BMFP 4512 Chapter-3 Tutorial (Activity Based Costing)
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Transcript of BMFP 4512 Chapter-3 Tutorial (Activity Based Costing)
TUTORIAL TUTORIAL --ABCABC
Ir. Haery Ir. Haery SihombingSihombing/IP/IPPensyarah PelawatFakulti Kejuruteraan PembuatanUniversiti Teknologi Malaysia Melaka
TOTAL COST for a COST OBJECTTOTAL COST for a COST OBJECT
Direct Cost Direct Cost (Labor Material)(Labor Material)Overhead CostOverhead Cost
++Total Object CostTotal Object Cost
EXAMPLE: 1
TRADITIONAL COST ACCOUNTINGTRADITIONAL COST ACCOUNTING
Arbitrarily allocates to the cost objectsArbitrarily allocates to the cost objects
Total CompanyTotal Company’’s overhead is allocated s overhead is allocated o the products based on volume based o the products based on volume based measure (measure (e.g. labor hours, machine hourse.g. labor hours, machine hours))
Assumption: relation between Assumption: relation between overhead and the volume based overhead and the volume based measuremeasure
Product A :Product A :1 hours of direct labor1 hours of direct labor
(direct labor cost 1 *RM20/hour(direct labor cost 1 *RM20/hour=RM =RM 20.00/20.00/hours)hours)
Demand = 100Demand = 100
TRADITIONAL COST ACCOUNTINGTRADITIONAL COST ACCOUNTING
Product B:Product B:2 hours of direct labor2 hours of direct labor
(direct labor cost 2 *RM20/ hour (direct labor cost 2 *RM20/ hour =RM =RM 40.0040.00/hours)/hours)
Demand = 950Demand = 950
•Two products: Product AProduct A and Product BProduct B
TOTAL OVERHEAD = RM 100,000.00TOTAL OVERHEAD = RM 100,000.00TOTAL DIRECT LABOR = 2,000 HoursTOTAL DIRECT LABOR = 2,000 Hours
RM 100,000/2000 Hours = RM 50/ HoursRM 100,000/2000 Hours = RM 50/ Hours
Product A :Product A : 1 hours of direct labor1 hours of direct laborProduct B :Product B : 2 hours of direct labor2 hours of direct laborTCA Overhead Allocation : TCA Overhead Allocation : AA = RM = RM 50/unit50/unit
BB = RM = RM 100/unit100/unit
TRADITIONAL COST ACCOUNTINGTRADITIONAL COST ACCOUNTING
ACTIVITY BASED COSTINGACTIVITY BASED COSTING
More Accurate Cost Management MethodologyMore Accurate Cost Management MethodologyFocuses on indirect costs (overhead)Focuses on indirect costs (overhead)Traces rather than allocates each expense Traces rather than allocates each expense category to the particular cost objectcategory to the particular cost objectMakes Makes ““indirectindirect”” expense expense ““directdirect””
ABC Basic PremiseABC Basic Premise
Cost objects consume activitiesCost objects consume activitiesActivities consume resourcesActivities consume resourcesThis consumption of resources is what This consumption of resources is what driver costsdriver costsUnderstanding this relationship is critical Understanding this relationship is critical to successfully managing overheadto successfully managing overhead
When To Use ABCWhen To Use ABC
Overhead is highOverhead is highProducts are diverse: complexity, Products are diverse: complexity, volume, amount of direct laborvolume, amount of direct laborCost of errors are highCost of errors are highCompetition is stiffCompetition is stiff
ABC StepsABC Steps
Identifies activitiesIdentifies activitiesDetermine cost for each activityDetermine cost for each activityDetermine cost driversDetermine cost driversCollect activity dataCollect activity dataCalculate product costCalculate product cost
ABC IllustrationABC Illustration
SetSet--upupMachiningMachiningReceivingReceivingPackingPackingEngineeringEngineering
