Activity-Based Costing CHAPTER Activity-Based Costing

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

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 cost is the total cost associated with the units produced divided by the number of units 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

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

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

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

Measurement 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.(estimasi overhead cost).

Measurement Systems A predetermined overhead rate is a rate based on estimated data. Budgeted (estimated) cost Estimated activity usage

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

Activity Cost Measures Units (of driver) Theoretical Practical Expected actual Normal Time

Functional-Based Costing: Plantwide Rate Overhead Costs Assign Costs Direct Tracing Plantwide Pool Stage One: Pool Formation Assign Costs Unit-Level Driver Products Stage Two: Costs Assigned

Belring, Inc. Budgeted overhead $360,000 Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following actual and budgeted data: . Budgeted overhead $360,000 Expected activity (DLH) 100,000 Actual activity (DLH) 100,000 Actual overhead $380,000

Belring, Inc. Predetermined Overhead Rate = Budgeted (estimated) cost Estimated activity usage Predetermined Overhead Rate = $360,000 100,000 DLH Predetermined Overhead Rate = $3.60 per DLH

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

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

Belring, Inc. Per-Unit Cost Cordless Regular Prime costs $ 78,000 $ 738,000 Overhead costs: $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 $ 10.62

Functional-Based Costing Department Rates Overhead Costs Assign Costs Allocation Driver Tracing Direct Tracing Department A Pool Department B Pool Stage One: Pool Formation Assign Costs Unit-Level Drivers Products Stage Two: Costs Assigned

Belring, Inc. Departmental Data Fabrication Assembly Budgeted overhead $252,000 $108,000 Expected and actual usage (dlh): Cordless 7,000 3,000 Regular 13,000 77,000 20,000 80,000 Expected and actual usage (mh.): Cordless 4,000 1,000 Regular 36,000 9,000 40,000 10,000

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

Per-Unit Cost: Departmental Rates Belring, Inc. Per-Unit Cost: Departmental Rates Cordless Regular Prime costs $ 78,000 $ 738,000 Overhead costs: ($6.30 x 4,000) + ($1.35 x 3,000) 29,250 --- ($6.30 x 36,000) + (1.35 x 77,000) --- 330,750 Total manufacturing costs $107,250 $1,068,750 Units produced  10,000  100,000 Unit cost $ 10.73 $ 10.69

Symptoms of an Outdated Functional Cost 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

Symptoms of an Outdated Functional Cost 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.

Non-unit activity drivers are factors that measure the consumption of non-unit activities by products and other cost objects.

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

Activity Usage Measures Belring, Inc. Product-Costing Data Cordless Regular Total Units produced per year 10,000 100,000 110,000 Prime costs $78,000 $738,000 $816,000 Direct labor hours 10,000 90,000 100,000 Machine hours 5,000 45,000 50,000 Production runs 20 10 30 Number of moves 60 30 90 Activity Usage Measures

Belring, Inc. Product-Costing Data Overhead Activities Setups $120,000 Activity Activity Cost Setups $120,000 Material handling 60,000 Machining 100,000 Testing 80,000 Total $360,000 Overhead Activities

Product Diversity: Consumption Ratios Belring, Inc. Product Diversity: Consumption Ratios Overhead Cordless Regular Activity Activity Phone Phone Driver a a Setups 0.67 0.33 Production runs Material handling 0.67 0.33 Number of moves Machining 0.10 0.90 Machine hours Testing 0.10 0.90 Direct labor hours b b c c d d 20/30 (cordless) and 10/30 (regular) a

Product Diversity: Consumption Ratios Belring, Inc. Product Diversity: Consumption Ratios Overhead Cordless Regular Activity Activity Phone Phone Driver a a Setups 0.67 0.33 Production runs Material handling 0.67 0.33 Number of moves Machining 0.10 0.90 Machine hours Testing 0.10 0.90 Direct labor hours b b c c d d 60/90 (cordless) and 30/90 (regular) b

