Activity-Based Costing and Management CHAPTER 5 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Traditional, Volume-Based Product-Costing System Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records: Aerotech produces three complex printed circuit boards referred to as Mode I, Mode II, and Mode III. The following information is obtained from company records: 5-2

Traditional, Volume-Based Product-Costing System Additional information includes: Manufacturing overhead is determined as follows 5-3

Traditional, Volume-Based Product-Costing System Budgeted manufacturing overhead $3,894,000 Budgeted direct-labor hours 118,000 = $33 per hour 5-4

Traditional, Volume-Based Product-Costing System With these product costs, Aerotech established target selling prices (Cost × 125%) x

Activity Based Costing System (ABC) two-stage ABC systems follow a two-stage procedure to assign overhead costs to products. Stage One Identify significant activities and assign overhead costs to each activity in proportion to resources used. Stage Two Identify cost drivers appropriate to each activity and allocate overhead to the products. 5-6

Overhead Costs Total budgeted cost = $3,894,000 ActivityCostPools Machinery cost pool $1,212,600Setup $3,000Engineering $700,000Facility $507,400 Unit- Level Batch- Level Product- Sustaining- Level Facility- Level Identification of Activity Cost Pools Identification of Activity Cost Pools Activity must be done on each unit produced. Activityperformed on each batchproduced. Activities needed to support an entire product line Activity required in order for the production process to occur. 5-7

Receiving/Inspection cost pool $200,000 Material-Handling cost pool $600,000 Quality-Assurance cost pool $421,000 Packaging/Shipping cost pool $250,000 Machinery cost pool $1,212,600Setup $3,000Engineering $700,000Facility $507,400 Unit- Level Batch- Level Product- Sustaining- Level Facility- Level 5-8

Machinery Cost Pool Total budgeted cost = $1,212,600 Maintenance Depreciation Computer Support Lubrication Electricity Calibration Activitycostpool STAGE ONE Various overhead costs related to machinery 5-9

Calculate the pool rate Budgeted Machinery Costs $1,212,600 Budgeted Machine Hours 43,000 $28.20/hour $28.20/hour CostAssignment STAGE TWO = = 5-10

Calculation of total setup cost Setup Cost Pool Total budgeted cost = $3,000 Activitycostpool STAGE ONE 5-11

Calculate the pool rate Budgeted Setup Costs $3,000 Planned Production Runs 15 runs $200 per run $200 per run CostAssignment STAGE TWO = = 5-12

Various overhead costs related to engineering Engineering salaries Engineering supplies Engineering software Depreciation Engineering Cost Pool Total budgeted cost = $700,000Activitycostpool STAGE ONE 5-13

Allocate based on engineering transactions CostAssignment STAGE TWO Engineering Cost Pool Total budgeted cost = $700,

Various overhead costs related to general operations Plant depr. Plant mgmt. Plant maint. Property taxes Insurance Security Facility Cost Pool Total budgeted cost = $507,400Activitycostpool STAGE ONE 5-15

Budgeted Facilities Cost $507,400 Budgeted Direct-Labor Hours 118,000 $4.30/hour $4.30/hour CostAssignment STAGE TWO = = Calculate the pool rate 5-16

Other Overhead Costs 5-17

Other Overhead Costs $

Product Cost from ABC These are the new product costs when Aerotech uses ABC. 5-19

Distorted Product Costs Both original and ABC target selling prices are based on (Cost × 125%). [$ × 1.25][$ × 1.25] The selling price of Mode I and II are decreased, while the selling price for Mode III is increased. 5-20

Can you identify any problems Aerotech is likely to face as a result of this distortion? Traditional costing understates the cost of complex, low volume products. Distorted Product Costs 5-21

Two Key Points A large proportion of non-unit- level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately. A large proportion of non-unit- level activities A unit-level cost driver, such as direct labor, machine hours, or throughput, will not be able to assign the costs of non-unit-level activities accurately. Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs. Product diversity When the consumption ratios differ widely between activities, no single cost driver will accurately assign the resulting overhead costs. 5-22

Activity-Based Management The use of ABC costing information to help management make decisions 5-23

Activity-Based Management Activity-based costing establishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based management focuses on managing activities to reduce costs. 5-24

Two-Dimensional ABC and Activity-Based Management Activities 5-25

Two-Dimensional ABC and Activity-Based Management Cost Objects Activities Resource costs Cost Assignment View 5-26

Two-Dimensional ABC and Activity-Based Management ActivityTriggersActivityTriggers Cost Objects Activities RootCausesRootCauses Process View Activity Analysis Resource costs Cost Assignment View PerformanceMeasuresPerformanceMeasures Activity Evaluation 5-27

Elimination of Non-Value-Added Costs Non-value- added activities Necessary Unnecessary Activities Reduce or Eliminate Continually Evaluate and Improve 5-28

Using ABM to Eliminate Non-Value-Added Activities and Costs Inspection time Process time Storage time Move time Waiting time 5-29

End of Chapter 5 This is my kind of cost pool! 5-30