Activity-Based Costing Activity-Based Costing andand

Activity-Based Activity-Based

Chapter 5

Learning Objective 1Learning Objective 1

Explain undercostingand overcosting ofproducts and

Undercosting andUndercosting andOvercosting ExampleOvercosting Example

Jose, Roberta, and Nancy orderseparate items for lunch.

Jose’s order amounts to $14Roberta consumed 30Nancy’s order is 16Total $60

What is the average cost per lunch?

Undercosting andUndercosting andOvercosting ExampleOvercosting Example

$60 ÷ 3 = $20

Jose and Nancyare overcosted.

Roberta isundercosted.

Learning Objective 2Learning Objective 2

Present three guidelines for

refining a costing

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Kole Corporation manufactures a normal lens(NL) and a complex lens (CL).

Kole currently uses a single indirect-cost ratejob costing system.

Cost objects: 80,000 (NL) and 20,000 (CL).

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Normal Lenses (NL)Direct materials $1,520,000Direct mfg. labor 800,000Total direct costs $2,320,000

Direct cost per unit: $2,320,000 ÷ 80,000 = $29

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Complex Lenses (CL)Direct materials $ 920,000Direct mfg. labor 260,000Total direct costs $1,180,000

Direct cost per unit: $1,180,000 ÷ 20,000 = $59

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

All Indirect Costs

$2,900,000

50,000 DirectManufacturingLabor-Hours

INDIRECT-COSTPOLL

INDIRECTCOST-ALLOCATIONBASE

$58 per DirectManufacturing

Labor-Hour

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Indirect Costs

Direct Costs

COST OBJECT:NL AND CLLENSES

DIRECTCOSTS

DirectMaterials

DirectManufacturing

Labor

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Kole uses 36,000 direct manufacturinglabor-hours to make NL and 14,000 directmanufacturing labor-hours to make CL.

How much indirect costs are allocatedto each product?

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

NL: 36,000 × $58 = $2,088,000

CL: 14,000 × $58 = $812,000

What is the total cost of normal lenses?

Direct costs $2,320,000 +Allocated costs $2,088,000 = $4,408,000

What is the cost per unit?

$4,408,000 ÷ 80,000 = $55.10

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

What is the total cost of complex lenses?

Direct costs $1,180,000 + Allocated costs $812,000 = $1,992,000

What is the cost per unit?

$1,992,000 ÷ 20,000 = $99.60

Existing Single Indirect-Existing Single Indirect-Cost Pool System ExampleCost Pool System Example

Normal lenses sell for $60 each andcomplex lenses for $142 each.

Normal ComplexRevenue $60.00 $142.00Cost 55.10 99.60Income $ 4.90 $ 42.40Margin 8.2% 29.9%

Refining a Costing Refining a Costing SystemSystem

Direct-cost tracing

Indirect-cost pools

Cost-allocation basis

Refining a Costing SystemRefining a Costing System

1. Design of Products and Process

The Design Department designs the moldsand defines processes needed (details of

the manufacturing operations).

Refining a Costing SystemRefining a Costing System

2. Manufacturing Operations

Lenses are molded, finished,cleaned, and inspected.

3. Shipping and Distribution

Finished lenses are packed andsent to the various customers.

Learning Objective 3Learning Objective 3

Distinguish between thetraditional and the activity-based costingapproaches to

Activity-Based Costing Activity-Based Costing SystemSystem

FundamentalCost Objects

Activities

Costs of Activities

Assignment to Other

Cost ObjectsCost of:ProductServiceCustomer

Activity-Based Costing Activity-Based Costing SystemSystem

A cross-functional team at KoleCorporation identified key activities:

Design products and processes.

Set up molding machine.

Operate machines to manufacture lenses.

Maintain and clean the molds.

Activity-Based Costing Activity-Based Costing SystemSystem

Set up batches of finished lenses for shipment.

Distribute lenses to customers.

Administer and manage all processes.

Activity-Based Costing Activity-Based Costing SystemSystem

No. ofSetupHours

LensesNL

LensesCL

LensesOther

CostAllocationBase

ProductCostObjects

No. ofShipments

Parts-Square

feet

SetupDesign ShippingActivityIndirect CostPool

Activity-Based Costing Activity-Based Costing SystemSystem

NL CLQuantity produced 80,000 20,000No. produced/batch 250 50Number of batches 320 400Setup time per batch 2 hours 5 hoursTotal setup-hours 640 2,000

Total setup costs are $409,200.

