Downloaded 72 times
Uploaded byRao Rehman
Activity based costing
The document discusses Activity Based Costing (ABC), which assigns costs to products based on their use of activities and resources. It provides more accurate product costs than traditional costing. ABC identifies activities, assigns costs to activity cost pools, calculates activity rates, and assigns costs to cost objects like products. This helps determine which products are truly profitable. However, ABC requires substantial resources and managers may resist differing from traditional costing figures. ABC data also requires careful use for decision making.
More Related Content
Activity based costing
- 1. Activity Based Costing: ATool to Aid Decision Making
- 2. Overhead rates mayOverheadrates may be based on activitybe based on activity at capacity.at capacity. Overhead rates mayOverhead rates may be based on activitybe based on activity at capacity.at capacity. Activity Based Costing (ABC) Both manufacturingBoth manufacturing and nonmanufacturingand nonmanufacturing costs may becosts may be assigned toassigned to products.products. Both manufacturingBoth manufacturing and nonmanufacturingand nonmanufacturing costs may becosts may be assigned toassigned to products.products. Some manufacturingSome manufacturing costs may be excludedcosts may be excluded from productfrom product costs.costs. Some manufacturingSome manufacturing costs may be excludedcosts may be excluded from productfrom product costs.costs. A numberA number of cost pools eachof cost pools each allocated to a productallocated to a product or cost object.or cost object. A numberA number of cost pools eachof cost pools each allocated to a productallocated to a product or cost object.or cost object. Allocation bases oftenAllocation bases often differ fromdiffer from traditional costingtraditional costing systems.systems. Allocation bases oftenAllocation bases often differ fromdiffer from traditional costingtraditional costing systems.systems.
- 3. How Costs areTreated Under Activity-Based Costing Level of Com plexity Overhead Allocation PlantwidePlantwide OverheadOverhead RateRate PlantwidePlantwide OverheadOverhead RateRate DepartmentalDepartmental OverheadOverhead RatesRates DepartmentalDepartmental OverheadOverhead RatesRates Activity BasedActivity Based CostingCosting Activity BasedActivity Based CostingCosting
- 4. Cost of IdleCapacity Traditional CostTraditional Cost AccountingAccounting The predeterminedThe predetermined overhead rate is basedoverhead rate is based on budgeted activity.on budgeted activity. This results in applyingThis results in applying overhead costs ofoverhead costs of unused, or idle,unused, or idle, capacity.capacity. Traditional CostTraditional Cost AccountingAccounting The predeterminedThe predetermined overhead rate is basedoverhead rate is based on budgeted activity.on budgeted activity. This results in applyingThis results in applying overhead costs ofoverhead costs of unused, or idle,unused, or idle, capacity.capacity. Activity BasedActivity Based CostingCosting Products are charged forProducts are charged for the costs of capacitythe costs of capacity they use – not for thethey use – not for the costs of capacity theycosts of capacity they don’t use.don’t use. Activity BasedActivity Based CostingCosting Products are charged forProducts are charged for the costs of capacitythe costs of capacity they use – not for thethey use – not for the costs of capacity theycosts of capacity they don’t use.don’t use.
- 5. Difference Between ABCand Traditional Product Costs Batch-level or product-Batch-level or product- level costs willlevel costs will ordinarily shiftordinarily shift overhead costs fromoverhead costs from high-volumehigh-volume products producedproducts produced in large batches toin large batches to low-volume productslow-volume products produced in smallproduced in small batches.batches. Batch-level or product-Batch-level or product- level costs willlevel costs will ordinarily shiftordinarily shift overhead costs fromoverhead costs from high-volumehigh-volume products producedproducts produced in large batches toin large batches to low-volume productslow-volume products produced in smallproduced in small batches.batches. Under ABC bothUnder ABC both manufacturing andmanufacturing and nonmanufacturingnonmanufacturing costs may becosts may be assigned to products.assigned to products. Organization-Organization- sustaining costs andsustaining costs and the costs of idlethe costs of idle capacity are notcapacity are not assigned to products.assigned to products. Under ABC bothUnder ABC both manufacturing andmanufacturing and nonmanufacturingnonmanufacturing costs may becosts may be assigned to products.assigned to products. Organization-Organization- sustaining costs andsustaining costs and the costs of idlethe costs of idle capacity are notcapacity are not assigned to products.assigned to products.