1. INDENTIFY ACTIVITIES1. INDENTIFY ACTIVITIES
SetSet--upupMachiningMachiningReceivingReceivingPackingPackingEngineeringEngineering
ABC IllustrationABC Illustration
2. DETERMINE ACTIVITY COST2. DETERMINE ACTIVITY COST
= RM 10,000= RM 10,000= RM 40,000= RM 40,000= RM 10,000= RM 10,000= RM 10,000= RM 10,000= RM 30,000= RM 30,000
ABC IllustrationABC Illustration
3. DETERMINE COT DRIVERS3. DETERMINE COT DRIVERS
SetSet--upupMachiningMachiningReceivingReceivingPackingPackingEngineeringEngineering
= Number of Setups= Number of Setups= Machining Hours= Machining Hours= Number of Receipt= Number of Receipt= Number of Deliveries= Number of Deliveries= Engineering Hours= Engineering Hours
ABC IllustrationABC Illustration
4. ACTIVITY DATA4. ACTIVITY DATA
75,50075,50024,50024,500
15,00015,00050050015,00015,00050050030,00030,000EngineeringEngineering7,5007,500332,5002,5001110,00010,000PackingPacking7,5007,500332,5002,5001110,00010,000ReceivingReceiving
38,00038,000190019002,0002,00010010040,00040,000MachiningMachining7,5007,500332,5002,5001110,00010,000SetSet--upup
RMRMPRODUCTPRODUCTBB
RMRMPRODUCTPRODUCTAA
Cost Cost (RM)(RM)
ACTIVITYACTIVITY
Overhead for Product A =Overhead for Product A =RM 24,500 : 100 = RM RM 24,500 : 100 = RM 245245
Overhead for Product B =Overhead for Product B =RM 75,000 : 950 = RM RM 75,000 : 950 = RM 79. 4779. 47
ABC IllustrationABC Illustration
5. PRODUCT COST CALCULATION5. PRODUCT COST CALCULATION
PRODUCT COST TCA Vs. ABCPRODUCT COST TCA Vs. ABC
Overhead Overhead TCATCA RM RM 50,0050,00Overhead Overhead ABCABC RM RM 245,00245,00Direct Cost Direct Cost TCATCA RM RM 20,0020,00Direct Cost Direct Cost ABC ABC RM RM 20,0020,00TOTAL TOTAL TCATCA RM RM 70,0070,00TOTAL TOTAL ABCABC RM RM 265,00 265,00
Overhead Overhead TCA TCA RM RM 100,00100,00Overhead Overhead ABC ABC RM RM 79.4779.47Direct Cost Direct Cost TCATCA RM RM 40,0040,00Direct Cost Direct Cost ABC ABC RM RM 40,0040,00TOTAL TOTAL TCATCA RM RM 140,00140,00TOTAL TOTAL ABC ABC RM RM 119,47 119,47
Cost for Product A : Cost for Product A : Cost for Product B :Cost for Product B :
Undercosting & Undercosting & OvercostingOvercosting
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?
EXAMPLE: 2
$60 ÷ 3 = $20
Jose and Nancyare overcosted.
Roberta isundercosted.
Undercosting & Undercosting & OvercostingOvercosting
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
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).
EXAMPLE: 3
Normal Lenses (NL)Direct materials $1,520,000Direct mfg. labor 800,000Total direct costs $2,320,000Direct cost per unit: $2,320,000 ÷ 80,000 = $29
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
Complex Lenses (CL)Direct materials $ 920,000Direct mfg. labor 260,000Total direct costs $1,180,000Direct cost per unit: $1,180,000 ÷ 20,000 = $59
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
All Indirect Costs$2,900,000
All Indirect Costs$2,900,000
50,000 DirectManufacturingLabor-Hours
50,000 DirectManufacturingLabor-Hours
INDIRECT-COSTPOLL
INDIRECTCOST-ALLOCATIONBASE
$58 per DirectManufacturing
Labor-Hour
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
Indirect Costs
Direct Costs
Indirect Costs
Direct Costs
COST OBJECT:NL AND CLLENSES
DIRECTCOSTS
DirectMaterialsDirect
MaterialsDirect
ManufacturingLabor
DirectManufacturing
Labor
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
Kole uses 36,000 direct manufacturinglabor-hours to make NL and 14,000 directmanufacturing labor-hours to make CL.How much indirect costs are allocated
to each product?