Product Diversity: Consumption Ratios Belring, Inc. Product Diversity: Consumption Ratios Overhead Cordless Regular Activity Activity Phone Phone Driver a a Setups 0.67 0.33 Production runs Material handling 0.67 0.33 Number of moves Machining 0.10 0.90 Machine hours Testing 0.10 0.90 Direct labor hours b b c c d d 5,000/50,000 (cordless) and 45,000/50,000 (regular) c

Product Diversity: Consumption Ratios Belring, Inc. Product Diversity: Consumption Ratios Overhead Cordless Regular Activity Activity Phone Phone Driver a a Setups 0.67 0.33 Production runs Material handling 0.67 0.33 Number of moves Machining 0.10 0.90 Machine hours Testing 0.10 0.90 Direct labor hours b b c c d d 10,000/100,000 (cordless) and 90,000/100,000 (regular) d

Belring, Inc. Activity 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

Belring, Inc. Activity Rates Cordless Regular Prime costs $ 78,000 $ 738,000 Overhead costs: Setups 80,000 40,000 Material handling 40,000 20,000 Machining 10,000 90,000 Testing 8,000 72,000 Total manufacturing costs $216,000 $ 960,000 Units produced  10,000  100,000 Unit cost (total costs/units) $ 21.60 $ 9.60 $4,000 x 20 $4,000 x 10 $667 x 60 $667 x 30 $2 x 5,000 $2 x 45,000 $0.80 x 10,000 $0.80 x 90,000

Comparison of Unit Costs Belring, Inc. Comparison of Unit Costs Cordless Regular Plantwide rate $11.40 $10.62 Departmental rate 10.73 10.69 Activity rate 21.60 9.60

ABC: Two-Stage Assignment Cost of Resources Assign Costs Driver Tracing Driver Tracing Activities Assign Costs Driver Tracing Products

A primary activity is one that is consumed by a product or customer. A secondary activity is one that is consumed by other primary and secondary activities. A primary activity is one that is consumed by a product or customer.

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

Classification of 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.

Classification of 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.

Classification of 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.

Classification of 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.

A A A A A Activity Level Filter Unit Level Batch Level Product Level 1 2 3 4 5 Activity Level Filter Unit Level Batch Level Product Level Facility Level Driver Filter Set 7 Set 1 Set 2 Set 3 Set 4 Set 5 Set 6

Customer Costing versus Product Costing

Large Customer Ten Smaller Customers Example Large Customer Ten Smaller Customers (50% of sales) (50% of sales) Units purchased 500,000 500,000 Orders placed 2 200 Number of sales calls 10 210 Manufacturing cost $3,000,000 $3,000,000 Order-filling costs allocated $202,000 $202,000 Sales-force costs allocated $110,000 $110,000

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 Costs Repairing products $800,000 Expending products 200,000

Example Repair rate = $800,000 ÷ 2,000 = $400 per failed part Murray Inc. Plata Associates Part A 1 Part B2 Part A 1 Part B2 Unit purchase price $20 $52 $24 $56 Units purchased 80,000 40,000 10,000 10,000 Failed units 1,600 380 10 10 Late shipments 60 40 0 0 Repair rate = $800,000 ÷ 2,000 = $400 per failed part (1,600 + 380 + 10 + 10) Expediting rate = $200,000 ÷ 100 = $2,000 per late delivery 60 + 40

Example Murray Inc. Plata Associates Part A 1 Part B2 Part A 1 Part B2 Purchase cost $1,600,000 $2,080,000 $240,000 $560,000 Repairing products 640,000 152,000 4,000 4,000 Expediting products 120,000 80,000 Total costs $2,360,000 $2,312,000 $244,000 $564,000 Units ÷ 80,000 ÷ 40,000 ÷ 10,000 ÷ 10,000 Total unit cost $ 29.50 $ 57.80 $ 24.40 $ 56.40

Chapter Four The End