Activity-Based Costing and
Activity-Based Management
Activity-Based Costing and
Activity-Based Management
Learning Objective 1
Explain undercosting
and overcosting of
Undercosting and
Overcosting Example
Undercosting and
Overcosting Example
Jose, Roberta, and Nancy order separate items for lunch.
Jose’s order amounts to $14 Roberta consumed 30 Nancy’s order is 16
Total $60
Undercosting and
Overcosting Example
$60 ÷ 3 = $20
Jose and Nancy are overcosted.
Learning Objective 2
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Kole Corporation manufactures a normal lens (NL) and a complex lens (CL).
Kole currently uses a single indirect-cost rate job costing system.
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Normal Lenses (NL)
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Complex Lenses (CL)
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
All Indirect Costs $2,900,000
All Indirect Costs $2,900,000 50,000 Direct Manufacturing Labor-Hours 50,000 Direct Manufacturing Labor-Hours INDIRECT-COST POLL INDIRECT COST-ALLOCATION BASE
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Indirect Costs Direct Costs
Indirect Costs Direct Costs COST OBJECT:
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Kole uses 36,000 direct manufacturing labor-hours to make NL and 14,000 direct
manufacturing labor-hours to make CL. How much indirect costs are allocated
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost 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 +
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
What is the total cost of complex lenses? Direct costs $1,180,000 + Allocated costs
Existing Single
Indirect-Cost Pool System Example
Existing Single
Indirect-Cost Pool System Example
Normal lenses sell for $60 each and complex lenses for $142 each.
Refining a Costing System
Direct-cost tracing
Indirect-cost pools
Refining a Costing System
Refining a Costing System
1. Design of Products and Process
The Design Department designs the molds and defines processes needed (details of
Refining a Costing System
Refining a Costing System
2. Manufacturing Operations
Lenses are molded, finished, cleaned, and inspected.
3. Shipping and Distribution
Learning Objective 3
Distinguish between the
traditional and the
activity-based costing
approaches to designing
Activity-Based Costing System
Activity-Based Costing System
Fundamental Cost Objects
Activities
Costs of Activities
Assignment to Other Cost Objects
Activity-Based Costing System
Activity-Based Costing System
A cross-functional team at Kole Corporation identified key activities:
Design products and processes. Set up molding machine.
Activity-Based Costing System
Activity-Based Costing System
Set up batches of finished lenses for shipment. Distribute lenses to customers.
Activity-Based Costing System
Activity-Based Costing System
No. of Setup Hours
Activity-Based Costing System
Activity-Based Costing System
NL CL Quantity produced 80,000 20,000 No. produced/batch 250 50 Number of batches 320 400 Setup time per batch 2 hours 5 hours Total setup-hours 640 2,000
Activity-Based Costing System
Activity-Based Costing System
What is the setup cost per setup-hour? $409,200 ÷ 2,640 hours = $155
What is the setup cost per
Activity-Based Costing System
Activity-Based Costing System
Allocation using direct labor-hours: NL: $8.184 × 36,000 = $294,624 CL: $8.184 × 14,000 = $114,576 Total $409,200
Learning Objective 4
Cost Hierarchies
Cost Hierarchies
A cost hierarchy is a categorization of costs into different cost pools.
Cost drivers bases (cost-allocation bases) Degrees of difficulty in determining
Cost Hierarchies
Cost Hierarchies
ABC systems commonly use a four-part cost hierarchy to identify cost-allocation bases: 1. Output unit-level costs
2. Batch-level costs
Output Unit-Level Costs
Output Unit-Level Costs
These are resources sacrificed on activities performed on each individual unit of product or service.
Energy
Batch-Level Costs
Batch-Level Costs
These are resources sacrificed on activities that are related to a group
of units of product(s) or service(s) rather than to each individual unit
of product or service. Setup-hours
Product-Sustaining Costs
Product-Sustaining Costs
These are often called service-sustaining costs and are resources sacrificed on
activities undertaken to support individual products or services.
Facility-Sustaining Costs
Facility-Sustaining Costs
These are resources sacrificed on activities that cannot be traced to individual products or services but support the organization as a whole.
