Appendix C – Activity-Based Costing
Appendix C
Activity-Based Costing
QUESTIONS
1. Manufacturing overhead costs cannot be directly traced to units of product like
direct materials and direct labor. Assigning overhead costs to units of product
requires some sort of allocation on some “reasonable” basis.
2. In the first stage, service department costs are assigned to operating departments.
In the second stage, a predetermined overhead rate is computed for each operating
department and used to assign overhead to output (or jobs or products).
3. Operating departments are directly involved in manufacturing or selling the products
or services of a business. Service departments support operating departments
through activities such as accounting, payroll, and legal services.
4. Activity-based costing (ABC) is a method for allocating shared costs among
departments or products. It is especially common for overhead allocation. The goal
of ABC is to provide reliable information about costs and their sources. One
advantage of ABC is that it forces managers to examine the behavior of cost drivers
and cost levels, with the result that costs are more likely to be managed effectively.
5. Anything to which costs would be assigned is considered a “cost object.” Common
cost objects are units of product, product lines, departments, activities, and
projects.
6. An activity cost driver is the measure of the activity that causes costs to be incurred.
For instance, the activity driver for the activity “printing checks” might be number of
checks printed.
7. Activity-based costing is typically used when a company produces many different
and complex products or when products are directed at many different types of
customers.
8. Typical activity cost pools include: purchasing, order processing, accounting,
engineering, factory maintenance, and legal services (other answers are possible).
9. In activity-based costing, costs in a cost pool are allocated to output (or jobs or
products) using predetermined overhead rates.
10. While ABC may provide more accurate cost assignments, the additional cost to
implement activity-based costing may not be justified. That is, the value of the
improved accuracy may not result in higher profitability. Like any business decision,
the choice of accounting method depends on weighing the costs against the
benefits.
11. Activity-based costing may be used in any type of organization. The premise of ABC
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Appendix C – Activity-Based Costing
is that activities cause costs. Since all organizations engage in activities, these activities
may be associated with costs they incur. Service enterprises must determine
appropriate fees for the services they provide, so it would be just as appropriate for such
a company to determine the cost of providing those services as it is for a manufacturer
to determine the cost of making a product.
QUICK STUDIES
Quick Study C-1 (10 minutes)
Quick Study C-2 (10 minutes)
2. Assign overhead costs to Fast and Standard models
Fast
Standard
Quick Study C-3 (15 minutes)
Expected Activity Activity
Activity Cost Driver Rate
Handling material $ 625,000 100,000 parts $6.25/part
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Appendix C – Activity-Based Costing
Quick Study C-4 (10 minutes)
1. Cost of technical support per service call =
10,000
$250,000
= $25
2. Assign technical support costs to each model
Deluxe: 650 calls x $25 per call = $16,250
Basic: 150 calls x $25 per call = $ 3,750
Quick Study C-5 (15 minutes)
1.
Expected Activity Activity
Activity Cost Driver Rate
1 $ 87,000 5,800 $ 15.00
2.
Standard Deluxe
Activity 1
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Appendix C – Activity-Based Costing
Activity 2
Activity 3
Quick Study C-6 (15 minutes)
Overhead cost allocation of indirect labor and supplies to Department 1:
Overhead cost allocation of rent and utilities, general office, and
depreciation to Department 1
Total overhead allocated to Department 1
Quick Study C-7 (5 minutes)
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Appendix C – Activity-Based Costing
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Appendix C – Activity-Based Costing
EXERCISES
Exercise C-1 (25 minutes)
1. $1,004,000 + $465,300 + $232,000 = $283.55 per machine hour
6,000 machine hours
Model 145
1,800 machine hours x $283.55/machine hour $ 510,390
Model 212
4,200 machine hours x $283.55/machine hour $ 1,190,910
2. Model 145
Materials and labor $250.00
Model 212
Materials and Labor $180.00
3. Model 145 Model 212
Price per unit $800.00 $470.00
Using a single plantwide overhead rate, Model 212 appears to be
unprofitable. Management may be inclined to stop producing this
product, increase its selling price, or look for ways to cut the cost of
producing Model 212 in order to make it appear profitable. The
plantwide rate may be inappropriate in this case, since machine
hours are only accumulated in the components department, and over
40% of the overhead is incurred outside of that department.
