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Activity-Based Costing:
A Tool to Aid Decision Making
Chapter 7
ABC is designed to
provide managers
with cost information
for strategic and
other decisions that
potentially affect
capacity and
therefore affect
fixed
as well as variable
costs.
2015 McGraw-Hill Education
ABC is a
good supplement
to our traditional
cost system
I agree!
An Brief Overview
Learning Objective 1
Nonmanufacturing
costs
Traditional
product costing
ABC
product costing
Nonmanufacturing
costs
Traditional
product costing
Some
All
Mo
st,
not but
all
ABC
product costing
Level of complexity
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
ActivityBased
ActivityBased
Costing
Costing
Departmental
Departmental
Overhead
Overhead
Rates
Rates
Plantwide
Plantwide
Overhead
Overhead
Rate
Rate
Each
Each ABC
ABC cost pool has
has its
its
own
own unique measure of activity.
Traditional
Traditional cost systems usually rely
on
on volume
volume measures such as direct labor
hours and/or machine hours to allocate
all
all overhead
overhead costs
costs to
to products.
products.
ABC uses more cost pools.
2015 McGraw-Hill Education
Activity
Cost Pool
$$
$
$ $
$
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Activity
Measure
An allocation base
in an activity-based
costing system.
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Duration
driver
Simple count
of the number of
times an activity
occurs.
A measure
of the amount
of time needed
for an activity.
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Traditional
Traditional cost
cost systems
systems usually
usually rely
rely on
on volume
volume
measures
measures such
such as
as direct
direct labor
labor hours
hours and/or
and/or machine
machine
hours
hours to
to allocate
allocate all
all overhead
overhead costs
costs to
to products.
products.
2015 McGraw-Hill Education
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Batch-Level
Activity
Manufacturing
companies typically combine
their activities into five
classifications.
Product-Level
Activity
Organizationsustaining
Activity
Garrison, Noreen, Brewer, Cheng & Yuen
Customer-Level
Activity
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Strong top
management support
Link to evaluations
and rewards
Cross-functional
involvement
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Manufacturing
Manufacturing overhead
overhead is
is allocated
allocated to
to products
products using
using
aa single
single plantwide
plantwide overhead
overhead rate
rate based
based on
on machine
machine hours.
hours.
2015 McGraw-Hill Education
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17
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Learning Objective 2
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20
21
22
Indirect
$6,000,000
Indirect factory
factory wages
wages
$6,000,000
Percent
30%
Percent consumed
consumed by
by customer
customer orders
orders
30%
$1,800,000
$1,800,000
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Factory
$3,500,000
Factory equipment
equipment depreciation
depreciation
$3,500,000
Percent
20%
Percent consumed
consumed by
by customer
customer orders
orders
20%
$$ 700,000
700,000
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25
Learning Objective 3
Compute activity
rates for cost pools.
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Now
Now the
the team
team can
can compute
compute the
the individual
individual
activity
activity rates
rates by
by dividing
dividing the
the total
total cost
cost for
for
each
each activity
activity by
by the
the total
total activity
activity levels.
levels.
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Direct
Direct
Labor
Labor
Shipping
Shipping
Costs
Costs
Traced
Traced
Traced
Traced
Traced
Traced
Overhead
Overhead Costs
Costs
Cost
Cost Objects:
Objects:
Products,
Products, Customer
Customer Orders, Customers
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Direct
Direct
Labor
Labor
Shipping
Shipping
Costs
Costs
Overhead
Overhead Costs
Costs
First-Stage Allocation
Customer
Customer
Orders
Orders
Design
Design
Changes
Changes
Order
Order
Size
Size
Customer
Customer
Relations
Relations
Cost
Cost Objects:
Objects:
Products,
Products, Customer
Customer Orders, Customers
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Other
Other
Direct
Direct
Labor
Labor
Shipping
Shipping
Costs
Costs
Overhead
Overhead Costs
Costs
First-Stage Allocation
Customer
Customer
Orders
Orders
Design
Design
Changes
Changes
Order
Order
Size
Size
Customer
Customer
Relations
Relations
Other
Other
Second-Stage Allocations
$/Order
$/Order
$/Change
$/Change
$/MH
$/MH
$/Customer
Cost
Cost Objects:
Objects:
Products,
Products, Customer
Customer Orders, Customers
2015 McGraw-Hill Education
Unallocated
Unallocated
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Learning Objective 4
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33
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Machine-hours
Machine-hours
1.
1. The
The 480
480 SureStarts
SureStarts required
required 288
288 machine-hours.
machine-hours.
2.
2. The
The 200
200 LongLifes
LongLifes required
required 160
160 machine-hours.
machine-hours.
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Learning Objective 5
Use activity-based
costing to compute
product and customer
margins.
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40
41
42
43
44
45
Plantwide manufacturing
overhead rate
$14,000,000
800,000 MH
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53
54
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ABC Limitations
Substantial resources
required to implement
and maintain.
Resistance to
unfamiliar numbers
and reports.
Desire to fully
allocate all costs
to products.
Potential
misinterpretation of
unfamiliar numbers.
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Learning Objective 6
(Appendix 7A)
Prepare an action
analysis report using
activity-based costing
data and interpret the
report.
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Learning Objective 7
(Appendix 7B)
Use activity-based
costing techniques to
compute unit product
costs for external
reports.
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Appendix 7B
A modified
modified form of activity-based
costing can
can be
be used
used to
to develop
develop product
product
costs for external
external financial reports.
ABC
ABC product
product costs:
costs:
Include
Include all
all manufacturing
manufacturing costs
costs
e.g.organization-sustaining
e.g.organization-sustaining costs
costs
and
and unused
unused capacity
capacity costs.
costs.
Exclude
Exclude nonmanufacturing
nonmanufacturing costs
costs even
even
ifif they
they are
are caused
caused by
by the
the products.
products.
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Appendix 7B
Simmons Industries provides the following information
for the company as a whole and for its only two
productsdeluxe and standard hedge trimmers.
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Appendix 7B
Assuming that Simmons traditional cost system relies
on one predetermined plantwide overhead rate with
direct labor-hours (DLHs) as the allocation base, then
its plantwide overhead rate is computed as follows:
Predetermined
$1,800,000
=
overhead rate
400,000 DLHs
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Appendix 7B
Simmons traditional cost system would
report unit product costs as follows:
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Appendix 7B
The ABC project team at Simmons has
developed the following basic information.
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Appendix 7B
We can calculate the following activity rates:
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Appendix 7B
Deluxe Product
Standard Product
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Appendix 7B
Activity-based
Activity-based unit
unit product
product costs
costs for
for both
both product
product lines
lines
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Appendix 7B
Activity-based
Activity-based unit
unit product
product costs
costs for
for both
both product
product lines
lines
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Appendix 7B
Comparing the two approaches
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End of Chapter 7
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