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

2. 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:
Learning Objective 1
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

3. Traditional, Volume-Based Product-Costing System
Budgeted manufacturing overhead $3,894,000
Budgeted direct-labor hours ,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)

4. 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)
x 1.25

5. 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.
Learning Objective 2
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.

6. STAGE ONE Machinery Cost Pool Various overhead costs related
to machinery
Maintenance
Depreciation
Computer Support
Lubrication
Electricity
Calibration
Activity
cost
pool
Learning Objective 4
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

7. STAGE TWO Calculate the pool rate Cost Assignment
Budgeted Machinery Costs $1,212,600
Budgeted Machine Hours ,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)

8. 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

9. STAGE TWO Calculate the pool rate Cost Assignment
Budgeted Setup Costs $3,000
Planned Production Runs 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)

10. 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)

11. 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)

12. 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)

13. STAGE TWO Calculate the pool rate Cost Assignment
Budgeted Facilities Cost $507,400
Budgeted Direct-Labor Hours ,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)

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

15. 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 Objectives 3, 5, 6-11 can be found in the text book