Activity-Based Costing Activity-Based Costing SystemSystem

What is the setup cost per setup-hour?$409,200 ÷ 2,640 hours = $155

What is the setup cost perdirect manufacturing labor-hour?

$409,200 ÷ 50,000 = $8.184

Activity-Based Costing Activity-Based Costing SystemSystem

Allocation using direct labor-hours:NL: $8.184 × 36,000 = $294,624CL: $8.184 × 14,000 = $114,576Total $409,200

Allocation using setup-hours:NL: $155 × 640 = $ 99,200CL: $155 × 2,000 = $310,000Total $409,200

Learning Objective 4Learning Objective 4

Describe a four-part

cost hierarchy.

Cost HierarchiesCost Hierarchies

A cost hierarchy is a categorizationof costs into different cost pools.

Cost drivers bases (cost-allocation bases)

Degrees of difficulty in determiningcause-and-effect relationships

Cost HierarchiesCost Hierarchies

ABC systems commonly use afour-part cost hierarchy to

identify cost-allocation bases:

1. Output unit-level costs

2. Batch-level costs

3. Product-sustaining costs

4. Facility-sustaining costs

Output Unit-Level CostsOutput Unit-Level Costs

These are resources sacrificedon activities performed on each

individual unit of product or service.

Energy

Machine depreciation

Repairs

Batch-Level CostsBatch-Level Costs

These are resources sacrificed onactivities that are related to a groupof units of product(s) or service(s)rather than to each individual unit

of product or service.

Setup-hours

Procurement costs

Product-Sustaining CostsProduct-Sustaining Costs

These are often called service-sustainingcosts and are resources sacrificed on

activities undertaken to supportindividual products or services.

Design costs

Engineering costs

Facility-Sustaining CostsFacility-Sustaining Costs

These are resources sacrificed onactivities that cannot be traced to

individual products or services butsupport the organization as a whole.

General administration

– rent – building security

Learning Objective 5Learning Objective 5

Cost products or services using

activity-based costing.

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Identify cost objects.

NLCL

Identify the direct costs

of the products.Direct material

Direct laborMold cleaning and

maintenance

Step 1 Step 2

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Cleaning and maintenance costs of$360,000 are direct batch-level costs.

Why?

Because these costs consist of workers’wages for cleaning molds after each

batch of lenses is run.

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Normal Lenses (NL) Cost Hierarchy Description CategoryDirect materials Unit-level $1,520,000Direct mfg. labor Unit-level 800,000Cleaning and maint. Batch-level 160,000Total direct costs $2,480,000

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Complex Lenses (CL) Cost Hierarchy Description CategoryDirect materials Unit-level $ 920,000Direct mfg. labor Unit-level 260,000Cleaning and maint. Batch-level 200,000Total direct costs $1,380,000

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Select the cost-allocation bases to use for

allocating indirect costs to the (1) (2) (3)Activity Cost Hierarchy Total CostsDesign Product-sustaining$450,000

Step 3

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Identify the indirect costs associated

with each cost-allocation base.Overhead costs incurred are assigned

to activities, to the extent possible, on

Step 4

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Compute the rate per unit.

(1) (5)NL CL Total

Setup-hours: 640 2,000 2,640

Step 5

$409,200 ÷ 2,640 = $155

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Compute the indirect costs allocated

to the products.NL: $155 × 640 = $ 99,200

CL: $155 × 2,000 = 310,000

Step 6

ImplementingImplementingActivity-Based CostingActivity-Based Costing

Compute the costs of the products.NL and CL would show three

direct cost categories.

Step 7

1. Direct materials

2. Direct manufacturing labor3. Cleaning and maintenance

ImplementingImplementingActivity-Based CostingActivity-Based Costing

NL and CL would show six indirect cost pools.1. Design

2. Molding machine setups

3. Manufacturing operations

4. Shipment setup

5. Distribution

6. Administration

End of End of Chapter 5Chapter 5