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
NL: 36,000 × $58 = $2,088,000CL: 14,000 × $58 = $812,000
What is the total cost of normal lenses?Direct costs $2,320,000 +
Allocated costs $2,088,000 = $4,408,000What is the cost per unit?
$4,408,000 ÷ 80,000 = $55.10
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
What is the total cost of complex lenses?Direct costs $1,180,000 + Allocated costs
$812,000 = $1,992,000What is the cost per unit?
$1,992,000 ÷ 20,000 = $99.60
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
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%
Existing Single IndirectExisting Single Indirect-- Cost Pool SystemCost Pool System
Refining a Costing SystemRefining a Costing System
Direct-cost tracing
Indirect-cost pools
Cost-allocation basis
Refining a Costing SystemRefining a Costing System
1. Design of Products and ProcessThe Design Department designs the molds and defines
processes needed (details of the manufacturing operations).
2. Manufacturing OperationsLenses are molded, finished, cleaned, and inspected.
3. Shipping and DistributionFinished lenses are packed and sent to the various customers.
ActivityActivity--Based Costing SystemBased Costing System
FundamentalCost Objects
Activities
Costs of Activities
Assignment to OtherCost Objects
Cost of:• Product• Service• Customer
ActivityActivity--Based Costing SystemBased Costing System
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.
ActivityActivity--Based Costing SystemBased Costing System
Set up batches of finished lenses for shipment.Distribute lenses to customers.
Administer and manage all processes.
ActivityActivity--Based Costing SystemBased Costing System
No. ofSetupHours
LensesNL
LensesCL
LensesOther
CostAllocationBase
ProductCostObjects
No. ofShipments
Parts-Square
feet
SetupDesign ShippingActivityIndirect CostPool
ActivityActivity--Based Costing SystemBased Costing System
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.
ActivityActivity--Based Costing SystemBased Costing System
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
ActivityActivity--Based Costing SystemBased Costing System
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
Cost HierarchiesCost Hierarchies
A cost hierarchy is a categorizationof costs into different cost pools.
Cost drivers bases (cost-allocation bases)Degrees of difficulty in determining
cause-and-effect relationships
Cost HierarchiesCost Hierarchies
ABC systems commonly use afour-part cost hierarchy to
identify cost-allocation bases:1. Output unit-level costs2. Batch-level costs3. Product-sustaining costs4. Facility-sustaining costs
Output UnitOutput Unit--Level CostsLevel Costs
These are resources sacrificedon activities performed on each
individual unit of product or service.Energy
Machine depreciationRepairs
BatchBatch--Level CostsLevel 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
ProductProduct--Sustaining CostsSustaining Costs
These are often called service-sustainingcosts and are resources sacrificed on
activities undertaken to supportindividual products or services.
Design costsEngineering costs
FacilityFacility--Sustaining CostsSustaining 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
ImplementingImplementingActivityActivity--Based CostingBased Costing
Identify cost objects.
NLCL
Identify the direct costsof the products.
Direct materialDirect labor
Mold cleaning andmaintenance
Step 1Step 1 Step 2Step 2
ImplementingImplementingActivityActivity--Based CostingBased 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 eachbatch of lenses is run.