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Appendix C – Activity-Based Costing
Exercise C-2 (35 minutes)
1.
Components
Changeover $500,000 / 800 batches $625/batch
Finishing
Welding $180,300 / 3,000 welding hours $60.10/WH
Support
Model 145 Model 212
Changeover
400 batches x $625/batch $ 250,000 $ 250,000
Machining
1,800 MH x $46.50/MH 83,700
4,200 MH x $46.50/MH 195,300
Setups
60 setups x $1,875/setup 112,500 112,500
Welding
800 WH x $60.10/WH 48,080
2,200 WH x $60.10/WH 132,220
Inspecting
400 inspections x $300/inspection 120,000
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Appendix C – Activity-Based Costing
Exercise C-2 (concluded)
2. Model 145 Model 212
Materials & labor cost per unit $250.00 $180.00
3. Model 145 Model 212
Price per unit $800.00 $470.00
Both product lines appear profitable. Using ABC we see that Model
145 is not generating nearly as much profit as it appeared to generate
using the volume-based systems in Exercise C-1. Furthermore,
Exercise C-3 (35 minutes)
1. Total direct labor hours:
Product A: 10,000 units x 0.20 DLH/unit = 2,000 DLH
Plant-wide overhead rate:
Exercise C-3 (continued)
Product A Product B
Direct materials
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Appendix C – Activity-Based Costing
Direct labor
A: 2,000 DLH x $24/DLH 48,000
B: 500 DLH x $24/DLH 12,000
Overhead
A: 2,000 DLH x $99.60/DLH 199,200
2. Product A Product B
Price per unit $20.00 $60.00
It appears that Product A is not profitable. The company may decide
that this product line should be eliminated if it cannot reduce the cost
of Product A or increase the selling price.
Exercise C-3 (concluded)
3. Overhead rates
Machine setup $121,000/(10 + 12) setups $5,500/setup
*Product A: 1 part/unit x 10,000 units = 10,000 parts
Parts handling
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Appendix C – Activity-Based Costing
A: 10,000 parts x $3/part 30,000
B: 6,000 parts x $3/part 18,000
Quality control inspections
A: 40 insp. hr. x $320/insp. hr. 12,800
4. Product A Product B
Using this approach (activity-based costing) the company sees that
Product B is not profitable, and Product A is profitable. The company
should evaluate the activities used to produce Product B and
determine how costs can be reduced. If they cannot be reduced, the
company should consider discontinuing Product B. Volume-based
costing overstates the cost of high-volume products and understates
the cost of low-volume products. ABC more accurately reflects the
cost of production by assigning costs to product lines based on the
activities required to produce them.
Exercise C-4 (20 minutes)
1.
Client consultation $270,000/1,500 contact hours $180/con.hr.
Drawings $115,000/2,000 design hours $57.50/design hr.
2.
Client consultation 450 contact hours x $180/con. hr. $ 81,000
Drawings 340 design hrs. x $57.50/design hr. 19,550
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Appendix C – Activity-Based Costing
Exercise C-5 (25 minutes)
Part 1
Part 2
Determination of cost per driver unit
Cost Center Cost Driver Cost per Driver
Professional salaries…………………..$1,600,000 10,000 hours $160 per hour
Exercise C-5 (continued)
Part 3
Allocation of costs to the general surgery department using ABC
GENERAL SURGERY
Cost
Driver
Cost per
Driver Unit
Allocated
Cost
Professional salaries…………. 2,500 hours $160 per hr. $400,000
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