1. Activity-Based Costing: Part 2 of 3 Sections 1 and 2 January 25, 2013 Professor: Khim Kelly Office: HH386B Office Hours: Mon/Wed 11:30am – 12:30pm and Appointment Email: kokelly@uwaterloo.cakokelly@uwaterloo.ca TA: Kun Huo Email: khuo@uwaterloo.ca

2. 25 Jan 2013 Overview Last lecture … – Introduction to ABC (Chapter 5) ABC vs. Traditional Absorption Costing 5 Steps of Implementing an ABC System Today’s lecture … – Steps 2, 3, 4, and 5 of ABC – Product cost comparison

3. From last lecture: Steps of Implementing an ABC System  Identify and define activities, activity cost pools and activity measures.  Assign overhead costs to activity cost pools.  Calculate activity rates.  Assign overhead costs to cost objects using the activity rates and activity measures.  Prepare management reports. 1 st stage allocation 2 nd stage allocation

4. Step 2 Overhead costs are from the company’s general ledger What % of available capacity is consumed by each activity? (Use interviews) Attributing OH costs that are alike into a single group or pool of costs  Assign overhead costs to activity cost pools.

5. Step 2: Example (E5-8) OH Costs at Windsor Branch Teller Wages$150K Assistant Branch Manager’s Salary$70K Branch Manager’s Salary$85K Allocate OH to cost pools using the following information: Opening Accounts Processing Deposits Processing Other Other Activities Teller Wages0%75%15%10% Assistant Branch Manager’s Salary 10%15%25%50% Branch Manager’s Salary0% 20%80% * Based on interviews with employees

6. Step 2: Example (E5-8) Allocate OH to cost pools using the following information: Opening Accounts Processing Deposits Processing Other Other Activities Total Teller Wages$0$112.5K$22.5K$15K$150k Assistant Branch Manager’s Salary $7K$10.5K$17.5K$35K$70k Branch Manager’s Salary $0 $17K$68K$85k Total$7K$123K$57K$118K$305k

7. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

8. Clicker Question #1 – Step 2 OH Costs at the Waterloo branch Teller Wages$150K Assistant Branch Manager’s Salary$80K Branch Manager’s Salary$90K Allocate OH to activity cost pools using the following information: Opening Accounts Processing Deposits Processing Other Other Activities Teller Wages10%65%15%10% Assistant Branch Manager’s Salary 10%15%25%50% Branch Manager’s Salary0% 30%70% * Based on interviews with employees

9. Q: What are the total OH costs allocated to 1) opening accounts and 2) processing deposits at the Waterloo branch? A)1) $7,000 and 2) $123,000 B)1) $31,000 and 2) $99,850 C)1) $31,000 and 2) $123,000 D)1) $9,585 and 2) $99,850 E)1) $23,000 and 2)$109,500 Clicker Question #1 – Step 2 9

10. Clicker Question #1: Answer Allocated OH to cost pools: Opening Accounts Processing Deposits Processing Other Other Activities Teller Wages$15k$97.5K$22.5K$15K Assistant Branch Manager’s Salary $8K$12K$20K$40K Branch Manager’s Salary$0 $27K$63K Total$23K$109.5K$69.5K$118K Answer: E) 1) $23,000 and 2) $109,500

11. 5 Steps of Implementing an ABC System  Identify and define activities, activity cost pools and activity measures.  Assign overhead costs to activity cost pools.  Calculate activity rates.  Assign overhead costs to cost objects using the activity rates and activity measures.  Prepare management reports. 1 st stage allocation 2 nd stage allocation

12. Step 3 Divide the total cost for each activity by its total activity =Total Activity Cost Total Activity  Calculate activity rates. This can be capacity or total prior activity depending on the question

13. Step 3: Example (E5-9) Remember our OH allocation at the bank (Windsor branch): Opening Accounts Processing Deposits Processing Other Other Activities Teller Wages$0$112.5K$22.5K$15K Assistant Branch Manager’s Salary $7K$10.5K$17.5K$35K Branch Manager’s Salary$0 $17K$68K Total$7K$123K$57K$118K ActivityTotal Activity at Windsor Branch Opening Accounts200 Accounts Processing Deposits50,000 Deposits Processing Other1,000 Other Total activity:

