202 Ch 8 S08

202 Ch 8 S08 - ACC 202 Intro to Management Accounting Can...

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Unformatted text preview: ACC 202 Intro to Management Accounting Can we use ABC reports to set bid prices? Yes. Chapter 8: Activity Based Costing: A Decision Making Tool obj 1 Learning Objectives Understand differences between ABC & traditional costing systems Assign cost to cost pools Compute activity rates 1st stage allocation Assign costs to a cost object Compute activitybased costing 2nd stage allocation margins Activity Based Costing (ABC) ABC provides cost info for strategic and other decisions that potentially affect capacity, and therefore, affect fixed as well as variable costs. ABC prevents distortion of OH allocation due to volume. How Costs are Treated Under ActivityBased Costing ABC differs from traditional costing in three ways. Manufacturing costs Non-manufacturing costs Traditional product costing ABC product costing ABC assigns both types of costs to products. How Costs are Treated Under ActivityBased Costing ABC differs from traditional costing in three ways. Manufacturing costs Mo st, not but all Non-manufacturing costs Some ABC product costing Traditional product costing ABC does not assign all manufacturing costs to products. All How Costs are Treated Under ActivityBased Costing "ABC differs from traditional costing in three ways. Level of complexity ActivityBased Costing Departmental Overhead Rates Plantwide Overhead Rate Number of cost pools ABC uses more cost pools. How Costs are Treated Under ActivityBased Costing ABC differs from traditional costing in three ways. Each ABC cost pool has its own unique measure of activity. Traditional cost systems usually rely on volume measures such as direct labor hours and/or machine hours to allocate all overhead costs to products. ABC uses more cost pools. ABC uses more cost pools. How Costs are Treated Under ActivityBased Costing Activity An event that causes the consumption of overhead resources. A "cost bucket" in which costs related to a particular activity measure are accumulated. Activity Cost Pool $$ $ $ $ $ How Costs are Treated Under ActivityBased Costing Activity Measure The term cost driver is also used to refer to an activity measure. An allocation base in an activity-based costing system. How Costs are Treated Under ActivityBased Costing Two common types of activity measures: Transaction driver Simple count of the number of times an activity occurs. Duration driver A measure of the amount of time needed for an activity. How Costs are Treated Under ActivityBased Costing ABC defines five levels of activity that largely do not relate to the volume of units produced. Traditional cost systems usually rely on volume measures such as direct labor hours and/or machine hours to allocate all overhead costs to products. How Costs are Treated Under ActivityBased Costing Unit-Level Activity Batch-Level Activity Manufacturing companies typically combine their activities into five classifications. Product-Level Activity Organizationsustaining Activity Customer-Level Activity Characteristics of Successful ABC Implementations Strong top management support Link to evaluations and rewards Cross-functional involvement Implementing an ABC System Define activities, activity cost pools, & activity measures. Assign overhead costs to activity cost pools st (1 stage allocation). Compute activity rates for cost pools. nd Assign costs to a cost object (2 stage allocation). Classic Brass An ABC Example Classic Brass Income Statement Year Ended December 31, 2005 Sales Cost of goods sold Direct materials Direct labor Manufacturing overhead Gross margin Selling and administrative expenses Shipping expenses Marketing expenses General administrative expenses Net operating income loss $ 3,200,000 $ 975,000 351,250 1,000,000 2,326,250 873,750 65,000 300,000 510,000 $ 875,000 (1,250) Manufacturing overhead is allocated to products using a single plantwide overhead rate based on machine hours. Define Activities, Activity Cost Pools, and Activity Measures At Classic Brass, the ABC team, selected the following activity cost pools and activity measures: Activity Cost Pools at Classic Brass Activity Cost Pool Customer orders Product design Order size Customer relations Other Activity Measure Number of customer orders Number of product designs Machine-hours Number of active customers Not applicable Define Activities, Activity Cost Pools, and Activity Measures Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. Product Designs - assigned all costs of resources consumed by designing products. Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. Customer Relations assigned all costs associated with maintaining relations with customers. Other assigned all overhead costs that are not associated with the other cost pools. Assign Overhead Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total overhead costs 500,000 300,000 120,000 80,000 400,000 50,000 60,000 250,000 50,000 $ 1,000,000 510,000 $ 300,000 1,810,000 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and Nonmanufacturing) Production Department Indirect factory wages $ 500,000 Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 $ 1,000,000 General Administrative Department Administrative wages and salaries 400,000 Office equipment depreciation 50,000 Administrative building lease 60,000 510,000 Marketing Department Direct materials, direct labor, and shipping are excluded Marketing wages and salaries 250,000 because Classic Brass' existing cost system can directly Selling expenses 50,000 300,000 trace these costs to products or customer$ orders. Total overhead costs 1,810,000 Assign Overhead Costs to Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. Activity Cost Pools Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses 25% 20% 0% 0% 15% 30% 0% 22% 10% Product Design 40% 0% 10% 0% 5% 0% 0% 8% 0% Order Size 20% 60% 50% 0% 10% 0% 0% 0% 0% Customer Relations 10% 0% 0% 0% 30% 25% 0% 60% 70% Other 5% 20% 40% 100% 40% 45% 100% 10% 20% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% Assign Overhead Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and NonManufacturing) Production Department $ CostIndirect factory wages Pools Factory Product equipment depreciation Order Customer Factory utilities Design Size Relations Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total overhead costs Activity Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 125,000 500,000 300,000 120,000 Other $ 80,000 400,000 50,000 60,000 250,000 50,000 $ Total 1,000,000 510,000 300,000 1,810,000 Indirect factory wages $500,000 Percent consumed by customer orders 25% $125,000 Assign Overhead Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and NonManufacturing) Production Department $ CostIndirect factory wages Pools Factory Product equipment depreciation Order Customer Factory utilities Design Size Factory building lease Relations General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total overhead costs Activity Customer Orders Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total $ 125,000 60,000 500,000 300,000 120,000 Other $ 80,000 400,000 50,000 60,000 250,000 50,000 $ Total 1,000,000 510,000 300,000 1,810,000 Factory equipment depreciation $300,000 Percent consumed by customer orders 20% $ 60,000 Assign Overhead Costs to Activity Cost Pools Activity Cost Pools Customer Product Orders Design Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Total Order Size Customer Relations 50,000 $ 120,000 12,500 Other 25,000 $ 60,000 48,000 80,000 160,000 22,500 60,000 Total 500,000 300,000 120,000 80,000 400,000 50,000 60,000 $ 125,000 $ 200,000 $ 100,000 $ 60,000 180,000 12,000 60,000 60,000 15,000 20,000 40,000 - 55,000 20,000 150,000 25,000 250,000 5,000 35,000 10,000 50,000 $ 320,000 $ 252,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000 Calculate Activity Rates The ABC team determines that Classic Brass will have these total levels of activity for each activity cost pool: 1,000 customer orders, 400 new designs, 20,000 machinehours, 250 customer relations activities. Now the team can compute the individual activity rates by dividing the total cost for each activity cost pool by the total activity levels. Calculate Activity Rates Comput a tion of Ac t ivity Ra t e s Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost $ 320,000 252,000 380,000 367,500 490,500 (b) Total Activity 1,000 orders 400 designs 20,000 MHs 250 customer Not applicable (a) (b) Activity Rate $320 per order $630 per design $19 per MH $1,470 per customer Not applicable Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs Overhead Costs Traced Traced Traced Cost Objects: Products, Customer Orders, Customers Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs Overhead Costs First-Stage Allocation Order Size Customer Orders Product Design Customer Relations Other Cost Objects: Products, Customer Orders, Customers Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs FirstStage Allocation Overhead Costs Order Size Customer Orders Product Design Customer Relations Other Second-Stage Allocations $/MH $/Order $/Design $/Customer Cost Objects: Products, Customer Orders, Customers Unallocated Assigning Overhead to Products Classic Brass Information Standard Stanchions 1. Requires no new design resources. 