2. WHAT’S UP WITH C&C SPORTS?
Costs skyrocketed
Variance analysis – 4th quarter
Lining: $6,250 F price; $8,000 U quantity
DL: $1,650 U rate; $14,400 U efficiency
VOH: $26,195 U spending; $3,955 U efficiency
Additional jackets appear to have added complexity to production processes
Need to better understand product costs

4. TRADITIONAL COSTING AND PORS

5. ACTIVITY-BASED COSTING CONCEPT

6. Do both products consume the same amount of forklift resource?
WHAT’S THE COST DRIVER?
DLHS?
batches moved?
Suppose one batch of jackets takes 15 hours and three batches of jerseys take 15 hours.
Do both products consume the same amount of forklift resource?

7. TYPES OF ACTIVITIES Unit-level Batch-level Product-level
Customer-level
Organization-level

8. TYPES OF ACTIVITIES Unit-level Batch-level Product-level
Incurred by production or acquisition of a single unit of product or the delivery of a single unit of service
Batch-level
Incurred when a group of similar things are made, handled or processed at the same time
Product-level
Incurred in support of different products or processes
Customer-level
Incurred to support and sustain a specific customer
Organization-level
Incurred to support and sustain a business unit

9. UNIT LEVEL ACTIVITIES
Volume or level of activity is proportional to the number of units produced
Costs incurred to perform these activities can be allocated using traditional methods such as DLH or MH
C&C – operating sewing machines

10. BATCH-LEVEL ACTIVITIES
Volume or level of activity is proportional to the number of batches produced
Costs are incurred when a group of similar things are made or handled at the same time
C&C – Moving batches of products

11. PRODUCT-LEVEL ACTIVITIES
Activities that support the production and sale of individual products
Related to all units and batches produced, regardless of volume
C&C – creating patterns for new products

12. CUSTOMER LEVEL-ACTIVITIES
Activities performed to support specific customers
Not dependent on the number of units or products sold to that customer
Costs for these resources do not affect product cost
C&C – making sales calls

13. ORGANIZATION-SUSTAINING ACTIVITIES
Activities performed to maintain the plant facility and provide managerial infrastructure
Not dependent on the volume of production, just the number of facilities maintained
The cost of these resources is not allocated to products
C&C – renting factory space

14. COMPARISON OF GAAP AND ABC COSTS
Cost Category
GAAP-Based Product Cost
Activity-Based Product Cost
Direct Materials ✔
Direct Labor
Manufacturing Overhead
Unit-Level ✔
Batch-Level
Product-Level
Organization-Level
NOTICE: Under ABC, organization-level costs are not allocated to products
S&A Expense
Unit-Level ✔
Batch-Level
Product-Level
NOTICE: Under traditional costing, S&A expenses are not allocated to products

15. DO YOU KNOW YOUR ABCS?
Exercise 7-1
© scibak/iStockphoto

16. E 7-1 SOLUTION Unit Batch Product Customer Organizational a.
Setting up a machine for a production run of 500 units X b.
Conducting a seminar for local doctors on the benefits of a new drug c.
Embossing a company logo on every product made d.
Seating a party of 11 at a restaurant e.
Providing technical support for two years following a sale f.
Managing a corporation’s accounting department g.
Attaching a price tag to each product h.
Issuing an invoice i.
Developing a corporate advertising campaign j.
Recalling a defective product

18. FIVE STEPS TO IMPLEMENT ABC
Identify activities
Develop activity cost pools
Calculate activity cost pool rates
Allocate costs to products or services
Calculate unit product costs

19. ACTIVITY-BASED COSTING (STEPS 1 & 2)
See Exhibit 7-5 for details of costs to activity pools

20. ACTIVITY-BASED COSTING (STEP 3)
See Exhibit 7-6 for details of activity cost pool rates

21. ACTIVITY-BASED COSTING (STEP 4)
See Exhibit 7-7 for details of cost allocations to each product

22. ACTIVITY-BASED COSTING (STEP 5)÷ ÷ ÷

23. COMPARISON OF TRADITIONAL & ABC COSTING

24. UNDER TRADITIONAL COSTING SYSTEMS…
Small volume jobs are typically under-costed
Large volume jobs are typically over-costed
In ABC, this is corected as batch-related and product-level costs are allocated using appropriate batch and product cost drivers

25. WHEN YOU CHOOSE THE COST POOLS AND COST DRIVERS…
BE CAREFUL…
WHEN YOU CHOOSE THE COST POOLS AND COST DRIVERS…
Once you select a cost driver, you have to monitor and collect data about the consumption of that activity.
Can your system do that?
There is a cost/benefit tradeoff to consider

26. IT’S PRACTICE TIME
Exercise 7-9

27. E 7-9 SOLUTION a. Overhead rate = = $19.50/MH Simple Complex
Machine hours
50,000
32,000 ×
Overhead rate
$19.50 =
Total overhead to product
$975,000
$624,000
Total assigned overhead = $975,000 + $624,000 = $1,599,000
Simple
Complex
Total overhead to product
$975,000
$624,000 ÷
Number of units produced
125,000
40,000 =
Overhead per unit
$7.80
$15.60

