COST MANAGEMENT

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 4
Activity-Based Costing

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 1

Cengage Learning and South-Western are trademarks used herein under license.
 Study Objectives
1. Describe the basics of plantwide and
departmental overhead costing.
2. Explain why plantwide and departmental
overhead costing may not be accurate.
3. Provide a detailed description of activity-
based product costing.
4. Explain how the activity-based costing
systems can be simplified.
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 Functional-Based
Product Costing Model

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 Functional-Based Product Costing
Overhead costs are assigned to products using
predetermined overhead rates.

Budgeted Budgeted
Overhead = annual  annual
rate overhead driver level

Actual
Applied = Overhead  driver
overhead rate usage
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 Overhead Application:
Plantwide Rates
Suncal, Inc.
Budgeted overhead $360,000
Expected activity (in direct labor hours) 120,000
Predetermined overhead rate $ 3.00

Pocket Currency
calculator translator
Actual activity (in direct labor hours) 40,000 60,000
Predetermined overhead rate $3.00 $3.00
Overhead applied to production $120,000 $180,000
Units produced 80,000 90,000
Overhead per unit $1.50 $2.00

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 Overhead Variances
• Overapplied overhead
– Applied overhead > actual overhead
• Underapplied overhead
– Applied overhead < actual overhead

• Disposition of overhead variances

– Immaterial: assign to cost of goods sold
– Material: allocate among inventories and cost
of goods sold
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 Overhead Application:
Plantwide Rates
Pocket Currency
calculator translator Total
Actual activity (in direct labor hours) 40,000 60,000
Predetermined overhead rate $3.00 $3.00
Overhead applied to production $120,000 $180,000 $300,000
Units produced 80,000 90,000
Overhead per unit $1.50 $2.00
Actual overhead 320,000
Underapplied overhead $20,000

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 Overhead Application:
Departmental Rates
Production Departments
Fabrication Assembly Total
Overhead $ 280,000 $ 80,000 $ 360,000
Direct labor hours:
Pocket calculator 10,000 30,000 40,000
Currency translator 10,000 50,000 60,000
Total DL hours 20,000 80,000 100,000
Machine hours:
Pocket calculator 5,000 1,000 6,000
Currency translator 15,000 2,000 17,000
Total machine hours 20,000 3,000 23,000

Application rate $ 14.00 $ 1.00

per machine per direct labor
hour hour

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 Overhead Application:
Departmental Rates
Pocket Currency
calculator translator
Fabrication:
5,000 hr × $14.00 $70,000
15,000 hr × $14.00 $210,000
Assembly:
30,000 hr × $1.00 30,000
50,000 hr × $1.00 50,000
$100,000 $260,000
Units produced 80,000 90,000
Overhead per unit $1.25 $2.89

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 Limitations of Plantwide and
Departmental Rates
• Non-Unit-Related Costs
– The use of either plantwide or departmental
rates assumes that the number of units
produced causes overhead costs to increase
– Some overhead costs are not driven by the
number of units produced
• Product Diversity
– Products consume overhead activities in
different proportions
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Limitations of Plantwide and
Departmental Rates

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 Unit Cost Based on
Plantwide and Departmental Rates
Scented Regular
PLANT-WIDE RATE This schedule uses
Prime costs $ 160,000 $ 1,500,000 the data from exhibit
Overhead costs: 4-2 to determine unit
$4.00 × 20,000 80,000 cost using a single
$4.00 × 160,000 640,000
plantwide overhead
Total manufacturing costs $ 240,000 $ 2,140,000
Units of production 20,000 200,000 rate based on direct
Unit cost $ 12.00 $ 10.70 labor hours.
DEPARTMENTAL RATES
Prime costs $ 160,000 $ 1,500,000
Overhead costs:
Cutting Department:
This schedule uses
$1.35 × 10,000 13,500 the data from exhibit
$1.35 × 150,000 202,500 4-2 to determine unit
Printing deparment: cost using department
$6.30 × 8,000 50,400 overhead rates based
$6.30 × 72,000 453,600 on labor (cutting) and
Total manufacturing costs $ 223,900 $ 2,156,100
Units of production 20,000 200,000
machine (printing)
Unit cost $ 11.20 $ 10.78 hours. 12
 Limitations of Plantwide and
Departmental Rates
• Application of overhead using unit-based
drivers may be inappropriate if
– Multiple products are produced
– Product diversity exists
– Non-unit-level overhead is a significant
percentage of production costs

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 Limitations of Plantwide and
Departmental Rates
Scented Regular
ACTIVITY RATES
Prime costs $ 160,000 $ 1,500,000
4 Activities:
Overhead costs:
Setting up: Setup
$2,400 × 60 144,000 Cost $240,000
$2,400 × 40 96,000 Qty 100
Machining: Machining
$2.22 × 10,000 22,200 Cost $200,000
$2.22 × 80,000 177,600
Qty 90,000
Inspecting:
$8.89 × 2,000 17,780
Inspecting
$8.89 × 16,000 142,240 Cost $160,000
Moving materials: Qty 18,000
$400 × 180 72,000 Moving materials
$400 × 120 48,000 Cost $120,000
Total manufacturing costs $ 415,980 $ 1,963,840 Qty 300
Units of production 20,000 200,000
Unit cost $ 20.80 $ 9.82
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 Design Steps for an ABC System
1. Identify, define, and classify activities and
key attributes
 Activity inventory – a list of identified
activities
 Activity definition – financial and
nonfinancial descriptions of the activities
 Activity classification – primary and
secondary
 Activity dictionary – activity name,
description, driver, and cost objects
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 Design Steps for an ABC System
2. Assign the cost of resources to the
activities
 Cost of performing each activity
 Use both direct and indirect tracing
 General ledger costs are unbundled and
reassigned

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 Design Steps for an ABC System
3. Assign the cost of secondary activities
 To those activities that consume their
output
 Total cost of the secondary activity is the
sum of the direct and assigned costs

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 Design Steps for an ABC System
4. Identify cost objects and specify the
amount of each activity consumed by
specific cost objects
 Cost objects are identified
 Activity drivers are used to measure the
demands placed on activities.
 Transaction drivers – measure demand by
quantity of events
 Duration drivers – measure demand by
elapsed time

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 Design Steps for an ABC System
5. Calculate primary activity rates
 Budgeted activity costs 
 
 Practical activity capacity 
6. Assign activity costs to cost objects
 Multiply activity rate by activity measure

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Reducing the Size and Complexity
of an ABC System
• Approximately Relevant ABC Systems
– Use only the most expensive activities for
ABC assignment.
• Assign using cause-and-effect drivers
– All other activity costs are added to cost pools
of the expensive activities

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Reducing the Size and Complexity
of an ABC System
• Time-Driven ABC System
– Overcomes the drawback of traditional ABC
systems: few people report idle or unused
time
1) Managers estimate practical capacity as a
percentage of theoretical capacity
2) Determine a per-time-unit rate
3) Determine the time required for one unit of
activity
4) Multiply rate by time
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COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan

End Chapter 4

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