- 6. Designing an ABCSystem Cost ObjectsCost Objects (e.g., products(e.g., products and customers)and customers) Cost ObjectsCost Objects (e.g., products(e.g., products and customers)and customers) ActivitiesActivitiesActivitiesActivities ConsumptionConsumption of Resourcesof Resources ConsumptionConsumption of Resourcesof Resources CostCostCostCost
- 7. Designing of anABC System Steps for Implementing ABCSteps for Implementing ABC Identify and define activities and activityIdentify and define activities and activity cost pools.cost pools. Trace costs to activities and costTrace costs to activities and cost objects.objects. Assign costs to activity cost pools.Assign costs to activity cost pools. Calculate activity rates.Calculate activity rates. Assign costs to cost objects.Assign costs to cost objects.
- 8. Identify and DefineActivities and Activity Cost Pools A part of the productionA part of the production process for which managementprocess for which management wants a separate reporting of thewants a separate reporting of the costs of the activity involved.costs of the activity involved. Unit-LevelUnit-Level ActivityActivity Batch-LevelBatch-Level ActivityActivity Product-LevelProduct-Level ActivityActivity Customer-LevelCustomer-Level ActivityActivityOrganization-Organization- sustainingsustaining ActivityActivity
- 9. Identify and DefineActivities and Activity Cost Pools Activity CostActivity Cost PoolPool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system. $ $ $ $ $ $
- 10. Activity-Based Costing atClassic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Activity 1Activity 1Activity 1Activity 1 Activity 2Activity 2Activity 2Activity 2 Activity 3Activity 3Activity 3Activity 3 Activity 4Activity 4Activity 4Activity 4 OtherOtherOtherOther Overhead CostsOverhead Costs First-Stage AllocationFirst-Stage Allocation
- 11. Assign Costs toActivity Cost Pools Customer Orders Product Design Order Size Customer Relations Other Total Production Department Indirect factory wages 25% 40% 20% 10% 5% 100% Factory equipment depreciation 20% 0% 60% 0% 20% 100% Factory utilities 0% 10% 50% 0% 40% 100% Factory building lease 0% 0% 0% 0% 100% 100% Shipping costs ** General Administrative Department Administrative wages and salaries 15% 5% 10% 30% 40% 100% Office equipment depreciation 30% 0% 0% 25% 45% 100% Administrative building lease 0% 0% 0% 0% 100% 100% Marketing Department Marketing wages and salaries 20% 10% 0% 60% 10% 100% Selling expenses 10% 0% 0% 70% 20% 100% Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. **Not included because they are directly traced to customer orders.
- 12. Customer Orders Product Design Order Size Customer Relations Other Total ProductionDepartment Indirect factory wages 125,000$ Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total Activity Cost Pools Indirect factory wages $500,000Indirect factory wages $500,000 Percent consumed by customer orders 25%Percent consumed by customer orders 25% $125,000$125,000 Indirect factory wages $500,000Indirect factory wages $500,000 Percent consumed by customer orders 25%Percent consumed by customer orders 25% $125,000$125,000 Assign Costs to Activity Cost Pools Production Department Indirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$ Shipping costs traced to customer orders 40,000 General Administrative Department Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000 Marketing Department Marketing wages and salaries 250,000 Selling expenses 50,000 300,000 Total overhead costs 1,850,000$ Overhead Costs at Classic Brass (Manufacturing and NonManufacturing)
- 13. Customer Orders Product Design Order Size Customer Relations Other Total ProductionDepartment Indirect factory wages 125,000$ 200,000$ 100,000$ 50,000$ 25,000$ 500,000$ Factory equipment depreciation 60,000 - 180,000 - 60,000 300,000 Factory utilities - 12,000 60,000 - 48,000 120,000 Factory building lease - - - - 80,000 80,000 General Administrative Department Administrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000 Office equipment depreciation 15,000 - - 12,500 22,500 50,000 Administrative building lease - - - - 60,000 60,000 Marketing Department Marketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000 Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$ Activity Cost Pools Assign Costs to Activity Cost Pools
- 14. Calculate Activity Rates TheABC team determines that Classic Brass will have these total activities for each activity cost pool . . . 1,000 customer orders1,000 customer orders 200 new designs200 new designs 20,000 machine-hours20,000 machine-hours 100 customer relations activities100 customer relations activities Now the team can compute the individualNow the team can compute the individual activity rates by dividing the total cost foractivity rates by dividing the total cost for each activity by the total activity levels.each activity by the total activity levels.