14. Step 3: Example (E5-9) Otherwise shown as: (a) Total Cost (b) Total Activity (a)÷ (b) Activity Rate Opening Accounts$7,000200 Accounts $35/Account Processing Deposits$123,00050,000 Deposits $2.46/Account Processing Other$57,0001,000 Other $57/Other Other Activities$118,000--

15. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

16. Q: What do the results of ABC for the Windsor branch suggest when compared to the ‘lowest cost’ branch? (BENCHMARKING) A) Clicker Question #2 (E5-9) 16 ActivityReported Cost per Activity By lowest-cost branch ABC Cost per Activity At Windsor branch Opening Accounts$24.35/Account$35/Activity Processing Deposits$2.72/Deposits$2.46/Deposits Processing Other$48.90/Other$57/Other A.The costs of opening an account and processing deposits are higher than in the lowest-cost branch B.The Windsor branch may benefit from learning about how the lowest-cost branch open accounts and process other transactions. C.Banks (in general) charge me too little in bank fees and we should pay more D.This bank should pay its tellers more in salary

17. Q: What do the results of ABC for the Windsor branch suggest when compared to the ‘lowest cost’ branch? Answer: B) The Windsor branch may benefit from learning about how the lowest-cost branch open accounts and process other transactions. Clicker Question #2: Answer 17

18. Clicker Question #3: Step 3 OH allocation at the Kitchener branch: Opening Accounts Processing Deposits Processing Other Other Activities Teller Wages$0$112.5K$22.5K$15K Assistant Branch Manager’s Salary $7K$10.5K$17.5K$35K Branch Manager’s Salary$0 $17K$68K Total$7K$123K$57K$118K ActivityTotal Activity at Kitchener Branch Opening Accounts250 Accounts Processing Deposits40,000 Deposits Processing Other800 Other Total activity:

19. Q: What are the activity rates for 1) processing deposits and 2) processing other transactions at the Kitchener branch? A)1) $28 and 2) $71.25 B)1) $3.075 and 2) $71.25 C)1) $28 and 2) $3.075 D)1) $2.81 and 2) $28.125 E)1) $0.26 and 2)$21.875 Clicker Question #3 – Step 3 19

20. Clicker Question #3: Step 3 Answer (a) Total Cost (b) Total Activity (a)÷ (b) Activity Rate Opening Accounts$7,000250 Accounts $28/Account Processing Deposits$123,00040,000 Deposits $3.075/Account Processing Other$57,000800 Other $71.25/Other Other Activities$118,000-- Answer: B) 1) $3.075 and 2) $71.25

21. 5 Steps of Implementing an ABC System  Identify and define activities, activity cost pools and activity measures.  Assign overhead costs to activity cost pools.  Calculate activity rates.  Assign overhead costs to cost objects using the activity rates and activity measures.  Prepare management reports. 1 st stage allocation 2 nd stage allocation

22. Steps 3: E5-7 Fence Inc. makes two products: 1. Fence links 2. Fence posts Activity PoolDriverTotal (a) Estimated OH Cost (b)Rate (b/a) Machine Setups# of Setups180$21,600$120 Special ProcessingMachine Hrs4,000$180,000$45 General FactoryDL Hours24,000$288,000$12 22

23. Step 4: E5-7 Overhead allocation to fence links… Activity PoolDriver Fence links (a)Rate (b) ABC Cost (a*b) Machine Setups# of Setups100$120$12,000 Special ProcessingMachine Hrs4,000$45$180,000 General FactoryDL Hours8,000$12$96,000 Total$288,000 23

24. Step 4: E5-7 Overhead allocation to fence posts… Activity PoolDriver Fence Posts (a)Rate (b) ABC Cost (a*b) Machine Setups# of Setups80$120$9,600 Special ProcessingMachine Hrs0$450 General FactoryDL Hours16,000$12$192,000 Total$201,600 24

25. 5 Steps of Implementing an ABC System  Identify and define activities, activity cost pools and activity measures.  Assign overhead costs to activity cost pools.  Calculate activity rates.  Assign overhead costs to cost objects using the activity rates and activity measures.  Prepare management reports. 1 st stage allocation 2 nd stage allocation Often, involve profitability analyses of objects (e.g., products, customers, business units, etc.) Activity-based management to identify process improvements

26. Summary Today’s lecture … – Steps 2, 3, 4, and 5 of ABC – Product cost comparison Next lecture … – Finishing touches to Chapter 5 – A complete ABC example