1. Chapter 8 Activity-Based Costing

2. 8-2 Learning Objectives 4.Explain how activity-based costing and a two-stage product system are related. 2.Explain how a two-stage product costing system works. 3.Compare and contrast plantwide and department allocation methods. 5.Compute product costs using activity-based costing. 1.Understand the potential effects of using reported product costs for decision making. 6.Compare activity-based product costing to traditional department product costing methods. 7.Demonstrate the flow of costs through accounts using activity- based costing. 8.Apply activity-based costing to marketing and administrative services.

3. 8-3 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. 8-4 Sammy’s Skis and Boards Sammy’s costs without snowboards.

5. 8-5 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. 8-6 Allocate overhead costs to departments. Allocate department overhead costs to the products or services. Stage One Stage Two Two-Stage Allocation Systems L.O. 2. Explain how a two-stage product costing system works.

7. 8-7 Cost Pool Overhead Intermediate Cost Pools Cost Allocation Rule Department ADepartment B Direct Labor Hours Machine Hours Two-Stage Cost Allocation Continued

8. 8-8 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 Factory Overhead Costs One allocation rate Products

9. 8-9 Department Allocation One cost pool for each department Overhead costs traced to separate departments and applied to products using a department allocation rate. Packaging Department Overhead Costs Products Assembly Department Overhead Costs Each department has an allocation rate

10. 8-10 Cost Allocation: An Example Production and Cost Data Port Arthur Manufacturing Facility Third Quarter

11. 8-11 Cost Allocation: An Example Production and Cost Data Port Arthur Manufacturing Facility Third Quarter

12. 8-12 Cost Allocation: An Example Continued Plantwide Cost Allocation Port Arthur Manufacturing Facility Third Quarter

13. 8-13 Cost Pool Overhead Intermediate Cost Pools Cost Allocation Rule AssemblyPackaging Machine Hours Direct Labor Cost Two-Stage Cost Allocation Continued

14. 8-14 Cost Allocation: An Example Continued Department Cost Allocation Port Arthur Manufacturing Facility Third Quarter

15. 8-15 Choice of Cost Allocation Method Similar products using same resources Multiple products using resources differently Which cost allocation method is appropriate? Plantwide Allocation Department Allocation

16. 8-16 Activity-Based Costing (ABC) L.O. 4 Explain how activity-based costing and a two-stage product system are related. Costing method that first assigns costs to activities and then allocate them to products based on the products’ consumption of activities. Stage OneAssign costs to activities Stage TwoAllocate costs to products based on the use of each activity Activity-Based Costing

17. 8-17 Activities consume resources Products consume activities ABC Continued

18. 8-18 1.Identify the activities that consume resources and assign costs to them. 2.Identify the cost driver(s) associated with each activity. 3.Compute a cost rate per cost driver unit or transaction. 4.Allocate costs to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product. Developing Activity-Based Costing

19. 8-19 Cost Drivers Factors that cause or “drive” an activity’s costs. Preparing cafeteria foodNumber of students in the dorm Taking customer ordersNumber of orders Setting up equipmentNumber of set-ups Purchasing materialsNumber of purchase orders Identified activityIdentified cost driver

20. 8-20 Cost Allocation Pools PlantwideOne pool DepartmentAs many pools as departments ABCAs many pools as activities and cost drivers identified

21. 8-21 Cost Allocation Pools: ABC Cost Flow Diagram: Activity-Based Costing System Set-up hours Production runs Machine hours Shipments OverheadSet-upHandle Material Pack & Ship ProductsMachine Assign costs to activities Allocate costs to products based on the use of each activity

22. 8-22 Cost Hierarchy Classification of cost drivers into general levels of activity; volume, batch, product and so on.

23. 8-23 Cost Hierarchy Classification of cost drivers into general levels of activity; volume, batch, product and so on.

24. 8-24 Cost Hierarchy Classification of cost drivers into general levels of activity; volume, batch, product and so on.

25. 8-25 Cost Hierarchy Classification of cost drivers into general levels of activity; volume, batch, product and so on.

26. 8-26 Cost Hierarchy Classification of cost drivers into general levels of activity; volume, batch, product and so on.

27. 8-27 ABC Example L.O. 5 Compute product costs using activity-based costing. Production and Cost Data Port Arthur Manufacturing Facility Third Quarter

28. 8-28 ABC Example Continued Identify the activitiesStep 1

29. 8-29 ABC Example Continued Identify the cost drivers and the expected volume of each cost driver. Step 2

30. 8-30 ABC Example Continued Compute the Cost Driver RatesStep 3 Overhead Cost Data Port Arthur Manufacturing Facility Third Quarter

31. 8-31 ABC Example Continued Step 4Allocate costs to products

32. 8-32 ABC Example Continued

33. 8-33 Cost Flow Diagram Activity-Based Costing System Port Arthur Manufacturing Facility Direct costsOverhead costs AssemblyPackaging AssembleHandle Material Set-upInspect & Pack Ship J3MPJ5MP

34. 8-34 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. 8-35 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. 8-36 Assembly WIP J5MP Material Inventory Direct Material Costs Assembly WIP J3MP 1,500,000 DM 1,500,000 2,400,000 DM 2,400,000

37. 8-37 Direct Labor Costs Wages Payable 750,000 600,000 Assembly WIP J3MP Assembly WIP J5MP DM 1,500,000 DM 2,400,000 DL 750,000 DL 600,000

38. 8-38 Handling Material Overhead Costs Setting up Machines Assembly WIP J3MP Assembly WIP J5MP DM 1,500,000 DM 2,400,000 DL 750,000 DL 600,000 Assembling 180,000 36,000 24,000 OH 240,000 900,000 360,000 120,000 OH 1,380,000

39. 8-39 Transfer from Assembly to Packaging Assembly WIP J3MP Assembly WIP J5MP DM 1,500,000 DM 2,400,000 DL 750,000 DL 600,000 OH 240,000 OH 1,380,000 Packaging WIP J3MP Packaging WIP J5MP 2,490,000 4,380,000 2,490,000 4,380,000

40. 8-40 ABC in Administration L.O. 8 Apply activity-based costing to marketing and administrative services. 1.Identify the activities that consume resources. 2.Identify the cost driver associated with each activity. 3.Compute a cost rate per cost driver for each unit or transaction. 4.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. The same four-step process

41. 8-41 Chapter 8