two problems in costing

Activity-Based Costing (ABC)

Lecture 22

Chapter 9

Overview:

1. Explain how a two stage product costing system works.

2. Compare plantwide and department allocation methods.

3. Explain how activity-based costing and a two-stage product system are related.

4. Compute product costs using activity-based costing.

5. Compare activity-based product costing to traditional department product costing methods.

6. Demonstrate the flow of costs through accounts using activity- based costing.

7. Apply activity-based costing to marketing and administrative services.

Plant-wide Allocation Method

Plantwide Allocation Method All overhead costs are

recorded in one cost pool

and applied to products using

one overhead allocation rate.

One cost pool for the factory

Factory

Overhead

Costs

One

allocation

rate

Products

Cost Pool

Cost

Allocation

Rule

Cost Objects

OH

$?????

Object 1 Object 2

Single-Stage Allocation Systems

Recap of what we covered in Chapter 6

Cost Pool

Cost

Allocation

Rule

Cost Objects

Factory OH

$?????

Product 1 Product 2

Plant-wide Allocation Method

Department Allocation

One cost pool for each department

Overhead costs traced to separate

departments and applied to products using a

department allocation rate.

Packaging

Department

Overhead

Costs

Products

Assembly

Department

Overhead

Costs

Each

department

has an

allocation

rate

Allocate overhead costs to

departments.

Allocate department

overhead costs to the

products or services.

Stage One

Stage Two

Department Allocation

Two-Stage Allocation Systems

Cost

Allocation

Rule

X Costs Y Hours

Cost Pool Overhead

$?????

Intermediate

Cost Pools

X-related

$????? $?????

Y-related

Recap of what we covered in Chapter 6

Cost Pool Overhead

Intermediate

Cost Pools

Cost

Allocation

Rule

Department A Department B

Direct Labor

Hours/Costs

Machine

Hours/Costs

Department Allocation

Production and Cost Data

Port Arthur Manufacturing Facility

Third Quarter

Cost Allocation: An Example (Port Arthur)

(Assembly)

Example: Port Arthur (Plant-wide Allocation)

Plantwide Cost Allocation

Port Arthur Manufacturing Facility

Third Quarter

Allocating overhead based on direct labor costs

OH $2,430,000 DLC $2,700,000

Department (Two-Stage) Cost Allocation

Cost Pool Overhead

Intermediate

Cost Pools

Cost

Allocation

Rule

Assembly Packaging

Machine

Hours

Direct

Labor Cost

1,620,000/36,000

= $45/MH 810,000/1,350,000

= 60%

Example: Cost Allocation, Continued. . .

Department Cost Allocation Port Arthur Manufacturing Facility

Third Quarter

J25P J40X

Units produced 100,000 40,000

Machine-hours per unit 0.06 0.75

Direct material 15.00$ 60.00$

Direct labor

Assembly 7.50 15.00

Packaging 9.90 9.00

Total DL Cost 17.40$ 24.00$

Direct costs 32.40$ 84.00$

Applied overhead

Assembly (@ $45 per machine hour) 2.70 33.75

Packaging (@ 60% of direct labor cost) 5.94 5.40

Total Overhead 8.64$ 39.15$

Unit costs 41.04$ 123.15$

Choice of Cost Allocation Method

Similar products using

same resources

Multiple products using

resources differently

Which cost allocation method is appropriate?

Plantwide

Allocation

Department

Allocation

Product Costs and Decision Making

Units produced 10 30 40

Direct Labor hrs 2,000 3,000 5,000

C-27s C-20s TotalUnits

Cost per unit $19,840 $6,920

Direct Material $40,000 $36,000 $76,000

Direct Labor 72,000 78,000 150,000

OH @ 120% DL$ 86,400 93,600 180,000

Costs

Total Costs $198,400 $207,600 $406,000

Grange is considering dropping C-27s.

Example: Grange Boats (Cost Estimates)

Cost Estimates

Original C-20s Only

Direct Materials $76,000 $36,000

Direct Labor 150,000 78,000

Manufacturing Overhead

Utilities 2,400 1,800

Supplies 2,500 1,300

Training 30,000 15,600

Supervision 54,900 54,900

Machine Depreciation 29,550 29,550

Plant Depreciation 40,050 40,050

Miscellaneous 20,600 20,600

Total Overhead 180,000 163,800

Total Costs $406,000 $277,800

Grange’s cost with both C-20s and C-27s versus cost wihout C- 27s

Example: Grange Boats (Overhead)

Original C-20s Only

Manufacturing Overhead

Utilities 2,400 1,800

Supplies 2,500 1,300

Training 30,000 15,600

Supervision 54,900 54,900

Machine Depreciation 29,550 29,550

Plant Depreciation 40,050 40,050

Miscellaneous 20,600 20,600

Total Overhead 180,000 163,800

Change in Overhead: $16,200

Look at Overhead

Grange allocates $86,400 overhead to the C-27s.

Only $16,200 of the overhead is avoided if C-27s are not produced.

Activity-Based Costing (ABC)

Costing method that first assigns costs to

activities and then allocate them to products

based on the products’ consumption of

activities.

Stage One Assign costs to activities

Stage Two Allocate costs to products based

on the use of each activity

Activity-Based Costing

Activities

consume

resources

Products

consume

activities

Developing Activity-Based Costing

1. Identify the activities that consume

resources and assign costs to them.

