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Chapter 17 Activity-Based Costing and Analysis
Chapter 17
Activity-Based Costing and Analysis
Related Assignment Materials
Student Learning Objectives
Discussion
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Distinguish among the plant
wide overhead rate method, the
departmental overhead rate
method, and activity-based
costing method.
1, 2, 3, 4
17-2
17-1
C2. Explain cost flows for activity-
based costing.
11, 12, 13,
14, 15, 16
17-1
17-2
RIA , CA,
GD, TIA,
HTR
C3. Describe the four types of
activities that cause overhead
costs.
17-4
17-4
17-3
ED
Analytical objectives:
A1. Identify and assess advantages
and disadvantages of the plant
wide overhead and department
overhead rate methods.
5, 6, 7, 8, 9,
10
17-3
17-5
17-1, 17-2,
17-3, 17-5
A2. Identify and assess advantages
and disadvantages of activity-
based costing.
17-10, 17-15
17-16
17-3, 17-
5,17-14
17-1, 17-2,
17-3, 17-5
CA, EC, CIP
Procedural objectives:
P1. Allocate overhead costs to
products using the plant wide
overhead rate method.
17-5, 17-7
17-5, 17-6,
17-9, 17-11,
17-12
17-1, 17-3,
17-5
P2. Allocate overhead costs to
products using the
departmental overhead rate
method.
17-6
17-7, 17-10,
17-11
P3. Allocate overhead costs to
products using activity-based
costing.
17-8, 17-9,
17-11, 17-12,
17-13, 17-14,
17-5, 17-8,
17-11, 17-12,
17-13, 17-14,
17-15
17-1, 17-3,
17-4, 17-5
TIA, HTR
*See additional information on next page that pertains to these quick studies, exercises and
problems.
Chapter 17 Activity-Based Costing and Analysis
Additional Information on Related Assignment Material
Assignment materials that can be completed by students using:
Sage 50 and QuickBooks Pro 2013 templates – none
Excel templates – none.
McGraw-Hill’s Connect – All of the Quick Studies, all of the Exercises, and Problems in set A.
** The Serial Problem for Success Systems, which covers numerous learning objectives, can be
the chapters. Even if previous segments were not assigned, students can begin the segment of the
serial problem that is included in this chapter. It is most readily solved if students use the Working
Papers that accompany the book.).
Synopsis of Chapter Revision
• Belgium Brewing Company: NEW opener with new entrepreneurial assignment
• New section on activity-based costing for service providers
• Enhanced discussions and exhibits on overhead allocation methods
• New Decision Insight on the use of activity-based costing for business decisions
• New section on the costs of quality
• Added several new assignments for better learning
Chapter 17 Activity-Based Costing and Analysis
Chapter Outline
I. Assigning Overhead Costs
Knowing accurate costs for producing, delivering, and servicing
products helps managers set a price to cover product costs and yield a
profit. Product costs consist of direct labor, direct materials and
manufacturing overhead. Overhead costs cannot be traced to units of
product in the same way that direct labor and direct materials can.
Therefore, we must assign such overhead costs using an allocation
system.
A. Plant-Wide Overhead Rate Method
1. Cost Flows Under Plantwide Overhead Rate Method. This
method is also referred to as the single plantwide overhead
rate method or the plantwide overhead rate method.
a. Target of the cost object is the unit of product.
b. The rate is determined using volume-related measures
such as direct labor hours, direct labor cost dollars, or
machine hours.
c. For industries where overhead costs are closely related to
these volume-related measures, it is logical to use this
method to allocate indirect manufacturing costs to
products.
required to manufacture each product.
B. Departmental Overhead Rate Method
1. Cost Flows Under Departmental Overhead Rate Method
a. If overhead resources are consumed in substantially
c. The departmental overhead rate method uses a different
overhead rate for each production department. This is
usually done through a two-stage assignment process where
departments are the cost objects in the first stage and
products are the cost objects in the second stage.
Notes
Chapter 17 Activity-Based Costing and Analysis
Chapter Outline
Notes
for each production department to allocate the overhead.
e. This method allows each department to have its own
overhead rate and its own allocation base.
2. Applying the Departmental Overhead Rate Method.
a. The first stage requires assignment of overhead cost to
production departments. If overhead costs are common to
several departments, companies must allocate overhead to
departments applying reasonable allocation bases.
b. The second stage requires that each department determine
an allocation base for its operations. The final part of the
second stage is to apply overhead costs to each product
based on departmental overhead rates.
c. Costs vary depending upon the allocation methods used.
d. The departmental overhead rate method usually results in
more accurate overhead allocations. When analysts are
able to logically trace costs to cost objects, costing
accuracy is improved.
C. Assessing the Plantwide and Departmental Overhead Rate
Methods
1. Advantages:
a. They are based on readily available information.
b. They are easy to implement.
c. They are consistent with GAAP and can be used for
external reporting needs.
hours.
3. Usefulness based on the single plantwide overhead rate
intensive, the single plantwide method can yield
reasonably useful information.
of the single plantwide rate are not reasonable.
5. The departmental overhead rate method is more refined but
also has limitations.
Chapter 17 Activity-Based Costing and Analysis
Chapter Outline
Notes
b. When products differ in batch size and complexity, they
usually consume different amounts of overhead costs.