General administration
Learning Objective 5
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Identify cost objects.
NL CL
Identify the direct costs of the products.
Direct material Direct labor
Mold cleaning and
Implementing
Activity-Based Costing
Implementing
Activity-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
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Normal Lenses (NL) Cost Hierarchy
Description Category
Direct materials Unit-level $1,520,000 Direct mfg. labor Unit-level 800,000
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Complex Lenses (CL) Cost Hierarchy
Description Category
Direct materials Unit-level $ 920,000 Direct mfg. labor Unit-level 260,000
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Select the cost-allocation bases to use for allocating indirect costs to the products. (1) (2) (3)
Activity Cost Hierarchy Total Costs Design Product-sustaining $450,000 Setups Batch-level $409,200
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Identify the indirect costs associated with each cost-allocation base.
Overhead costs incurred are assigned to activities, to the extent possible, on
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Compute the rate per unit.
(1) (5) NL CL Total Setup-hours: 640 2,000 2,640
Step 5
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Compute the indirect costs allocated to the products.
NL: $155 × 640 = $ 99,200 CL: $155 × 2,000 = 310,000
Total $409,200
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
Compute the costs of the products. NL and CL would show three
direct cost categories. Step 7
1. Direct materials
Implementing
Activity-Based Costing
Implementing
Activity-Based Costing
NL and CL would show six indirect cost pools. 1. Design
2. Molding machine setups 3. Manufacturing operations 4. Shipment setup
Learning Objective 6
Use activity-based
costing systems for
Activity-Based Management
Activity-Based Management
ABM describes management decisions that use activity-based costing information to satisfy
customers and improve profits. Product pricing and mix decisions
Product Pricing and
Mix Decisions
Product Pricing and
Mix Decisions
ABC gives management insight into the cost
structures for making and selling diverse products. It provides more accurate product cost
information and more detailed information
Cost Reduction and Process
Improvement Decisions
Cost Reduction and Process
Improvement Decisions
Manufacturing and distribution personnel use ABC systems to focus on cost-reduction efforts.
Managers set cost-reduction targets in terms of
Design Decisions
Design Decisions
Management can identify and evaluate new designs to improve performance by evaluating how product
and process designs affect activities and costs. Companies can work with their customers to
Learning Objective 7
Compare activity-based costing
systems and
ABC and Department
Indirect-Cost Rates
ABC and Department
Indirect-Cost Rates
Many companies have evolved their costing system from using a single cost pool to using separate indirect-cost
rates for each department: Design
ABC and Department
Indirect-Cost Rates
ABC and Department
Indirect-Cost Rates
Why?
Because the cost drivers of resources in each department or subdepartment differ from the single, company-wide, cost-allocation base.
Learning Objective 8
Evaluate the costs and benefits
of implementing activity-based
Benefits of ABC Systems
Benefits of ABC Systems
Significant amounts of indirect costs are allocated using only one or two cost pools.
All or most costs are identified as output unit-level costs.
Products make diverse demands on resources because of differences in
Benefits of ABC Systems
Benefits of ABC Systems
Products that a company is well-suited to make and sell show small profits while
products for which a company is less suited show large profits.
Benefits of ABC Systems
Benefits of ABC Systems
Operations staff have significant disagreements with the accounting staff about the costs of manufacturing
Limitations of ABC Systems
Limitations of ABC Systems
The main limitations of ABC are the measurements necessary to
implement the system.
ABC systems require management to estimate costs of activity pools
Limitations of ABC Systems
Limitations of ABC Systems
Activity-cost rates also need to be updated regularly.
ABC In Service and
Merchandising Companies
ABC In Service and
Merchandising Companies
The general approach to ABC in the service and merchandising areas is very similar to the approach in manufacturing.
Costs are divided into homogeneous cost pools and classified as output unit-level, batch-level, product- or service-sustaining,
ABC In Service and
Merchandising Companies
ABC In Service and
Merchandising Companies
The cost pools correspond to key activities. Costs are allocated to products or customers
using activity drivers or cost-allocation bases that have a cause-and-effect
End of Chapter 5
