Chapter 4-1 Don R. Hansen Maryanne M. Mowen Nabil S. Elias David W. Senkow MANAGEMENT ACCOUNTING Copyright 2001 Nelson Thomson Learning

Chapter 4-2 Chapter Four Activity-Based Costing

Chapter 4-3 Learning Objectives l Discuss the importance of unit costs. l Describe functional-based costing approaches. l Explain why functional-based costing approaches may produce distorted costs. l Explain how an activity-based costing system works.

Chapter 4-4 l Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates. l Describe the role of activity-based costing for organizations with only one product, homogeneous products, or a JIT structure. Learning Objectives (continued)

Chapter 4-5 Unit Costs The unit cost is the total cost associated with the units produced divided by the number of units produced Although the concept is simple, the practical reality of the computation can be somewhat more complex because of the following issues: –What is meant by “total cost”? –How do we measure the costs to be assigned? –How do we assign costs to the product?

Chapter 4-6 Unit Costs (continued) Unit costs are important for: l inventory valuation l income determination l providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders

Chapter 4-7 Measurement Systems Two possible measurement systems are actual costing and normal costing. Actual costing assigns the actual costs of direct materials, direct labour, and overhead to products. Normal costing assigns the actual costs of direct materials and direct labour to products; however, overhead cots are assigned to products using predetermined rates.

Chapter 4-8 Activity Capacity Measures Units (of driver) Theoretical Practical Expected actual Normal Time

Chapter 4-9 Functional-Based Costing: Plantwide Rate Overhead Costs Assign Costs Plantwide Pool Assign Costs Products Direct Tracing Stage One: Pool Formation Unit-Level Driver Stage Two: Costs Assigned

Chapter 4-10 Belring, Inc. 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

Chapter 4-11 Belring, Inc. (continued) CordlessRegular Units produced10,000100,000 Prime costs$78,000$738,000 Direct labour hours10,00090,000

Chapter 4-12 Belring, Inc. (continued) Predetermined Overhead Rate= Budgeted overhead  Expected activity =$360,000  100,000 DLH =$3.60 per DLH

Chapter 4-13 Belring, Inc. – Unit Cost Computation: Plantwide Rate CordlessRegular Prime costs$ 78,000$ 738,000 Overhead costs: $3.60 x 10,00036, $3.60 x 90, ,000 Total mfg. costs$114,000$1,062,000 Units produced  10,000  100,000 Unit cost$ 11.40$ ===============

Chapter 4-14 Functional-Based Costing: Departmental Rates Overhead Costs Assign Costs Department A Pool Assign Costs Products Department B Pool Assign Costs Products Stage One: Pool Formation Unit-Level Drivers Stage Two: Costs Assigned

Chapter 4-15 Belring, Inc. – Departmental Data FabricationAssembly Budgeted OH$252,000$108,000======= Expected and actual usage (DLH): Cordless7,0003,000 Regular13,00077,000 20,00080,000===== Expected and actual usage (MH): Cordless4,0001,000 Regular36,000 9,000 40,00010,000=====

Chapter 4-16 Belring, Inc. – Departmental Rates Overhead Rates: Fabrication Rate=Budgeted OH / Expected MH =$252,000/40,000 =$6.30 per MH Assembly Rate=Budgeted OH / Expected DLH =$108,000/80,000 =$1.35 per DLH

Chapter 4-17 Belring, Inc. – Unit Cost Computation: Departmental Rate CordlessRegular Prime costs$ 78,000$738,000 Overhead costs: ($6.30 x 4,000) + ($1.35 x 3,000) 29, ($6.30 x 36,000) + ($1.35 x 77,000) ,750 Total mfg. costs$107,250$1,068,750 Units produced  10,000  100,000 Unit cost$ 10.73$ ===============

Chapter 4-18 Symptoms of an Outdated Functional Cost System l The outcome of bids is difficult to explain. l Competitors’ prices appear unrealistically low. l Products that are difficult to produce show high profits. l Operational managers want to drop products that appear profitable. l Profit margins are difficult to explain.

Chapter 4-19 Symptoms of an Outdated Functional Cost System (continued) l The company has a highly profitable niche all to itself. l Customers do not complain about price increases. l The accounting department spends a lot of time supplying cost data for special projects. l Some departments are using their own accounting system. l Product costs change because of changes in financial reporting regulations.

Chapter 4-20 Belring, Inc.– Activity Usage CordlessRegularTotal Units produced per year10,000100,000110,000 Prime costs$78,000$738,000$816,000 Direct labour hours10,00090,000100,000 Machine hours5,00045,00050,000 Production runs Number of moves603090

Chapter 4-21 Belring, Inc. – Additional OH Cost Data ActivityActivity Cost Setups$120,000 Material handling60,000 Machining100,000 Testing 80,000 Total$360,000 =======

Chapter 4-22 ABC: Two-Stage Assignment Cost Of Resources Assign Costs Activities Assign Costs Products Direct Tracing Driver tracing Driver Tracing

Chapter 4-23 Belring, Inc. – Activity Rates Activity rates are computed below: Setup rate:$120,000/30 = $4,000 per run Material-handling rate:$60,000/90 = $ per move Machining rate:$100,000/50,000 = $2 per MH Testing rate:$80,000/100,000 = $0.80 per DLH

Chapter 4-24 Belring, Inc. – Activity-Based Costing Unit Cost Computation CordlessRegular Prime costs$ 78,000$ 738,000 Overhead costs: Setups80,00040,000 Material handling40,00020,000 Machining10,00090,000 Testing 8,000 72,000 Total mfg. costs$216,000$ 960,000 Units produced  10,000  100,000 Unit cost$ 21.60$ 9.60=====

Chapter 4-25 Comparison of Unit Costs CordlessRegular Plantwide rate$11.40$10.62 Departmental rate Activity rate

Chapter 4-26 Activity Categories 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 labour activities are also unit-level activities, even though they are not overhead costs.

Chapter 4-27 Activity Categories (continued) Batch-level Activities are those that are performed each time a batch of products is produced. Examples: Setups, inspections, production scheduling, and material handling.

Chapter 4-28 Activity Categories (continued) 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, and expediting.

Chapter 4-29 Activity Categories (continued) Facility-level Activities are those that sustain a factory's general manufacturing processes. Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.

Chapter 4-30 When To Use An ABC System Cost Low High Optimal Cost Level Measurement Cost Error Costs Level of Accuracy

Chapter 4-31 Comparison of JIT with Traditional Manufacturing JITTraditional 1.Pull-through system1.Push-through system 2.Insignificant inventories2.Significant inventories 3.Small supplier base3.Large supplier base 4.Long-term supplier contracts4.Short-term supplier contracts 5.Cellular structure5.Departmental structure 6.Multiskilled labour6.Specialized labour 7.Decentralized services7.Centralized services 8.High employee involvement8.Low employee involvement 9.Facilitating management style9.Supervisory management style 10.Total quality control10.Acceptable quality level

Chapter 4-32 End of Chapter 4