2. Identify the cost driver(s) associated with

each activity.

3. Compute a cost rate per cost driver unit or

transaction.

4. Allocate costs to products by multiplying

the cost driver rate by the volume of cost

driver units consumed by the product.

Cost Drivers

Factors that cause or “drive” an activity’s costs.

Setting up machines Number of labor hours

Handling material Number of production runs

Machining Number of machine hours

Packaging and shipping Number of shipments

Identified activity Identified cost driver

Cost Allocation Pools

Plantwide One pool

Department As many pools

as departments

ABC As many pools as

activities and cost

drivers identified

Cost Allocation Pools: ABC

Cost Flow Diagram: Activity-Based Costing System

Set-up hours

Production runs

Machine hours

Shipments

Overhead

Set-up Handle

Material

Pack &

Ship

Products

Machine

Assign costs to activities

Allocate

costs to

products

based on

the use of

each

activity

Classification of cost drivers into general levels

of activity; volume, batch, product and so on.

Hierarchy Level Example Costs Cost Driver Examples

Supplies Direct labor costs

Volume related Lubricating oil Machine-hours

Machine repair Number of units

Batch related Material handling Production runs

Shipping costs Number of shipments

Product related

Design and

specification costs Number of products

Facility related General plant costs Direct costs

Plant administration costs Value added

Cost Hierarchy

Example: ABC, Continued. . .

Production and Cost Data

Port Arthur Manufacturing Facility

Third Quarter

J25P J40X Total

Number of units 100,000 40,000 140,000

Machine-hours 6,000 30,000 36,000

Direct material 1,500,000$ 2,400,000$ 3,900,000$

Direct labor

Assembly 750,000 600,000 1,350,000

Packaging 990,000 360,000 1,350,000

Direct labor total 1,740,000$ 960,000$ 2,700,000$

Total direct cost 3,240,000$ 3,360,000$ 6,600,000$

Overhead costs

Assembly 1,620,000$

Packaging 810,000

Total overhead 2,430,000$

Total costs 9,030,000$

Example: ABC (Step 1)

Identify the activitiesStep 1

Department

Assembly Machine set-up

Material handling

Product assembly

Packaging Inspection and packing

Shipping

Activity

Example: ABC (Step 2)

Identify the cost drivers and the

expected volume of each cost driver.Step 2

Activity Cost Driver

Assembly Building J25P J40X Total

Product assembly Machine hours 6,000 30,000 36,000

Material handling Production runs 8 40 48

Machine set-up Set-up hours 40 400 440

Packaging Building

Inspection and packing Direct labor hours 60,000 22,800 82,800

Shipping Number of shipments 100 200 300

Cost Driver Volume

Example: ABC (Step 3)

Compute the Cost Driver RatesStep 3

Overhead Cost Data Port Arthur Manufacturing Facility

Third Quarter

Building and Activity

Overhead

Cost

Cost Driver

Volume

Assembly

Product assembly 1,080,000 36,000 mh

Material handling 144,000 48 runs

Machine set-up 396,000 440 hours

Total assembly 1,620,000$

Packaging

Inspection and packing 414,000$ 82,800 dlh

Shipping 396,000 300 shipments

Total packaging 810,000$

Total overhead 2,430,000$

Cost Driver

Rate

$30 per machine hour

$3,000 per run

$900 per set-up hour

$5 per direct labor hour

$1,320 per shipment

Example: ABC (Step 4)

Step 4 Allocate costs to products

Overhead J25P J40X

Assembly

Product assemby @ $30 per machine hour 180,000 900,000

Material handling at $3,000 per run 24,000 120,000

Machine set-up @ $900 per set-up hour 36,000 360,000

Packaging

Inspection and packing @ $5 per direct labor hour 300,000 114,000

Shipping @ $1,320 per shipment 132,000 264,000

Total ABC Overhead 672,000$ 1,758,000$

Activity

J25P J40X

Product assembly 6,000 30,000

Material handling 8 40

Machine set-up 40 400

Inspection and packing 60,000 22,800

Shipping 100 200

Cost Driver Volume

Example: ABC, Continued. . .

Direct Costs J25P J40X

Direct material 1,500,000$ 2,400,000$

Direct labor

Assembly 750,000 600,000

Packaging 990,000 360,000

Direct labor total 1,740,000$ 960,000$

Total direct cost 3,240,000$ 3,360,000$

Overhead

Assembly

Product assembly @ $30 per setup hour 180,000 900,000

Material handling at $3,000 per run 24,000 120,000

Machine set-up @ $900 per set-up hour 36,000 360,000

Packaging

Inspection and packing @ $5 per direct labor hour 300,000 114,000

Shipping @ $1,320 per shipment 132,000 264,000

Total ABC Overhead 672,000$ 1,758,000$

Total ABC Cost 3,912,000$ 5,118,000$

Number of units 100,000 40,000

Unit costs 39.12$ 127.95$

Product Cost Methods: A Comparison

Comparison of Reported Unit Product Costs

J25P J40X

Plantwide rate 48.06$ 105.60$

Department rate 41.04$ 123.15$

Activity-based costing 39.12$ 127.95$

Number of units 100,000 40,000