Activity-Based Absorption Costing Appendix 3A

Use activity-based absorption costing to compute unit product costs. Learning Objective 8 (Appendix 3A) Use activity-based absorption costing to compute unit product costs.

Activity-Based Absorption Costing Activity-based absorption costing assigns all manufacturing overhead costs to products using activity cost pools instead of Plantwide or department cost pools.

Activity-Based Absorption Costing Key Definitions and Concepts An activity is an event that causes the consumption of overhead resources. An activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity. An activity measure is an allocation that is used as the denominator for an activity cost pool. An activity rate is used to assign costs from an activity cost pool to products.

Activity-Based Adsorption Costing Activity-based absorption costing differs from traditional absorption costing in two ways: The activity based approach uses more cost pools than a traditional approach. The activity-based approach includes some batch-level and product-level activities and activity measures that do not relate to the volume of units produced, whereas the traditional approach relies exclusively on volume-related overhead allocation.

Simmons Industries – a traditional approach Simmons Industries provides the following information for the company as a whole and for its only two products—deluxe and standard hedge trimmers.

Simmons Industries – a traditional approach Assuming that Simmons’ traditional cost system relies on one predetermined plantwide overhead rate with direct labor-hours (DLHs) as the allocation base, then its plantwide overhead rate is computed as follows: Predetermined overhead rate = $4.50 per DLH = $1,800,000 400,000 DLHs

Simmons Industries – a traditional approach Simmons’ traditional cost system would report unit product costs as follows: 2.0 DLH × $4.50 per DLH 1.0 DLH × $4.50 per DLH

Simmons Industry Activity-Based Absorption Costing The ABC project team at Simmons has developed the following basic information.

Simmons Industry Activity-Based Absorption Costing We can calculate the following activity rates: Using the new activity rates, let’s assign overhead to the two products based upon expected activity.

Simmons Industry Activity-Based Absorption Costing Deluxe Product Standard Product

Simmons Industry Activity-Based Absorption Costing Activity-based unit product costs for both product lines

Simmons Industry Activity-Based Absorption Costing Activity-based unit product costs for both product lines $1,130,000 ÷ 100,000 units $670,000 ÷ 200,000 units

Comparing the Two Approaches Note that the unit product cost of a Standard unit decreased from $44.50 to $43.35 . . . . . . . . . . while the unit cost of a Deluxe unit increased from $71.00 to $73.30.

Comparing the Two Approaches Note that the unit product cost of a Standard unit decreased from $44.50 to $43.35 . . . . . . . . . . while the unit cost of a Deluxe unit increased from $71.00 to $73.30. The activity-based approach contains two non-volume-related cost pools –”setting up machines” which is a batch-level activity and “parts administration” which is a product-level activity. The activity–based approach assigned these costs to products in a way that shifted costs from the high volume product (standard) to the low volume product (deluxe).

End of Chapter 3 – Appendix A