MANAGEMENT ACCOUNTING

AGUS SISWANDI 01153056

Chapter 1 -

Chapter Four

ActivityBased Costing

Chapter 1 -

Learning Objectives
Discuss the importance of unit costs.
Describe functional-based costing approaches. Explain why functional-based costing approaches may produce distorted costs.

Explain how an activity-based costing system works.

Chapter 1 3

Learning Objectives (continued)

Provide a detailed description of how activities can be grouped into homogeneous sets to reduce the number of activity rates.
Describe the role of activity-based costing for organizations with only one product, homogeneous products, or a JIT structure.
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Unit Costs
The unit cost is the total cost associated with the units produced divided by the number of units produced
Although the concept is simple, the practical reality of the computation can be somewhat more complex because of the following issues:
What is meant by total cost?

How do we measure the costs to be assigned?

How do we assign costs to the product?
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Unit Costs (continued)

Unit costs are important for:
inventory valuation income determination providing input to a variety of decisions such as pricing, make or buy, and accept or reject special orders

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Measurement Systems
Two possible measurement systems are actual costing and normal costing.
Actual costing assigns the actual costs of direct materials, direct labor, and overhead to products.
Normal costing assigns the actual costs of direct materials and direct labor to products; however, overhead cots are assigned to products using predetermined rates. Chapter 1 -

Activity Capacity Measures

Units (of driver)
Theoretical Practical Expected actual Normal

Time Chapter 1 -

Functional-Based Costing: Plantwide Rate

Overhead Costs Direct Tracing Stage One: Pool Formation Unit-Level Driver

Assign Costs Plantwide Pool

Assign Costs
Products

Stage Two: Costs Assigned

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Belring, Inc.
Belring, Inc. produces two telephones: a cordless and a regular model. The company has the following actual and budgeted data:
Budgeted overhead Expected activity (DLH) Actual activity (DLH) Actual overhead
Chapter 1 -

$360,000 100,000 100,000 $380,000

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Belring, Inc. (continued)

Cordless
Units produced Prime costs Direct labor hours 10,000 $78,000 10,000

Regular
100,000 $738,000 90,000

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Belring, Inc. (continued)

Predetermined Overhead Rate Budgeted overhead Expected activity = = $360,000 100,000 DLH $3.60 per DLH =

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Belring, Inc. Unit Cost Computation: Plantwide Rate

Cordless Prime costs Overhead costs: $3.60 x 10,000 36,000 --$ 78,000 Regular $ 738,000

$3.60 x 90,000
Total mfg. costs Units produced Unit cost

--$114,000 10,000 $ 11.40 =======

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324,000
$1,062,000 100,000 $ 10.62 ========
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Functional-Based Costing: Departmental Rates

Overhead Costs Assign Costs Department A Pool Assign Costs Products
Stage One: Pool Formation Unit-Level Drivers Stage Two: Costs Assigned
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Department B Pool Assign Costs Products

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Belring, Inc. Departmental Data

Fabrication Budgeted OH $252,000 ======= Expected and actual usage (DLH): Cordless 7,000 Regular 13,000 20,000 ===== Expected and actual usage (MH): Cordless 4,000 Regular 36,000 40,000 =====
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Assembly $108,000 ======= 3,000 77,000 80,000 ===== 1,000 9,000 10,000 =====
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Belring, Inc. Departmental Rates

Overhead Rates: Fabrication Rate = Budgeted OH / Expected MH = $252,000/40,000 = $6.30 per MH Assembly Rate = Budgeted OH / Expected DLH = $108,000/80,000

= $1.35 per DLH

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Belring, Inc. Unit Cost Computation: Departmental Rate

Prime costs Overhead costs:
($6.30 x 4,000) + ($1.35 x 3,000)

Cordless $ 78,000

Regular $738,000 --330,750 $1,068,750 100,000 $ 10.69 ========

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29,250 ($6.30 x 36,000) + ($1.35 x 77,000) --Total mfg. costs $107,250 Units produced 10,000 Unit cost $ 10.73 =======
Chapter 1 -

Symptoms of an Outdated Functional Cost System

The outcome of bids is difficult to explain.
Competitors prices appear unrealistically low. Products that are difficult to produce show high profits. Operational managers want to drop products that appear profitable. Profit margins are difficult to explain.
Chapter 1 18

Symptoms of an Outdated Functional Cost System (continued)

The company has a highly profitable niche all to itself. Customers do not complain about price increases. The accounting department spends a lot of time supplying cost data for special projects. Some departments are using their own accounting system. Product costs change because of changes in financial reporting regulations.
Chapter 1 19

Belring, Inc.

Activity Usage
Cordless Regular 100,000 $738,000 90,000 45,000 10 Total 110,000 $816,000 100,000 50,000 30

Units produced per year Prime costs Direct labor hours Machine hours Production runs

10,000 $78,000 10,000 5,000 20

Number of moves

60

30

90

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Belring, Inc. Additional OH Cost Data

Activity Setups Material handling Machining Testing Total Activity Cost $120,000 60,000 100,000 80,000 $360,000 =======

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ABC: Two-Stage Assignment

Cost Of Resources

Direct Tracing

Assign Costs Activities

Driver tracing

Driver Tracing

Assign Costs Products

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Belring, Inc. Activity Rates

Activity rates are computed below:
Setup rate: Material-handling rate: $120,000/30 =$4,000 per run $60,000/90 = $666.67 per move

Machining rate:
Testing rate:

$100,000/50,000 = $2 per MH
$80,000/100,000 = $0.80 per DLH

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Belring, Inc. Activity-Based Costing Unit Cost Computation

Prime costs Overhead costs: Setups Material handling Machining Testing Total mfg. costs Units produced Unit cost

Cordless $ 78,000
80,000 40,000 10,000 8,000 $216,000 10,000 $ 21.60

Regular $ 738,000
40,000 20,000 90,000 72,000 $ 960,000 100,000 $ 9.60

=====
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=====
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Comparison of Unit Costs

Cordless
Plantwide rate Departmental rate $11.40 10.73

Regular
$10.62 10.69

Activity rate

21.60

9.60

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Activity Categories

Unit-level Activities are those that are performed each time a unit is produced.
Examples: Power and machine hours are used each time a unit is produced. Direct materials and direct labor activities are also unit-level activities, even though they are not overhead costs.
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Activity Categories (continued)

Batch-level Activities are those that are performed each time a batch of products is produced.
Examples: Setups, inspections, production scheduling, and material handling.

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Activity Categories (continued)

Product-level (Sustaining) Activities are those that are performed as needed to support the various products produced by a company. These activities consume inputs that develop products or allow products to be produced and sold.
Examples: Engineering changes, and expediting.

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Activity Categories (continued)

Facility-level Activities are those that sustain a factory's general manufacturing processes.
Examples: Plant management, landscaping, maintenance, security, property taxes, and plant depreciation.
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When To Use An ABC System

Cost Measurement Cost

Error Costs Optimal Cost Level Low High

Chapter 1 30

Comparison of JIT with Traditional Manufacturing

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. JIT Pull-through system Insignificant inventories Small supplier base Long-term supplier contracts Cellular structure Multiskilled labor Decentralized services High employee involvement Facilitating management style Total quality control 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Traditional Push-through system Significant inventories Large supplier base Short-term supplier contracts Departmental structure Specialized labor Centralized services Low employee involvement Supervisory management style Acceptable quality level
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Chapter 1 -

End of Chapter 4

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