functional Cost System 1.The outcome of bids is difficult to explain. 2.Competitors’ prices appear unrealistically low. 3.Products that are difficult to produce show high profits. 4.Operational managers want to drop products that appear profitable. 5.Profit margins are difficult to explain. ContinuedContinued

4 -23 Symptoms of an Outdated Functional Cost System 6.The company has a highly profitable niche all to itself. 7.Customers do not complain about price increases. 8.The accounting department spends a lot of time supplying cost data for special projects. 9.Some departments are using their own accounting system. 10.Product costs change because of changes in financial reporting regulations.

4 -24 Non-unit activity drivers are factors that measure the consumption of non-unit activities by products and other cost objects.

4 -25 Product diversity means that the products consume overhead activities in systematically different proportions.

4 -26 Units produced per year10,000100,000110,000 Prime costs$78,000$738,000$816,000 Direct labor hours10,00090,000100,000 Machine hours5,00045,00050,000 Production runs Number of moves Belring, Inc. Activity Usage Measures Product-Costing Data CordlessRegularTotal

4 -27 ActivityActivity Cost Belring, Inc. Setups$120,000 Material handling60,000 Machining100,000 Testing 80,000 Total$360,000 Overhead Activities Product-Costing Data

4 -28 Belring, Inc. Product Diversity: Consumption Ratios Setups Production runs Material handling Number of moves Machining Machine hours Testing Direct labor hours Overhead Cordless Regular Activity Activity Phone Phone Driver aa bb cc d d 20/30 (cordless) and 10/30 (regular) a

4 -29 Belring, Inc. Product Diversity: Consumption Ratios Setups Production runs Material handling Number of moves Machining Machine hours Testing Direct labor hours Overhead Cordless Regular Activity Activity Phone Phone Driver aa bb cc d d 60/90 (cordless) and 30/90 (regular) b

4 -30 Belring, Inc. Product Diversity: Consumption Ratios Setups Production runs Material handling Number of moves Machining Machine hours Testing Direct labor hours Overhead Cordless Regular Activity Activity Phone Phone Driver aa bb cc d d 5,000/50,000 (cordless) and 45,000/50,000 (regular) c

4 -31 Belring, Inc. Product Diversity: Consumption Ratios Setups Production runs Material handling Number of moves Machining Machine hours Testing Direct labor hours Overhead Cordless Regular Activity Activity Phone Phone Driver aa bb cc d d 10,000/100,000 (cordless) and 90,000/100,000 (regular) d

4 -32 Setup rate:$120,000/30 =$4,000 per run Material-handling rate: $60,000/90 = $ per move Machining rate:$100,000/50,000 = $2 per MH Testing rate:$80,000/100,000 = $0.80 per DLH Belring, Inc. Activity Rates

4 -33 CordlessRegular Prime costs$ 78,000$ 738,000 Overhead costs: Setups 80,00040,000 Material handling40,00020,000 Machining10,00090,000 Testing 8,000 72,000 Total manufacturing costs$216,000$ 960,000 Units produced  10,000  100,000 Unit cost (total costs/units)$ $ 9.60 Belring, Inc. Activity Rates $4,000 x 20 $4,000 x 10 $667 x 60 $667 x 30 $2 x 5,000 $2 x 45,000 $0.80 x 10,000 $0.80 x 90,000

4 -34 Plantwide rate$11.40$10.62 Departmental rate Activity rate Comparison of Unit Costs Cordless Regular Belring, Inc.

4 -35 ABC: Two-Stage Assignment Cost of Resources Assign Costs Activities Products Driver Tracing

4 -36 A primary activity is one that is consumed by a product or customer. A secondary activity is one that is consumed by other primary and secondary activities.

4 -37 Resource drivers are factors that measure the consumption of resources by activities.

4 -38 Unit-level activities are those that are performed each time a unit is produced. Examples: Power and machine hours are used each time a unit is produced. Direct materials and direct labor activities are also unit-level activities, even though they are not overhead costs. Classification of Activities

4 -39 Batch-level activities are those that are performed each time a batch of products is produced. Examples: Setups, inspections, production scheduling, and material handling. Classification of Activities

4 -40 Product-level (sustaining) activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold. Examples: Engineering changes, process engineering, and expediting. Classification of Activities

4 -41 Facility-level activities are those that sustain a factory's general manufacturing processes. Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation. Classification of Activities

4 -42 DriverFilterDriverFilterDriverFilter Unit LevelBatch LevelProduct LevelFacility Level A 1 AAAA 2345 Set 1 Set 2 Set 3 Set 4 Set 5 Set 6 Set 7 Activit y Level Filter

4 -43 Customer Costing versus Product Costing

4 -44 Large Customer Ten Smaller Customers (50% of sales) (50% of sales) Units purchased500,000500,000 Orders placed2200 Number of sales calls10210 Manufacturing cost$3,000,000$3,000,000 Order-filling costs allocated $202,000$202,000 Sales-force costs allocated$110,000$110,000 ExampleExample

4 -45 The purchasing manager uses two suppliers, Murray Inc. and Plata Associates, as the source of two machine parts: Part A1 and Part B2. ExampleExample ActivityCosts Repairing products$800,000 Expending products200,000

4 -46 ExampleExample Murray Inc.Plata Associates Part A 1 Part B2 Unit purchase price$20$52$24$56 Units purchased80,00040,00010,00010,000 Failed units1, Late shipments Repair rate = $800,000 ÷ 2,000 = $400 per failed part Expediting rate = $200,000 ÷ 100 = $2,000 per late delivery (1, )

4 -47 ExampleExample Murray Inc.Plata Associates Part A 1 Part B2 Purchase cost$1,600,000$2,080,000$240,000$560,000 Repairing products640,000152,0004,0004,000 Expediting products 120,000 80,000 Total costs$2,360,000$2,312,000$244,000$564,000 Units÷ 80,000÷ 40,000÷ 10,000÷ 10,000 Total unit cost$ 29.50$ 57.80$ 24.40$ 56.40

4 -48 The End Chapter Four

4 -49