4 -1

CHAPTER

Activity-Based
Costing

4 -2

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

4 -3

Objectives
Objectives
5. 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.

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

4 -4

4 -5

Product
Product cost
cost isis often
often defined
defined as
as the
the
sum
sumof
of direct
direct materials,
materials, direct
direct labor,
labor,
and
and manufacturing
manufacturing overhead.
overhead. This
This
definition
definition isis required
requiredfor
for external
external
financial
financial reporting.
reporting.

4 -6

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

4 -7

The
The process
process of
ofassociating
associating
the
the costs,
costs, once
once measured,
measured,
with
with the
the units
units produced
produced isis
called
called cost
cost assignment.
assignment.

4 -8

Measurement
Measurement Systems
Systems
Two possible measurement systems are
actual costing and normal costing.
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
Measurement Systems
Systems
A
Apredetermined
predetermined
overhead
overhead rate
rate isis aa rate
rate
based
based on
on estimated
estimated data.
data.
Budgeted (estimated) cost
Estimated activity usage

4 -10

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

4 -11

Units
(of
driver)

Theoretical
Practical
Expected actual

Normal

Time

4 -12

Functional-Based
Functional-Based Costing:
Costing: Plantwide
Plantwide Rate
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
Expected activity (DLH)
Actual activity (DLH)
Actual overhead

$360,000
100,000
100,000
$380,000

4 -14

Belring, Inc.
Predetermined Overhead
Rate =

Budgeted (estimated) cost

Estimated activity usage

Predetermined
Overhead Rate =
Predetermined
Overhead Rate =

$360,000
100,000 DLH
$3.60 per DLH

The
The total
total overhead
overhead
assigned
assigned to
to actual
actual
production
production isis called
called
applied
applied overhead.
overhead.
Overhead rate
Applied
x
=
overhead
Actual activity
output

4 -15

4 -16

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

4 -17

Per-Unit Cost

Belring, Inc.
Cordless

Regular

$ 78,000

$ 738,000

$3.60 x 10,000

36,000

---

$3.60 x 90,000

---

324,000

Total manufacturing costs

$114,000

$1,062,000

Units produced

10,000

100,000

Unit cost

$ 11.40

Prime costs
Overhead costs:

10.62

Functional-Based
Functional-Based Costing
Costing Department
Department Rates
Rates

4 -18

Overhead Costs
Allocation
Direct Tracing

Assign Costs

Driver Tracing

Department A Pool

Stage One: Pool

Formation

Department B Pool

Assign Costs

Unit-Level Drivers

Assign Costs

Products

Stage Two: Costs

Assigned

Products

Departmental
Departmental Data
Data

4 -19

Belring, Inc.
Fabrication Assembly
Budgeted overhead

$252,000

$108,000

Cordless

7,000

3,000

Regular

13,000

77,000

20,000

80,000

Cordless

4,000

1,000

Regular

36,000

9,000

40,000

10,000

Expected and actual usage (dlh):

Expected and actual usage (mh.):

4 -20

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

4 -21

Belring, Inc.
Per-Unit
Per-Unit Cost:
Cost: Departmental
Departmental Rates
Rates
Cordless
Prime costs

Regular

$ 78,000

$ 738,000

29,250

---

---

330,750

Total manufacturing costs

$107,250

$1,068,750

Units produced

10,000

100,000

Unit cost

Overhead costs:
($6.30 x 4,000) + ($1.35 x 3,000)
($6.30 x 36,000) + (1.35 x 77,000)

10.73

10.69

4 -22

Symptoms
Symptoms of
of an
an Outdated
Outdated
Functional
Functional Cost
Cost System
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.
Continued
Continued

4 -23

Symptoms
Symptoms of
of an
an Outdated
Outdated
Functional
Functional Cost
Cost System
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
Non-unit activity
activity drivers
drivers are
are
factors
factors that
that measure
measure the
the
consumption
consumption of
of non-unit
non-unit
activities
activities by
by products
products and
and other
other
cost
cost objects.
objects.

4 -25

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

4 -26

Belring, Inc.
Product-Costing
Product-Costing Data
Data
Cordless

Regular

Total

10,000

100,000

110,000

$78,000

$738,000

$816,000

10,000

90,000

100,000

5,000

45,000

50,000

Production runs

20

10

30

Number of moves

60

30

90

Units produced per year

Prime costs
Direct labor hours
Machine hours

Activity
Activity Usage
Usage
Measures
Measures

4 -27

Belring, Inc.
Product-Costing
Product-Costing Data
Data
Activity

Activity Cost

Setups

$120,000

Material handling
Machining

60,000
100,000

Testing

80,000

Total

$360,000

Overhead Activities

4 -28

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead
Activity

Setups

Cordless
Phone

Regular
Phone

0.67

0.33

Activity
Driver

Production runs

0.33

Number of moves

0.90

Machine hours

0.90

Direct labor hours

Material
handling
Machining
Testing
a

0.67
0.10

0.10

20/30 (cordless) and 10/30 (regular)

