Activity-Based Costing

Prof. GOURAV VALLABH XLRI JAMSHEDPUR

Objectives
1. Discuss the limitations of using only unit-based drivers to assign costs. 2. Provide a detailed description of activity-based product costing.

Functional-Based Product Costing Model

Direct Materials Direct Labor

Overhead
Direct Tracing Driver Tracing Allocation

Direct Tracing

Direct Tracing

Plant/Department al Cost Pools

Unit-Based Driver

PRODUCTS

Unit and Non Unit Based Drivers

Unit Based Drivers are factors that measure the demands placed on unit level activities by products. Unit-level activities are activities performed each and every time a unit of a product is produced. The use of only unit-based drivers to assign overhead costs to products assumes that all overhead consumed by products is highly correlated with the number of units produced. Nonunit-based drivers are factors, other than the number of units produced, that measure the demand that cost centre place on activities.

Goodmark CompanyAn Example

Product Costing Data
Scented Cards Regular Cards Total Unit produced per year Prime costs Direct labor hours Number of setups Machine hours Inspection hours Number of moves 20,000 $160,000 20,000 60 10,000 2,000 180 200,000 $1,500,000 160,000 40 80,000 16,000 120 -$1,660,000 180,000 100 90,000 18,000 300

Goodmark CompanyAn Example

Product Costing Data Departmental Data Cutting Dept. Printing Dept. Total Direct labor hours: Scented cards Regular cards Total Machine hours: Scented cards Regular cads Total 10,000 150,000 160,000 2,000 8,000 10,000 10,000 10,000 20,000 8,000 72,000 80,000 20,000 160,000 180,000 10,000 80,000 90,000

Continued

Departmental Data Cutting Dept. Printing Dept. Total

Overhead costs: Setting up equipment Moving materials Machining Inspecting products Total

$120,000 60,000 20,000 16,000 $216,000

$120,000 60,000 180,000 144,000 $504,000

$240,000 120,000 200,000 160,000 $720,000

Goodmark CompanyAn Example

Plantwide Overhead Rate

Total overhead cost Plantwide rate = Direct labor hours $720,000 = 180,000 DLH = $4 per direct labor hour

Goodmark CompanyAn Example

Departmental Rates

Dept. overhead cost Cutting Department rate = Cutting Dept. DLH = = $216,000 160,000 DLH

$1.35 per dlh

Goodmark CompanyAn Example

Departmental Rates

Dept. overhead cost Printing Department rate = Printing Dept. MH = = $504,000 80,000 MH

$6.30 per mh

Goodmark CompanyAn Example

Unit Cost Computation: Plantwide Rates
Scented Cards Regular Cards Prime costs Overhead costs: $4.00 x 20,000 $4.00 x 160,000 Total manufacturing costs Units of production Unit cost $160,000 80,000 $240,000 20,000 $ 12.00 $1,500,000

640,000 $2,140,000 200,000 $ 10.70

Goodmark CompanyAn Example

Unit Cost Computation: Departmental Rates
Scented Cards Regular Cards Prime costs Overhead costs: [($1.35 x 10,000) + ($6.30 x 8,000)] [($1.35 x 150,000) + ($6.30 x 72,000)] Total manufacturing costs Units of production Unit cost
*Rounded to nearest cent

$160,000 63,900

$1,500,000

$223,900 20,000 $ 11.20 *

656,100 $2,156,100 200,000 $ 10.78 *

The Inadequacy of Plantwide and Departmental Rates

There are at least two major factors that can impair the ability of the unit-based plantwide and departmental rates to assign overhead costs accurately:
1. The proportion of nonunit-related overhead costs

to total overhead costs is large, and

2. The degree of product diversity is great.

Goodmark CompanyAn Example

Product Diversity: Consumption Ratios
Overhead Activity Scented Cards Regular Cards Activity Drivers Setups Moving materials Machining Inspection
a b c d
*

0.60 a 0.60 b 0.11 c* 0.11 d*

0.40 a 0.40 b 0.89 c* 0.89 d*

Production runs Number of moves Machine hours Inspection hours

60/100 (scented) and 40/100 (regular) 180/300 (scented) and 120/300 (regular) 10,000/90,000 (scented) and 80,000/90,000 (regular) 2,000/18,000 (scented) and 16,000/18,000 (regular) rounded

Goodmark CompanyAn Example

Unit Cost Computation: Activity Rates
Scented Cards Regular Cards Prime costs Overhead costs: Setting up: $240,000 x 0.60 $240,000 x 0.40 Machining: $200,000 x (10,000/90,000) $200,000 x (80,000/90,000) Continued $160,000 $1,500,000

144,000
96,000

22,200
177,600

Scented Cards Regular Cards

Overhead costs(contd): Inspecting: $160,000 x (2,000/18,000) $160,000 x (16,000/18,000) Moving materials: $120,000 x (180/300) $120,000 x (120/300) Total manufacturing costs Units of production Unit cost

17,780 142,240 72,000

$415,980 20,000 $ 20.80

48,000 $1,963,840 200,000 $ 9.82

Rounded

Activity-Based Costing Model

Cost of Resources
Costs assigned using driver tracing and direct tracing

Activities
Costs assigned using activity drivers

Products