17-1
CHAPTER 17
ACTIVITY-BASED COSTING AND ANALYSIS
Related Assignment Materials
Student Learning Objectives
Discussion
Questions
Quick
Studies*
Exercises*
Problems*
AA and
BTN
Conceptual objectives:
C1. Distinguish between the plant-
wide overhead rate method, the
departmental overhead rate
method, and the activity-based
costing method.
1, 2, 3, 4
17-1, 17-2
C2. Explain cost flows for activity-
based costing.
10, 12, 13,
14, 15
17-3
AA 17-2, BTN 17-4,
BTN 17-5
C3. Describe the four types of
activities that cause overhead
costs.
16, 18
17-4, 17-5
17-1, 17-2
17-3
AA 17-1, 17-3,
BTN 17-1, BTN 17-4,
BTN 17-5, BTN 17-6
Analytical objectives:
A1. Identify and assess advantages
and disadvantages of the
plantwide overhead and
departmental overhead rate
methods.
5, 6, 7, 8, 9,
11
17-6
17-1, 17-2,
17-3, 17-5
A2. Identify and assess advantages
and disadvantages of activity-
based costing.
10, 17
17-7, 17-8
17-1, 17-2,
17-3, 17-5
AA 17-1, AA 17-2,
BTN 17-1, BTN 17-2,
BTN 17-3
Procedural objectives:
P1. Allocate overhead costs to
products using the plantwide
overhead rate method.
17-9, 17-10
17-3, 17-6,
17-8, 17-10,
17-12, 17-13
17-1, 17-3,
17-5
products using the
departmental overhead rate
method.
17-10
P3. Allocate overhead costs to
17-13, 17-14,
17-4, 17-5,
17-15, 17-16,
17-1, 17-3,
17-17, 17-18
Additional Information on Related Assignment Material
See Chapter 1 of the Instructor’s Resource Manual for more information on materials for this text available in
Connect.
Connect
Available on the instructor’s course-specific website, Connect:
• All numerical Quick Studies, all Exercises and Problems Set A.
o Connect also provides algorithmic versions for Quick Study, Exercises, and Problems.
• General Ledger Problems
• Excel Simulations
• LearnSmart/SmartBook
Need-to-Know Videos
LO
Title
Time
P1, P2
Plantwide and Departmental Rate Methods
P3
Activity-Based Costing
C3
Activities Causing Overhead Costs
Concept Overview Videos
LO
Title
Time
C1
C2
C3
17-3
P3
Synopsis of Chapter Revision
NEW opener – GrandyOats and entrepreneurial assignment.
Revised discussion of why overhead costs must be assigned.
Revised discussion of plantwide and departmental methods.
New exhibit on overhead allocation using plantwide method.
Chapter Outline
I. Assigning Overhead Costs
Product pricing, product mix decisions, and cost control depend on accurate product cost information.
Product costs consist of direct labor, direct materials, and overhead (indirect costs). Overhead costs
cannot be traced directly 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. Plantwide Overhead Rate Method
1. Cost Flows Under Plantwide Overhead Rate Method. This method is also referred to as the
2. Applying the Plantwide Overhead Rate Method
a. Total budgeted overhead costs are divided by the chosen allocation base to arrive at a single
plantwide overhead rate.
b. This rate is then applied to assign overhead costs to all products based on the allocation base
such as direct labor hours or machine hours required to manufacture each product.
B. Departmental Overhead Rate Method—use of a single plantwide overhead rate can produce cost
assignments that do not reflect the cost to manufacture products.
1. Cost Flows Under Departmental Overhead Rate Method
a. Use of multiple overhead rates can result in better overhead cost allocations and improve
management decisions.
b. 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.
c. Overhead costs are first determined separately for each production department. Then an
overhead rate is computed for each production department to allocate the overhead.
d. This method allows each department to have its own overhead rate and its own allocation
base.
2. Applying the Departmental Overhead Rate Method—4-step process.
a. Step 1: Assign overhead costs to departmental cost pools.
accuracy is improved.
1. Advantages:
a. Based on readily available information.
b. Easy to implement.
c. Consistent with GAAP and can be used for external reporting needs.
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2. Disadvantage—overhead costs are too complex to be explained by one factor, like direct labor
or machine hours.
3. Usefulness of the single plantwide overhead rate depends on two assumptions:
4. The departmental overhead rate method assumes that:
a. Different products are similar in volume, complexity, and batch size, and
b. Departmental overhead costs are directly proportional to the department allocation base.
D. Activity-Based Costing
1. Cost Flows Under Activity-Based Costing Method. Activity-based costing (ABC) attempts to
more accurately assign overhead costs by focusing on activities.
a. Basic principle is that activities, which are tasks, operations, or procedures, cause costs to be
incurred.
b. All activities of an organization can be linked to use of resources.
c. Activity cost pool is a collection of costs that are related to the same or similar activities.
d. The first step of ABC is to identify activities (cost objects) involved in manufacturing
products and match those activities with the costs they cause (drive).
e. To reduce the number of activities, the homogenous activities (those caused by the same
factor) are grouped into activity cost pools.
II. Applying Activity-Based Costing—Activity-based costing accumulates overhead costs into activity
cost pools and then allocates those costs to products using activity rates.
A. Step 1: Identify Activities and the Costs They Cause
B. Step 2: Trace overhead costs to activity cost pools.
C. Step 3: Compute overhead allocation rates for each activity. Proper determination of activity rates
depends on:
III. Assessing Activity-Based Costing
A. Advantages of Activity-Based Costing
1. More Effective Overhead Cost Control—can be used to identify activities that can benefit from
process improvement by focusing on activities instead of focusing only direct labor or machine
hours.
2. Better Production and Pricing Decisions—can reduce cost distortions.
3. Additional Uses—ABC has uses beyond determining product costs. ABC can be used to
allocate selling and administrative costs expensed by GAAP to activities, and to determine the
profitability of various market segments or customers.
B. Disadvantages of Activity-Based Costing
1. Costs to Implement and Maintain ABC. Collecting and analyzing cost data is expensive, and so
is maintaining an ABC system.
IV. Activity Levels and Cost Management
A. Activity Levels—activities can be separated into four levels:
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.
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.
B. Costs of quality—costs resulting from manufacturing defective products or providing services that
do not meet customer expectations. Costs of quality include prevention, appraisal, internal failure
and external failure costs. Can be summarized in a cost of quality report.
C. Lean Manufacturing—focusing on activities is common in lean manufacturing which strives to
eliminate waste while satisfying customers. Common features include:
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IV. 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.
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Chapter 17 Alternate Demo Problem
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
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Chapter 17 Solution: Alternate Demo Problem
Activities River Float Trips
Trailer Rent Fee $ 127
Advertising 215