Chapter 9

Activity-Based Costing

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Product Costs and Decision Making

L.O. 1 Understand the potential effects of using externally
reported product costs for decision making.
C-27s
10
2,000

C-20s
30
3,000

Total
40
5,000

Units produced
Direct labor-hours
Costs:
Direct materials
Direct labor
Manufacturing overhead
(@ 120%)
Total

$ 40,000
72,000

$ 36,000
78,000

$ 76,000
150,000

86,400
$198,400

93,600
$207,600

180,000
$406,000

Cost per unit

$ 19,840

6,920

Grange is considering dropping C-27s.

9-2

LO
1

Product Costs and Decision Making

Direct materials
Direct labor
Manufacturing overhead
Total costs

Original

C-20s only

$ 76,000
150,000
180,000
$406,000

$ 36,000
78,000
163,800
$277,800

The cost per unit for the C-20s will

increase from $6,920 to $9,260.

9-3

Two-Stage Cost Allocation

L.O. 2

Explain how a two-stage product costing system works.

Allocate overhead costs to departments.

Allocate department overhead costs

to the products or services.

9-4

Plantwide versus
Department-Specific Rates
L.O. 3 Compare and contrast plantwide and
department allocation methods.

All overhead costs are recorded in one

cost pool and applied to products using
one overhead allocation rate.

9-5

Activity-Based Costing (ABC)

L.O. 4 Explain how activity-based costing and
a two-stage product system are related.

ABC is a costing method that first assigns costs

to activities and then assigns them to products
based on the products consumption of activities.

Assign costs to activities.

Assign costs to products based

on the use of each activity
9-6

LO
4

Developing Activity-Based Costs

Step 1: Identify the activities that consume resources
and assign costs to them.
Step 2: Identify the cost driver(s) associated with
each activity.
Step 3: Compute a cost rate per cost driver unit
or transaction.
Step 4: Assign costs to products by multiplying the
cost driver rate by the volume of cost driver
units consumed by the product.
9-7

Activity-Based Costing Illustrated

L.O. 5

Compute product costs using activity-based costing.

Third Quarter Production and Cost Data
J25P

J40X

Total

Number of units
Machine hours Assembly

100,000
6,000

40,000
30,000

140,000
36,000

Direct materials
Direct labor Assembly
Direct labor Packaging
Total direct labor
Total direct cost
Overhead costs:
Assembly
Packaging
Total overhead
Total costs

$1,500,000
$ 750,000
990,000
$1,740,000
$3,240,000

$2,400,000
$ 600,000
360,000
$ 960,000
$3,360,000

$3,900,000
$1,350,000
1,350,000
$2,700,000
$6,600,000
$1,620,000
810,000
$2,430,000
$9,030,000
9-8

LO
5

Activity-Based Costing Illustrated

Step 1: Identify the Activities
Assembly Department

Setting up machines
Handling material
Product Assembly

Packaging Department
Inspection
Packing
Shipping

9-9

LO
5

Activity-Based Costing Illustrated

Step 2: Identify the Cost Drivers
Cost Driver Volume
Activity
Assembly building:
Assembling
Setting up machines
Handling material
Packaging building:
Inspecting and packing
Shipping

Cost Driver
Machine-hours
Setup hours
Production runs

J25P

J40X

Total

6,000 30,000 36,000

40
400
440
8
40
48

Direct labor hours 60,000 22,800 82,800

No. of shipments
100
200
300

9 - 10

LO
5

Activity-Based Costing Illustrated

Step 3: Compute the Cost Driver Rates

Building and Activity

Assembly building:
Assembling
Setting up machines
Handling material
Total assembly overhead
Packaging building:
Inspecting and packing
Shipping
Total packaging overhead
Total overhead

Overhead
Cost

Cost Driver
Volume

$1,080,000 36,000 machine hour

396,000
440 hours
144,000
48 runs
$1,620,000

Cost Driver
Rate
$ 30/machine hour
$ 900/setup hour
$3,000/run

$ 414,000 82,800 direct labor hour $

5/direct labor hour
396,000
300 shipments
$ 1,320/shipment
$ 810,000
$2,430,000

9 - 11

LO
5

Activity-Based Costing Illustrated

Step 4: Assign Costs Using ABC
Overhead

J25P

J40X

Assembly building:
Assembling @ $30/machine hour
Machine setup @ $900/setup hour
Handling material @ $3,000/run

$180,000
36,000
24,000

$ 900,000
360,000
120,000

Packaging building:
Inspection and packaging @ $5/direct labor hour
Shipping @ $1,320/ shipment
Total ABC overhead

300,000
132,000
$672,000

114,000
264,000
$1,758,000

9 - 12

Unit Costs Compared

L.O. 6 Compare activity-based product costing to
traditional department product costing methods.

Comparison of Reported Unit Product Costs

Plantwide rate
Department (building) rate
Activity-based costing

J25P

J40X

$48.06
$41.04
$39.12

$105.60
$123.15
$127.95

9 - 13

Cost Flows through Accounts

L.O. 7 Demonstrate the flow of costs through
accounts using activity-based costing.

Lets see ABC cost flow for the Assembly Department.

It's T-account time!

9 - 14

LO
7

Overhead Costs
Assembling
1,080,000 180,000
900,000
Setting Up
396,000 36,000
360,000
Handling Material
144,000 24,000
120,000

Assembly WIP J25P

DM 1,500,000
DL
750,000
OH
240,000
Assembly WIP J40X
DM 2,400,000
DL
600,000
OH1,380,000
9 - 15

ABC Costing in Administration

L.O. 8 Apply activity-based costing to marketing
and administrative services.

Step 1: Identify the activities that consume resources.

Step 2: Identify the cost driver associated with each activity.
Step 3: Compute a cost rate per cost driver for each unit
or transaction.
Step 4: Assign costs to the marketing or administration
activity by multiplying the cost driver rate by the
volume of cost driver units consumed by the product.
9 - 16

End of Chapter 9

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.