1. Chapter 5 Activity-Based Costing

3. Over- and Undercosting Overcosting – a product consumes a low level of resources (costs) but is allocated high costs per unit Undercosting – a product consumes a high level of resources (costs) but is allocated low costs per unit

4. Plastim Corporation Manufactures lenses for rear taillights of automobiles Makes two types of lenses for Giovanni Motors –A complex lens, CL5 –A simple lens, S3 Processes at Plastim include: –Design products –Manufacture lenses –Distribute lenses

5. Some Basic Data at Plastim Simple S3 lenses – 60,000 units (sales) budgeted for 2010 –Uses 30,000 DLH’s –Sells for $63 each –Competitor has offered this product for $53 to Giovanni Complex CL5 lenses – 15,000 units (sales) budgeted for 2010 –Uses 9,750 DLH’s –Sells for $137 each –No price pressure exists

6. Product Costing at Plastim To guide pricing and cost-management decisions, Plastim assigns all costs (both mfg. and non-mfg.) to its products Plastim’s simple costing system traces direct materials and direct labor costs to products (CL5 and S3 lenses) All other costs in the value chain are allocated to products using a single overhead rate using DLH as the allocation base

7. Overview of Plastim’s Simple Costing System

9. Allocation of Indirect Costs to Products (Step 6) Plastim expects to use 30,000 total direct manufacturing labor-hours to make the 60,000 S3 lenses, and 9,750 total direct manufacturing labor- hours to make the 15,000 CL5 lenses. Thus, indirect costs of $1,800,000 are allocated to the simple lens, and $585,000 are allocated to the complex lens.

10. Plastim’s Product Costs Using Simple Costing

12. Guidelines for Refining a Cost System Direct-cost tracing - categorize as many of the overall costs as direct costs (as economically feasible) Divide indirect-cost pool into several homogeneous groups (pools) with cause-and- effect relationships between the cost driver and indirect cost Define cost-allocation bases (cost drivers) for each cost pool using cause-and-effect criterion

13. Activity-Based Costing Systems

17. Allocation of Setup Costs to Products SimpleComplex S3 LensCL5 LensTotal Setup cost allocated using direct manufacturing $ 226,415 $ 73,585 $ 300,000 labor-hours: $7.54717 X 30,000; $7.54717 X 9,750 Setup cost allocated using setup-hours: $ 75,000 $ 225,000 $ 300,000 $150 X 500; $150 X 1,500

18. Cost Hierarchies A cost hierarchy defines each activity cost pool as falling into one of four categories The four categories in ABC systems are as follows: –Unit-level (output-level) costs –Batch-level costs –Product-sustaining-level costs –Facility-sustaining-level costs

19. Definitions Unit-level – activities undertaken for every part made (machining operations) Batch-level – activity is related to a group of units produced (setup, move material) Product-sustaining – activity supports individual products regardless of the number of units or batches produced Facility-sustaining – activities that support the organization as a whole. Assigned costs cannot be traced to any particular product (administrative costs, building rent, landscaping services)

20. Overview of Plastim’s ABC System

22. Activity-Cost Rates for Plastim’s Indirect Costs Pools

23. Plastim’s Product Costs Using ABC

24. Plastim: Simple & ABC Compared

25. Activity-Based Management A method of management that used ABC as an integral part in critical decision-making situations, including: –Pricing and product-mix decisions –Cost reduction and process improvement decisions –Design decisions –Planning and managing activities