1. Activity-Based Costing
Chapter 8

2. Learning Objectives
Understand the potential effects of using reported product costs for decision making.
Explain how a two-stage product costing system works.
Compare and contrast plantwide and department allocation methods.
Explain how activity-based costing and a two-stage product system are related.
Compute product costs using activity-based costing.
Compare activity-based product costing to traditional department product costing methods.
Demonstrate the flow of costs through accounts using activity-based costing.
Apply activity-based costing to marketing and administrative services.

3. Product Costs and Decision Making
L.O. 1 Understand the potential effects of using reported product costs for decision making.
Remember Sammy’s Skis and Boards?
Sammy is considering dropping snowboards.

4. Sammy’s Skis and Boards
Sammy’s costs without snowboards.

5. Sammy’s Skis and Boards
Look at overhead
Sammy allocates $18,000 overhead to the Snowboards.
Only $5,400 of the overhead is avoided if Snowboards are not produced.

6. Two-Stage Allocation Systems
L.O. 2. Explain how a two-stage product costing system works.
Allocate overhead costs to departments.
Stage One
Allocate department overhead costs to the products or services.
Stage Two

7. Two-Stage Cost Allocation Continued
Cost Pool
Overhead
Intermediate Cost Pools
Department A
Department B
Cost Allocation Rule
Direct Labor Hours
Machine Hours

8. Plantwide versus Department Allocation Method
L.O. 3 Compare and contrast plantwide and department allocation methods.
Plantwide Allocation Method
All overhead costs are recorded in one cost pool and applied to products using one overhead allocation rate.
One cost pool for the factory
One allocation rate
Factory Overhead Costs
Products

9. Department Allocation
Overhead costs traced to separate departments and applied to products using a department allocation rate.
One cost pool for each department
Each department has an allocation rate
Assembly Department Overhead Costs
Packaging Department Overhead Costs
Products

10. Production and Cost Data Port Arthur Manufacturing Facility
Cost Allocation: An Example
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter

11. Production and Cost Data Port Arthur Manufacturing Facility
Cost Allocation: An Example
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter

12. Plantwide Cost Allocation Port Arthur Manufacturing Facility
Cost Allocation: An Example Continued
Plantwide Cost Allocation
Port Arthur Manufacturing Facility
Third Quarter

13. Two-Stage Cost Allocation Continued
Cost Pool
Overhead
Intermediate Cost Pools
Assembly
Packaging
Cost Allocation Rule
Machine Hours
Direct Labor Cost

14. Department Cost Allocation Port Arthur Manufacturing Facility
Cost Allocation: An Example Continued
Department Cost Allocation
Port Arthur Manufacturing Facility
Third Quarter

15. Choice of Cost Allocation Method
Which cost allocation method is appropriate?
Similar products using same resources
Plantwide Allocation
Multiple products using resources differently
Department Allocation

16. Activity-Based Costing (ABC)
L.O. 4 Explain how activity-based costing and a two-stage product system are related.
Activity-Based Costing
Costing method that first assigns costs to activities and then allocate them to products based on the products’ consumption of activities.
Stage One
Assign costs to activities
Stage Two
Allocate costs to products based on the use of each activity

17. ABC Continued Why ABC? Activities consume resources
Products consume activities

18. Developing Activity-Based Costing
Identify the activities that consume resources and assign costs to them.
Identify the cost driver(s) associated with each activity.
Compute a cost rate per cost driver unit or transaction.
Allocate costs to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product.

19. Cost Drivers Factors that cause or “drive” an activity’s costs.
Identified activity
Identified cost driver
Preparing cafeteria food
Number of students in the dorm
Taking customer orders
Number of orders
Setting up equipment
Number of set-ups
Purchasing materials
Number of purchase orders

20. Cost Allocation Pools Plantwide One pool Department
As many pools as departments
ABC
As many pools as activities and cost drivers identified

21. Cost Allocation Pools: ABC
Cost Flow Diagram: Activity-Based Costing System
Overhead
Assign costs to activities
Set-up
Handle Material
Machine
Pack & Ship
Allocate costs to products based on the use of each activity
Set-up hours
Production runs
Machine hours
Shipments
Products

22. Cost Hierarchy
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

23. Cost Hierarchy
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

24. Cost Hierarchy
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

25. Cost Hierarchy
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

26. Cost Hierarchy
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

27. Production and Cost Data Port Arthur Manufacturing Facility
ABC Example
L.O. 5 Compute product costs using activity-based costing.
Production and Cost Data
Port Arthur Manufacturing Facility
Third Quarter

28. ABC Example Continued
Step 1
Identify the activities

29. ABC Example Continued
Identify the cost drivers and the expected volume of each cost driver.
Step 2

30. ABC Example Continued Step 3 Compute the Cost Driver Rates
Overhead Cost Data
Port Arthur Manufacturing Facility
Third Quarter

31. ABC Example Continued
Step 4
Allocate costs to products

32. ABC Example Continued

33. Cost Flow Diagram Direct costs Overhead costs Assembly Packaging
Activity-Based Costing System
Port Arthur Manufacturing Facility
Direct costs
Overhead costs
Assembly
Packaging
Assemble
Handle Material
Set-up
Inspect & Pack
Ship
J3MP
J5MP

34. Product Cost Methods: A Comparison
L.O. 6 Compare activity-based product costing to traditional department product costing methods.
Comparison of Reported Unit Product Costs

35. Overhead Costs using ABC
L.O. 7 Demonstrate the flow of costs through accounts using activity-based costing.
Let’s see ABC cost flow for the Assembly Department
It’s T Account time

36. Direct Material Costs Assembly WIP J3MP Material Inventory 1,500,000
DM1,500,000
Material Inventory
1,500,000
2,400,000
Assembly WIP J5MP
DM2,400,000

37. Direct Labor Costs Assembly WIP J3MP Wages Payable 750,000 600,000
DM1,500,000
Wages Payable
DL 750,000
750,000
600,000
Assembly WIP J5MP
DM2,400,000
DL 600,000

38. Overhead Costs Assembly WIP J3MP Assembly WIP J5MP Assembling
180,000
DM1,500,000
900,000
DL 750,000
Setting up Machines
OH 240,000
36,000
Assembly WIP J5MP
360,000
DM2,400,000
Handling Material
DL 600,000
24,000
OH1,380,000
120,000

39. Transfer from Assembly to Packaging
Assembly WIP J3MP
Packaging WIP J3MP
DM1,500,000
2,490,000
2,490,000
DL 750,000
OH 240,000
Assembly WIP J5MP
Packaging WIP J5MP
DM2,400,000
4,380,000
4,380,000
DL 600,000
OH1,380,000

40. ABC in Administration The same four-step process
L.O. 8 Apply activity-based costing to marketing and administrative services.
The same four-step process
Identify the activities that consume resources.
Identify the cost driver associated with each activity.
Compute a cost rate per cost driver for each unit or transaction.
Allocate costs to the marketing or administration activity by multiplying the cost driver rate by the volume of cost driver units consumed by that activity.

41. Chapter 8
The End