4 -29

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead
Activity

Setups

Cordless
Phone

Regular
Phone

0.67

0.33

Activity
Driver

Production runs

0.33

Number of moves

0.90

Machine hours

0.90

Direct labor hours

Material
handling
Machining
Testing
b

0.67
0.10

0.10

60/90 (cordless) and 30/90 (regular)

4 -30

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead
Activity

Setups

Cordless
Phone

Regular
Phone

0.67

0.33

Activity
Driver

Production runs

0.33

Number of moves

0.90

Machine hours

0.90

Direct labor hours

Material
handling
Machining
Testing
c

0.67
0.10

0.10

5,000/50,000 (cordless) and 45,000/50,000 (regular)

4 -31

Belring, Inc.
Product
Product Diversity:
Diversity: Consumption
Consumption Ratios
Ratios
Overhead
Activity

Setups

Cordless
Phone

Regular
Phone

0.67

0.33

Activity
Driver

Production runs

0.33

Number of moves

0.90

Machine hours

0.90

Direct labor hours

Material
handling
Machining
Testing
d

0.67
0.10

0.10

10,000/100,000 (cordless) and 90,000/100,000 (regular)

4 -32

Belring, Inc.
Activity
Activity Rates
Rates
Setup rate:

$120,000/30 =$4,000 per run

Material-handling
rate:
$60,000/90 = $666.67 per move
Machining rate:

$100,000/50,000 = $2 per MH

Testing rate:

$80,000/100,000 = $0.80 per DLH

4 -33

Belring, Inc.
Activity
Activity Rates
Rates
Cordless
$4,000
$ 78,000
x
$667
20
x
$2
60
x
80,000
$0.80
5,000
x
40,000
10,000
10,000

Regular
$4,000
$ 738,000
x
$667
10
x
$2
30
x
40,000
$0.80
45,000
x
20,000
90,000
90,000

8,000

72,000

$216,000

$ 960,000

Units produced

10,000

100,000

Unit cost (total costs/units)

Prime costs
Overhead costs:
Setups
Material handling
Machining
Testing
Total manufacturing costs

21.60

9.60

4 -34

Belring, Inc.
Comparison
Comparison of
of Unit
Unit Costs
Costs
Cordless

Regular

$11.40

$10.62

Departmental rate

10.73

10.69

Activity rate

21.60

9.60

Plantwide rate

ABC: Two-Stage Assignment

4 -35

Cost of Resources

Driver
Tracing

Assign Costs
Activities

Driver
Tracing

Assign Costs
Products

Driver
Tracing

4 -36

A
secondary
activity
isis
A
secondary
activity
A
primary
activity
isis
A
primary
activity
one
that
isis consumed
by
one
that
consumed
by
one
that
is
consumed
by
oneother
that is
consumed
by
primary
and
other primary
and
aa product
or
customer.
product oractivities.
customer.
secondary
secondary activities.

4 -37

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

4 -38

Classification
Classification of
of Activities
Activities
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.

4 -39

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

4 -40

Classification
Classification of
of Activities
Activities
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.

4 -41

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

4 -42

A1

A2

A3

A4

A5

Activit
y Level
Filter

Unit Level

Batch Level

Product Level

Driver
Filter

Driver
Filter

Driver
Filter

Set 1

Set 2

Set 3

Set 4

Set 5

Set 6

Facility Level

Set 7

4 -43

Customer
Costing versus
Product Costing

4 -44

Example
Example

Large Customer Ten Smaller Customers

(50% of sales)
(50% of sales)

Units purchased
Orders placed
Number of sales calls
Manufacturing cost
Order-filling costs
allocated
Sales-force costs
allocated

500,000

500,000

200

10

210

$3,000,000

$3,000,000

$202,000

$202,000

$110,000

$110,000

4 -45

Example
Example
The purchasing manager uses two suppliers,
Murray Inc. and Plata Associates, as the source of
two machine parts: Part A1 and Part B2.
Activity
Repairing products

Costs
$800,000

Expending products

200,000

4 -46

Example
Example
Unit purchase price
Units purchased
Failed units
Late shipments

Murray Inc.
Part A 1 Part B2
$20
$52

Plata Associates
Part A 1 Part B2
$24
$56

80,000

40,000

10,000

10,000

1,600

380

10

10

60

40

Repair rate = $800,000 2,000 = $400 per failed part

Expediting rate = $200,000 100 = $2,000 per late
(1,600 + 380 + 10 + 10)
delivery
60 + 40

4 -47

Example
Example
Purchase cost

Murray Inc.
Part A 1
Part B2
$1,600,000 $2,080,000

Repairing products

640,000

152,000

Expediting products

120,000

80,000

Plata Associates
Part A 1 Part B2
$240,000 $560,000
4,000

4,000

Total costs
Units

$2,360,000 $2,312,000
80,000 40,000

$244,000
10,000

$564,000
10,000

Total unit cost

$ 56.40

29.50

57.80

24.40

4 -48

Chapter Four

The
The End
End

4 -49