D. Activity-Based Costing Rates and Method
1. Cost Flows Under Activity-Based Costing Method. Activity-
based costing (ABC) attempts to more accurately assign
overhead costs to the users of overhead by focusing on
activities.
a. Basic principle is that activities, which are tasks,
operations, or procedures, are what cause costs to be
incurred.
b. All activities of an organization can be linked to use of
resources.
c. A cost pool is a collection of costs that are related to the
same or similar activity.
d. Pooling costs to determine an activity overhead (pool) rate
for all costs incurred by the same activity reduces the
activities (those caused by the same factor) are grouped
into activity cost pools.
g. The second stage is to compute an activity rate for each cost
pool and then use this rate to allocate overhead costs to
products.
accumulates overhead costs into activity cost pools and then allocates
those costs to products using activity rates. This involves four steps:
(1) identify activities and the costs they cause, (2) group similar
activities into activity cost pools, (3) determine an activity rate for
each activity cost pool, and (4) allocate overhead costs to products
using those activity rates.
A. Step 1: Identify Activities and the Costs They Cause
1. Commonly done through discussions with employees in
production departments and through review of production
activities. The more activities, the more accurately overhead
costs are assigned. First step is performed to understand
actions performed which drive costs.
Chapter 17 Activity-Based Costing and Analysis
Chapter Outline
Notes
B. Step 2: Trace Overhead Costs to Cost Pools
1. Step 2 involves assigning activities and their overhead costs to
cost pools. These costs are commonly accumulated by each
department in a traditional accounting system. Some costs are
traced directly to a specific activity cost pool.
2. Activity-based costing provides more detail about the activities
and the costs they cause than is provided from traditional
costing methods.
3. To form cost pools, companies look for costs that are caused by
the same or similar activities within each activity level.
Pooled costs include only those costs related to the same
1. Step 3 is to compute activity rates used to assign overhead
costs to final cost objects such as products.
the factor that drives the cost in each activity cost pool, and (2)
proper measures of activities.
3. The cost driver is that activity causing costs in the pool to be
5. Examples of activity drivers include: number of products
devised or modified, number of square feet occupied, and the
number of batches.
is divided by the measure of the activity.
D. Step 4: Assign Overhead Costs to Cost Objects
1. Step 4 is to assign overhead costs in each activity cost pool to
final cost objects using activity rates. This step is referred to
as the second stage assignment.
then divided by the number of units of that product line to
arrive at overhead cost per product unit.
3. The unit overhead cost is computed by dividing total overhead
cost allocated to the product lines by the number of product
units.
standardized, large volume products to low-volume,
customized specialty products that consume disproportionate
Chapter 17 Activity-Based Costing and Analysis
Chapter Outline
Notes
E. Differences between ABC and Multiple Departmental Rates.
1. ABC recognizes that overhead costs are complex and
emphasizes activities and costs of these activities.
2. ABC better reflects the complex nature of overhead costs and
how these costs are used in making products.
III. Assessing Activity-Based Costing
A. Advantages of Activity-Based Costing
1. More Accurate Overhead Cost Allocation - because (1) there
are more cost pools, (2) costs in each pool are more similar,
and (3) allocation is based on activities that cause overhead
costs.
2. More Effective Overhead Cost Control – can be used to
identify activities that can benefit from process improvement.
Also helps managers effectively control overhead cost by
focusing on processes or activities instead of only direct labor.
3. Focus on Relevant Factors – provides better customer
profitability information by including all resources consumed
4. Better Management of Activities – helps managers identify the
Activity-based management can be useful in distinguishing
value-added activities which add value to a product from non-
defective products or providing services that do not meet
customer expectations. Costs of quality include prevention,
appraisal, internal failure and external failure costs.
2. Uncertainty with Decisions Remains. Managers must
interpret ABC data with caution in making managerial
decisions. Managers must examine carefully the
providers. The only requirements are the existence of costs and
demand for reliable cost information.
Chapter 17 Activity-Based Costing and Analysis
website, in whole or part. 17-8
Chapter Outline
D. Types of Activities:
1. Unit level activities – performed on each product unit. Costs
tend to change with the number of units produced
2. Batch level activities – performed only on each batch or group
of units. Costs do not vary with the number of units, but with
the number of batches.
Notes
3. Product level activities – performed on each product line and
are not affected by either the number of units or batches. Costs
do not vary with the number of units or batches.
4. Facility level activities- performed to sustain facility capacity as
a whole and are not caused by any specific product. Costs do
not vary with what is manufactured, number of batches, or the
output quantity.
IV. Global View: Many lean manufacturers embrace lean accounting, which
has two key components:
A. First, the company applies lean thinking to eliminate waste in its
accounting process.
B. Instead of focusing on cost allocation methods, such as activity-based
costing, the company develops alternative performance measures that
better reflect the benefits of manufacturing process changes.
V. Decision Analysis: Customer Profitability. Companies cause the ABC
method to analyze their customer profitability. ABC encourages
management to consider all resources consumed to serve a customer, not
just manufacturing costs that are the focus of traditional costing methods.
Chapter 17 Activity-Based Costing and Analysis
website, in whole or part. 17-9
Chapter 17 Alternate Demonstration Problem #1
Windy River Float Trips uses activity-based costing to compute the cost of
the river raft trips. Each raft holds six customers and a guide. The costs
for these float trips are as follows:
Activities (cost driver) Costs
Trailer rent fee (trip) $127 per trip
Advertising (trips) 215 per trip
Insurance (trips) 50 per trip
Depreciation (trips, people) 40 per trip plus $8 per person
Wages (trips, guides) 400 per trip per guide
Shore lunch (people) 60 per person
Compute the cost of a raft trip with 4 rafts, 24 customers and 4 guides.
Chapter 17 Activity-Based Costing and Analysis
website, in whole or part. 17-10
Solution: Chapter 17 Alternate Demonstration Problem #1
Activities River Float Trips
Trailer Rent Fee $ 127
