1. Copyright © 2012 Pearson Education Chapter 18 1

2. Copyright © 2012 Pearson Education Develop activity-based costs (ABC) 1 1 2

3. Copyright © 2012 Pearson Education More accurate method to attach costs to products Refines the way indirect costs are allocated to production Focuses on costs incurred by each production activity Activity costs become the building blocks for allocating costs to products and services Each activity has its own cost driver 3

4. Copyright © 2012 Pearson Education Activity-based costing Divides production process into activities Assigns costs to products based on how much the product USES those activities Cost drivers Activity that drives the cost to being accumulated Examples Quality inspections–number of inspections Warranty Services–number of service calls Shipping–number of kilograms 4

5. Copyright © 2012 Pearson Education Traditional system Uses a plant-wide manufacturing overhead allocation rate 5

6. Copyright © 2012 Pearson Education ABC system Uses a separate allocation rate for each activity 6

7. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 7

8. Copyright © 2012 Pearson Education 8

9. Under traditional system: The gross profit for specialty DVD is $20 per DVD—five times as high as the $4 gross profit for the Excel DVD Management may decide to produce more specialty DVDs Under ABC: Costs are more accurate 9

10. Copyright © 2012 Pearson Education Day, Corp. is considering the use of activity-based costing. The following information is provided for the production of two product lines: Day plans to produce 400 units of Product A and 375 units of Product B. 1. Compute the ABC indirect manufacturing cost per unit for each product. 10

11. Copyright © 2012 Pearson Education 1.The indirect manufacturing cost for Product A is: 2.The indirect manufacturing cost for Product B is: 11 $81.50 $342.40 AB Set-up530.00 x 20 =$10,600530.00 x 180 =$95,400 Machine Maintenance 13.75 x 1,600 =22,00013.75 x 2,40033,000 32,600128,400 Divide by # units÷ 400÷ 325 Cost per unit$81.50342.40 Setup = $106,000 / 200 = $530.00 per set-up Maintenance = $55,000 / 4000 = $13.75 per machine hour

12. Copyright © 2012 Pearson Education Use activity-based management (ABM) to achieve target costs 2 2 12

13. Copyright © 2012 Pearson Education Uses ABC to make decisions Increase profits while meeting customer needs Types of decisions: Pricing and product mix Provides a more accurate cost of products Determines the profitability of products Cutting cost 13

14. Copyright © 2012 Pearson Education 14 Loss versus Profit

15. Copyright © 2012 Pearson Education Reevaluating activities to reduce costs Requires cross-functional teams Marketers—identify customer needs Engineers—design more efficient products Accountants—estimate costs Setting sales prices based on target prices Targeting what customers are willing to pay 15

16. Copyright © 2012 Pearson Education Cost-based: Full cost + Desired profit Sales Price Target based: Target price - Desired profit Target Cost 16

17. Copyright © 2012 Pearson Education Consider all production costs: Direct materials Direct labor Allocated manufacturing overhead Plus all nonmanufacturing costs (operating expenses): Administrative Selling expenses To determine target costs and target profits. 17

18. Copyright © 2012 Pearson Education Target Cost Full Cost Assemble team to: Cut costs, given current production process Redesign the production process to further cut costs 18

19. Copyright © 2012 Pearson Education Company decides to redesign setup to reduce the setup cost per batch Estimated total cost saving is $160,000 Number of batches stay the same 19

20. Copyright © 2012 Pearson Education Revised Cost 20

21. Copyright © 2012 Pearson Education Accel, Corp., makes two products: C and D. The following data have been summarized: Indirect manufacturing cost information includes the following: The company plans to manufacture 150 units of each product. 1. Calculate the product cost per unit for Products C and D using activity-based costing. 21 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit?? ActivityAllocation RateProduct CProduct D Setup$1,500/per setup38 setups75 setups Machine maintenance$ 12/per hour1,400 hours4,000 hours

22. Copyright © 2012 Pearson Education 22 CD Set-up1,500.00 X 38 =$57,0001,500.00 X 75 =$112,500 Machine Maintenance 12.00 X 1,400 =16,80012.00 X 4,000 =48,000 73,800160,500 Divide by # units÷ 150 Cost per unit$4921,070.00 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit4921,070 Product cost per unit$ 1,492$ 3,170

23. Copyright © 2012 Pearson Education In Short Exercise 18-5, Accel Corp. desires a 25% target profit after covering all costs. 1. Considering the total costs assigned to the Products C and D in S18-5, what would Accel have to charge the customer to achieve that profit? 23 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit4921,070 Product cost per unit$ 1,492$ 3,170 Total costs divided by (100% - target profit) = $1,492 ÷ 0.75 = $ 1,989.33 Total costs divided by (100% - target profit) = $3,170 ÷ 0.75 = $ 4,226.67

24. Copyright © 2012 Pearson Education Activity-based costing (ABC) focuses on activities. The costs of those activities become the building blocks for measuring (allocating) the costs of products and services. The total production process and the related costs are divided among the various production activities. A cost driver for the activity is identified, and a rate per activity is calculated. The costs are then allocated to individual products based on the amount of products’ USE of each activity. 24

25. Copyright © 2012 Pearson Education Activity-based management (ABM) uses activity-based costs to make decisions that increase profits while meeting customer needs. Most companies adopt ABC to get better product costs for pricing and product-mix decisions. However, they often benefit more by cutting costs. Target pricing takes the sales price and subtracts desired profit to determine the target cost of manufacturing. 25

26. Copyright © 2012 Pearson Education ABC and value engineering work together to re-evaluate activities with the goal of reducing manufacturing overhead costs to meet the target cost. By reducing costs, companies can maintain desired profit levels. 26

27. Copyright © 2012 Pearson Education 27 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.