1. 30,000 units ordered with 600 separate orders. 2. Each stanchion requires 35 minutes of machine time for a total of 17,500 machine-hours. Custom Compass Housing 1. Requires new design resources. 1. 400 separate orders. 2. 400 custom designs prepared. 3. 1,250 compass housings produced, requiring 2 machine-hours each for a total of 2,500 machine-hours. Assigning Overhead to Products Ove r he a d Cost for the Sta nda r d Sta nc hions Activity Cost Pools Customer orders Product design Order size Total (a) Activity Rate $ 320 630 19 (b) Activity 600 0 17500 (a) (b) ABC Cost $ 192,000 332,500 $ 524,500 Ove r he a d Cost for the Custom Housing Activity Cost Pools Customer orders Product design Order size Total (a) Activity Rate $ 320 630 19 (b) Activity 400 400 2500 (a) (b) ABC Cost $ 128,000 252,000 47,500 $ 427,500 Assigning Overhead to Customers Let's take a look at how Classic Brass system works for just one of the 250 customers Windward Yachts who placed a total of three orders. Orders 1. Two orders for 150 standard stanchions per order. 2. One order for a custom compass housing. Machine-hours 1. The 300 standard stanchions required 175 machine-hours. 2. The custom compass housing required 2 machine hours. Assigning Overhead to Customers Ove r he a d Cost for Winwa r d Ya c ht s Activity Cost Pools Customer orders Product design Order size Customer relations Total (a) Activity Rate $ 320 630 19 1,470 (b) Activity 3 1 177 1 (a) (b) ABC Cost $ 960 630 3,363 1,470 $ 6,423 Prepare Management Reports Product Margin Calculations Step #1: gather sales & direct cost data for each product Standard Stanchions $ 2,660,000 905,500 263,750 60,000 Custom Compass Housings $ 540,000 69,500 87,500 5,000 Total $ 3,200,000 975,000 351,250 65,000 Sales Direct costs Direct material Direct labor Shipping Prepare Management Reports Product Margin Calculations Step #2: incorporate activity-based cost assignments for each product Custom Compass Housings $ 540,000 69,500 87,500 5,000 128,000 252,000 47,500 Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Product design Order size Standard Stanchions $ 2,660,000 905,500 263,750 60,000 192,000 332,500 Total $ 3,200,000 975,000 351,250 65,000 320,000 252,000 380,000 Prepare Management Reports Product Margin Calculations Step #3: deduct direct & indirect costs from sales for each product Standard Stanchions $ 2,660,000 $ 905,500 263,750 60,000 192,000 332,500 1,753,750 $ 906,250 $ Custom Compass Housings $ 540,000 69,500 87,500 5,000 128,000 252,000 47,500 589,500 (49,500) Sales Costs Direct material Direct labor Shipping Customer orders Product design Order size Total cost Product margin Prepare Management Reports Product Margin Calculations Product margins can be reconciled with the company's net operating income. Standard Stanchions $ 2,660,000 1,753,750 $ 906,250 Custom Compass Housings $ 540,000 589,500 $ (49,500) Sales Total costs Product margins Total $ 3,200,000 2,343,250 $ 856,750 LESS COSTS NOT ASSIGNED TO PRODUCTS: Customer relations Other Total Net operating income t loss $ 367,500 490,500 858,000 (1,250) Prepare Management Reports Customer Profitability Analysis Step #1: gather sales & direct cost data for each customer Windward Yachts $ 11,350 2,123 1,900 205 Sales Direct costs Direct material Direct labor Shipping Prepare Management Reports incorporate activitybased cost assignments for each customer Windward Yachts $ 11,350 2,123 1,900 205 960 630 3,363 1,470 Customer Profitability Analysis Step #2: Sales Direct costs Direct material Direct labor Shipping ABC cost assignments Customer orders Product design Order size Customer relations Prepare Management Reports Customer Profitability Analysis Step #3: deduct direct & indirect costs from sales for each customer Sales Costs Direct material Direct labor Shipping Customer orders Product design Order size Customer