- 15. Calculate Activity Rates (a)(b) (a) (b) Activity Cost Pools Total Cost Total Activity Activity Rate Customer orders 315,000$ 1,000 orders $315 per order Product design 257,000 200 designs $1,285 per design Order size 380,000 20,000 MHs $19 per MH Customer relations 367,500 100 customer $3,675 per customer Other 490,500 Not applicable Not applicable Computation of Activity Rates ÷
- 16. TracedTracedTracedTraced TracedTracedTracedTraced TracedTracedTracedTraced Activity-BasedCosting at Classic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Overhead CostsOverhead Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers
- 17. Activity-Based Costing atClassic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers OrderOrder SizeSize OrderOrder SizeSize CustomerCustomer OrdersOrders CustomerCustomer OrdersOrders ProductProduct DesignDesign ProductProduct DesignDesign CustomerCustomer RelationsRelations CustomerCustomer RelationsRelations OtherOtherOtherOther Overhead CostsOverhead Costs First-Stage AllocationFirst-Stage Allocation Second-Stage AllocationsSecond-Stage AllocationsSecond-Stage AllocationsSecond-Stage Allocations $/MH$/MH$/MH$/MH $/Order$/Order$/Order$/Order $/Design$/Design$/Design$/Design $/Customer$/Customer$/Customer$/Customer UnallocatedUnallocatedUnallocatedUnallocated
- 18. Assigning Costs toCost Objects Let’s take a look at how our system works for just one customer – Windward Yachts. Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours . 3. Selling price is $34 each.3. Selling price is $34 each. 4. Direct materials total $2,110.4. Direct materials total $2,110. 5. Direct labor totals $1,850.5. Direct labor totals $1,850. 6. Shipping costs total $180.6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year.1. One order during the year. 2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours . 3. Selling price is $650 each.3. Selling price is $650 each. 4. Direct materials total $13.4. Direct materials total $13. 5. Direct labor totals $50.5. Direct labor totals $50. 6. Shipping costs total $25.6. Shipping costs total $25.
- 19. Assigning Costs toCost Objects (a) (b) (a) (b) Activity Cost Pools Activity Rate Activity ABC Cost Customer orders 315$ 2 630$ Product design 1,285 0 - Order size 19 200 3,800 Customer relations 3,675 N/A Overhead Cost for the Standard Stanchions (a) (b) (a) (b) Activity Cost Pools Activity Rate Activity ABC Cost Customer orders 315$ 1 315$ Product design 1,285 1 1,285 Order size 19 4 76 Customer relations 3,675 N/A Overhead Cost for the Custom Housing The customer-levelThe customer-level cost is assigned tocost is assigned to customers directly;customers directly; it is not assigned toit is not assigned to products.products.
- 20. Limitations of ABC ABCsystems are aABC systems are a major project requiringmajor project requiring substantial resources.substantial resources. The benefits ofThe benefits of increased accuracyincreased accuracy must outweigh thesemust outweigh these additional costs.additional costs. ABC systems are aABC systems are a major project requiringmajor project requiring substantial resources.substantial resources. The benefits ofThe benefits of increased accuracyincreased accuracy must outweigh thesemust outweigh these additional costs.additional costs. ABC producesABC produces numbers, like productnumbers, like product margins, that are atmargins, that are at odds with numbersodds with numbers produced by traditionalproduced by traditional costing system. Somecosting system. Some managers find itmanagers find it difficult to adjust to thisdifficult to adjust to this change.change. ABC producesABC produces numbers, like productnumbers, like product margins, that are atmargins, that are at odds with numbersodds with numbers produced by traditionalproduced by traditional costing system. Somecosting system. Some managers find itmanagers find it difficult to adjust to thisdifficult to adjust to this change.change. ABC data can be misinterpreted and mustABC data can be misinterpreted and must be used with care when making decisions.be used with care when making decisions. ABC data can be misinterpreted and mustABC data can be misinterpreted and must be used with care when making decisions.be used with care when making decisions.
Editor's Notes
- #2 Presented by Tahir Mahmood