28. E 7-9 SOLUTION (CONT.) b. Simple Assembly 250,000 DLH × $1.25/DLH
$312,500
Fabrication
50,000 MH × $9.75/MH
487,500
Setups
2,500 batches × $18.00/batch
45,000
Bonding
Total overhead
$845,000
Complex
Assembly
160,000 DLH × $1.25/DLH
$200,000
Fabrication
32,000 MH × $9.75/MH
312,000
Set ups
4,000 batches × $18.00/batch
72,000
Bonding
170,000
Total overhead
$754,000
Total assigned overhead = $845,000 + $754,000 = $1,599,000

29. E 7-9 SOLUTION (CONT.) Simple Complex Total overhead to product
$845,000
$754,000 ÷
Number of units produced
125,000
40,000 =
Overhead per unit
$6.76
$18.85

31. Labor costs are too high. What’s your first reaction?
MANAGEMENT SAYS…
Labor costs are too high. What’s your first reaction?
Reduce headcount

32. THE KEY IS ACTIVITY MANAGEMENT
LOOK AT THE ACTIVITIES THAT USE LABOR RESOURCES
Inefficient production processes
Poor facilities layout
Non-value added activities
Untrained workforce

33. WHAT ADDS VALUE TO THE PRODUCT?
Look at your activities
If customers are willing to pay for an activity, it is value-added
If customers aren’t willing to pay for it, the activity is non-value-added
Eliminate the non-value-added activities and the related resources to reduce costs

34. HOW IS ABC INFORMATION USED?
An ABC analysis may reveal interesting information about product profitability.
Source: Activity Based Costing: How ABC is Used in the Organization, Copyright 2005, SAS Institute Inc., Cary, NC. All Rights Reserved. Reproduced with permission of SAS Institute Inc., Cary, NC

35. TRADITIONAL VS ABC PROFITABILITY
Traditional Costing
Pants
Jerseys
Award Jackets
Sales
$12.00
$14.80
$125.00
Production Costs
9.87
11.17
77.12
Product Margin/Unit $ $ $
Product Margin %
17.75%
24.53%
38.30%
Activity-Based Costing
Pants
Jerseys
Award Jackets
Sales
$12.00
$14.80
$125.00
Production Costs
8.20
10.57
80.04
Selling and Administrative
1.65
2.02
20.82
Product Margin/Unit $ $ $
Product Margin %
17.92%
14.93%
19.31%

36. DOES ABC CHANGE PRODUCTION COSTS?NO
ABC re-allocates costs based on the activities consumed by the products

37. ACTIVITY-BASED COSTING RECAP
Recognizes that various activities and cost levels exist
Gathers costs into related cost pools
Uses multiple cost drivers to assign costs to products and services based on the consumption of resources by activities
ABC focuses on attaching costs to products and services based on the activities used to produce, perform, distribute or support those products and services

38. LET’S PUT IT ALL TOGETHER
Problem 7-19
© Denis Pepin/iStockphoto

39. P 7-19 SOLUTION a. POR = = 500% DL$ Cashews Chestnuts Direct material
$4.20
$3.20
Direct labor
0.30
Overhead
1.50
Cost/lb.
6.00
5.00
40% markup
2.40
2.00
Selling price
$8.40
$7.00

40. P 7-19 SOLUTION (CONT.) b. Cost Pool Calculation Activity Rate
Purchasing
= $1,000/purchase order
Material handling
= $800/setup
Quality control
= $500/batch
Roasting
= $20/roasting hour
Seasoning
= $20/seasoning hour
Packaging
= $20/packaging hour

41. P 7-19 SOLUTION (CONT.) Cashews Purchasing × $1,000 $4,000
Purchasing
× $1,000
$4,000
Material handling
× 3 setups × $800
24,000
Quality control
× $500
5,000
Roasting
× 1 hour × $20
20,000
Seasoning
× .5 hour × $20
10,000
Packaging
× .1 hour × $20
2,000
Total overhead
65,000
Pounds produced
÷ 100,000
Overhead per pound
$0.65

42. P 7-19 SOLUTION (CONT.) Chestnuts Purchasing × $1,000 $4,000
Purchasing
× $1,000
$4,000
Material handling
× 3 setups × $800
9,600
Quality control
× $500
2,000
Roasting
× 1 hour × $20
400
Seasoning
× .5 hour × $20
200
Packaging
× .1 hour × $20 40
Total overhead
16,240
Pounds produced
÷ 2,000
Overhead per pound
$8.12

43. P 7-19 SOLUTION (CONT.) Cashews Chestnuts Direct material $4.20 $3.20
Direct labor
.30
Overhead
.65
8.12
Cost/lb.
5.15
11.62
40% markup
2.06
4.65
Selling price
$7.21
$16.27