relations Customer margin Windward Yachts $ 11,350 $ 2,123 1,900 205 960 630 3,363 1,470 10,651 $ 699 Product Margins Computed Using the Traditional Cost System Step #1: gather sales & direct cost data for each product Standard Stanchions $ 2,660,000 905,500 263,750 Custom Compass Housings $ 540,000 69,500 87,500 Sales Direct costs Direct material Direct labor Total $ 3,200,000 975,000 351,250 Product Margins Computed Using the Traditional Cost System Step #2: compute the plantwide overhead rate. Manufacturing Overhead Costs at Classic Brass Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Total manufacturing overhead $ 500,000 300,000 120,000 80,000 $ 1,000,000 Plantwide manufacturing overhead rate = $1,000,000 20,000 MH = $50 per machine-hour Standard Stanchions Custom compass Housings Total machine-hours Machine-hours 17,500 2,500 20,000 Product Margins Computed Using the Traditional Cost System Step #3: allocate manufacturing overhead to each product Machine Overhead Overhead Hours Rate Allocated 17,500 $ 50.00 $ 875,000 2,500 50.00 125,000 $ 1,000,000 Standard Stanchions Custom Compass Housings Total overhead allocated to products 17,500 hours $50 per hour = $875,000 Product Margins Computed Using the Traditional Cost System Step #4: compute the product margins Standard Stanchions $ 2,660,000 $ 2,044,250 $ 615,750 Custom Compass Housings $ 540,000 69,500 87,500 125,000 $ 282,000 258,000 Total $ 3,200,000 975,000 351,250 1,000,000 Sales Cost of goods sold Direct materials $ 905,500 Direct labor 263,750 Manufacturing overhead 875,000 Product margin Selling and administrative Nett operating income operating loss 2,326,250 873,750 875,000 $ (1,250) Shipping expenses Marketing expenses General administrative expenses $ 65,000 300,000 510,000 $ 875,000 The Differences Between ABC and Traditional Product Costs Product margins traditional Product margins ABC Change in reported margins Standard Stanchions $ 615,750 906,250 $ 290,500 Custom Compass Housings $ 258,000 (49,500) $ (307,500) The traditional cost system overcosts the standard stanchions and reports a lower product margin for this product. The traditional cost system undercosts the custom compass housings and reports a higher product margin for this product. The Differences Between ABC and Traditional Product Costs Three reasons why product margins for the two costing systems differ: Traditional costing allocates all manufacturing overhead to products. ABC costing only assigns manufacturing overhead costs consumed by products to those products. The Differences Between ABC and Traditional Product Costs Three reasons why product margins for the two costing systems differ: Traditional costing allocates all manufacturing overhead costs using a volume-related allocation base. ABC costing also uses non-volume related allocation bases. The Differences Between ABC and Traditional Product Costs Three reasons why product margins for the two costing systems differ: Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products. Targeting Process Improvement Activity-based management is used in conjunction with ABC to identify areas that would benefit from process improvements. While the theory of constraints approach discussed in Chapter 1 is a powerful tool for targeting improvement efforts, activity rates can also provide valuable clues on where to focus improvement efforts. Benchmarking can be used to compare activity cost information with world-class standards of performance achieved by other organizations. Activity-Based Costing and External Reporting Most companies do not use ABC for external reporting because . . . 1. External reports are less detailed than internal reports. 2. It may be difficult to make changes to the company's accounting system. 3. ABC does not conform to GAAP. 4. Auditors may be suspect of the subjective allocation process based on interviews with employees. ABC Limitations Substantial resources required to implement and maintain. Desire to fully allocate all costs to products. Resistance to unfamiliar numbers and reports. Potential misinterpretation of unfamiliar numbers. Does not conform to GAAP. Two costing systems may be needed. ...
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This note was uploaded on 08/25/2008 for the course ACC 202 taught by Professor Woollen during the Spring '08 term at Hawaii.

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