ImplementingImplementingActivityActivity--Based CostingBased Costing
NormalNormal Lenses (NL)Lenses (NL)Cost HierarchyCost Hierarchy
DescriptionDescription CategoryCategoryDirect materialsDirect materials UnitUnit--levellevel $1,520,000$1,520,000Direct mfg. laborDirect mfg. labor UnitUnit--levellevel 800,000800,000Cleaning and maint.Cleaning and maint.BatchBatch--levellevel 160,000160,000Total direct costsTotal direct costs $2,480,000$2,480,000
ImplementingImplementingActivityActivity--Based CostingBased Costing
ComplexComplex Lenses (CL)Lenses (CL)Cost HierarchyCost Hierarchy
DescriptionDescription CategoryCategoryDirect materialsDirect materials UnitUnit--levellevel $ 920,000$ 920,000Direct mfg. laborDirect mfg. labor UnitUnit--levellevel 260,000260,000Cleaning and maint.Cleaning and maint.BatchBatch--levellevel 200,000200,000Total direct costsTotal direct costs $1,380,000$1,380,000
ImplementingImplementingActivityActivity--Based CostingBased Costing
Select the cost-allocation bases to use forallocating indirect costs to the products.
(1) (2) (3)Activity Cost Hierarchy Total CostsDesign Product-sustaining $450,000Setups Batch-level $409,200Operations Unit-level $637,500
Step 3
ImplementingImplementingActivityActivity--Based CostingBased Costing
Identify the indirect costs associatedwith each cost-allocation base.
Overhead costs incurred are assignedto activities, to the extent possible, on
the basis of a cause-and-effect relationship.
Step 4Step 4
ImplementingImplementingActivityActivity--Based CostingBased 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
ImplementingImplementingActivityActivity--Based CostingBased Costing
Compute the indirect costs allocatedto the products.
NL: $155 × 640 = $ 99,200CL: $155 × 2,000 = 310,000Total $409,200
Step 6
ImplementingImplementingActivityActivity--Based CostingBased Costing
Compute the costs of the products.NL and CL would show three
direct cost categories.
Step 7
1. Direct materials2. Direct manufacturing labor3. Cleaning and maintenance
ImplementingImplementingActivityActivity--Based CostingBased Costing
NL and CL would show six indirect cost pools.1. Design2. Molding machine setups3. Manufacturing operations4. Shipment setup5. Distribution6. Administration
ABC and DepartmentABC and DepartmentIndirectIndirect--Cost RatesCost Rates
Many companies have evolved theircosting system from using a single
cost pool to using separate indirect-costrates for each department:
DesignManufacturing
Distribution
ABC and DepartmentABC and DepartmentIndirectIndirect--Cost RatesCost Rates
Why?Because the cost drivers of resources in eachdepartment or subdepartment differ from thesingle, company-wide, cost-allocation base.
ABC systems are a further refinement ofdepartment costing systems.
SUMMARY of ABC APPOACHSUMMARY of ABC APPOACH
ABC is more accurate cost management ABC is more accurate cost management system than Traditional Cost Accounting system than Traditional Cost Accounting (TCA)(TCA)Traditional Cost Accounting (TCA) is unable Traditional Cost Accounting (TCA) is unable to calculate the to calculate the ““truetrue”” of a productof a product
Benefits of ABC SystemsBenefits of ABC Systems
Significant amounts of indirect costs areallocated using only one or two cost pools.
All or most costs are identifiedas output unit-level costs.
Products make diverse demands onresources because of differences involume, process steps, batch size,
or complexity.
Benefits of ABC SystemsBenefits of ABC Systems
Products that a company is well-suited tomake and sell show small profits whileproducts for which a company is less
suited show large profits.Complex products appear to be very
profitable and simple productsappear to be losing money.
Benefits of ABC SystemsBenefits of ABC Systems
Operations staff have significantdisagreements with the accounting
staff about the costs of manufacturingand marketing products and services.
Limitations of ABC SystemsLimitations of ABC Systems
The main limitations of ABC are themeasurements necessary to
implement the system.ABC systems require managementto estimate costs of activity poolsand to identify and measure cost
drivers for these pools.
Limitations of ABC SystemsLimitations of ABC Systems
Activity-cost rates also need to beupdated regularly.
Very detailed ABC systems are costlyto operate and difficult to understand.