Chapter 3 - Activity Based Costing PDF

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CHAPTER 3 – ACTIVITY BASED COSTING !

ACTIVITY BASED COSTING (ABC) Activity Based Costing is a more accurate way of allocating costs, from multiple resources, than conventional job costing. It is used when more than one cost pool make up the total overhead costs Note: Many companies have multiple product lines. Apple sells iPhones, Macbooks, iPads, etc. Therefore, it is important for Apple to allocate overhead based on department output. Products that take longer to make will require more resources and thus, incur higher costs. As a result, more overhead costs should be allocated to a Macbook than an iPhone. Conventional Job Costing Activity Based Costing • Have multiple cost pools - Has one cost pool (i.e. 5 cost pools make up the total overhead) (i.e. Total Overhead equals…) • Uses multiple activity rates (POHR) respective to each pool - Uses one activity rate (predetermined OH rate, POHR) • Uses multiple allocation bases respective to each cost pool - Uses one allocation base (i.e. one cost pool is based on machine hours and another is (i.e. direct labor hours) based on direct labor hours) • More accurate than traditional/conventional job costing • *Shifts overhead cost from high volume products to low volume products, thus making the overhead costs for products more uniform; and makes low volume products more costly • ABC is more costly to implement and use than traditional/conventional job costing Activity Cost Pool – the respective cost for each pool that make up the total overhead costs Activity Measure – the allocation base for the cost pool (i.e. machine hours, number of set ups, etc.) Activity Rate – the predetermined overhead rate for the cost pool -Cost Pool is the overhead cost, which is measured in total dollars. (i.e. If 100 kilowatts of electricity used in the month., cost is $500) -Activity measure is in terms of allocation base, which is the type of activity. (i.e. Electricity is measured in kilowatt.) -Activity rate is the cost per usage or type of activity…. (i.e. Electricity rates are $0.50 per kilowatt; $0.50/kilowatt) *Under traditional job costing, the allocation base is usually direct labor hours. Higher volume products require more labor hours, which leads to more overhead costs. Under ABC, the emphasis on hours is less because there are multiple allocation bases. Therefore, costs will shift from high volume to low volume products. Read up on Unit/Batch/Product/Facility Level if necessary. _________________________________________________________________________________________________________________________________ © COPYRIGHTED 2014. Y. PAN. ALL MATERIALS ARE COPYRIGHTED AND MAY NOT BE DUPLICATED, DISTRIBUTED, TRANSFERRED OR USED WITHOUT PERMISSION. EMAIL: [email protected]

CHAPTER 3 – ACTIVITY BASED COSTING !

Exercise – Traditional/Conventional Job Costing example, For many years, Zapro Company manufactured a single product called a mono-relay. Then three years ago, the company automated a portion of its plant and at the same time introduced a second product called a bi-relay that has become increasingly popular. The bi-relay is a more complex product, requiring one hour of direct labor time per unit to manufacture and extensive machining in the automated portion of the plant. The mono-relay requires only 0.75 hours of direct labor time per unit and only a small amount of machining. Manufacturing overhead costs are currently assigned to products on the basis of direct labor-hours. Despite the growing popularity of the company's new bi-relay, profits have been declining steadily. Management is beginning to believe that there may be a problem with the company's costing system. Material and labor costs per unit are as follows: Direct Materials Direct Labor (0.75 hours @ $12 per hour and 1.0 hours @ $12 per hour)

Mono-Relay $32

Bi-Relay $49

$9

$12

Management estimates that the company will incur $927,000 in manufacturing overhead costs during the current year and 40,000 units of the mono-relay and 10,000 units of the bi-relay will be produced and sold.

Compute the predetermined manufacturing overhead rate assuming that the company continues to apply manufacturing overhead cost on the basis of direct labor-hours. Using this rate and other data from the problem, determine the unit product cost of each product.

Predetermined Manufacturing Overhead Rate Unit Product Cost of Mono-Relay Unit Product Cost of Bi-Relay

$ ______________ per DLH $ ______________ $ ______________

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CHAPTER 3 – ACTIVITY BASED COSTING !

Direct Materials Direct Labor (0.75 hours @ 12 per hour and 1.0 hours @ 12 per hours)

Mono-Relay $32

Bi-Relay $49

$9

$12

Predetermined Overhead Rate = Estimated Total Overhead ($) / Estimated Allocation Base (Direct Labor Hours) “apply manufacturing overhead cost on the basis of direct labor hours” Find the total number of hours Mono: .75hr/unit X 40000 units = 30,000 hours Bi: 1hr/unit X 10000 units = 10,000 hours Total = 40,000 hours

Total overhead (given) = $927,000 Direct Labor Mono: .75 hours – it takes .75 hour to make 1 unit of mono Direct Labor Bi: 1 hour – it takes 1 hour to make 1 unit of bi

POHR = $927,000 / 40,000 hours = $23.18 per DLH Unit product costs = DM + DL + Applied Overhead

Applied Overhead = POHR X Actual Allocation Base

Unit Product Cost of Mono-Relay = $32 + $9 + ($23.18/DLH X .75hrs) = $58.39 Unit Product Cost of Bi-Relay = $49 + $12 + ($23.18/DLH X 1hr) =

$84.18

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CHAPTER 3 – ACTIVITY BASED COSTING !

Management is considering using activity-based costing to apply manufacturing overhead cost to products for external financial reports. The activity-based costing system would have the following four activity cost pools: Activity Cost Pool Maintaining parts inventory Processing purchase orders Quality control Machine related

Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

Expected Activity Level Mono-Relay Bi-Relay 75 150 800 200 2,500 3,250 4,000 6,000

Estimated Overhead Cost $ 227,000 190,000 40,000 470,000 $ 927,000 Total 225 1000 5,750 10,000

Determine the activity rate (i.e., predetermined overhead rate) for each of the four activity cost pools. Activity Cost Pool

Activity Rate

Maintaining Inventory Processing Purchase Orders Quality Control Machine-related

$ _____________ per part type $ _____________ per order $ _____________ per test $ _____________ per MH

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CHAPTER 3 – ACTIVITY BASED COSTING !

Predetermined Overhead Rate = Estimated Total Overhead / Estimated Allocation Base; with ABC activity rate is the POHR Activity Cost Pool Maintaining parts inventory Processing purchase orders Quality control Machine related

Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

Estimated Overhead Cost $ 227,000 190,000 40,000 470,000 $ 927,000

Expected Activity Level Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

Mono-Relay 75 800 2,500 4,000

Bi-Relay 150 200 3,250 6,000

Total 225 1000 5,750 10,000

Maintaining inventory:

(227000/225) =

$1,008.89 per part type

Processing purchase orders:

(190000/1000)=

$190 per order

Quality Control:

(40000/5750)=

$6.96 per test

Machine-Related

(470000/10000)=

Activity Cost Pool Maintaining parts inventory Processing purchase orders Quality control Machine related

Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

$47 per MH

Estimated Overhead Cost $ 227,000 190,000 40,000 470,000 $ 927,000

Expected Activity Level

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CHAPTER 3 – ACTIVITY BASED COSTING !

Activity Measure Number of part types Number of purchase orders Number of tests run Machine-hours

Mono-Relay 75 800 2,500 4,000

Maintaining inventory: Processing purchase orders: Quality Control: Machine-Related Number of units:

Mono-Relay – 40,000 units

Bi-Relay 150 200 3,250 6,000

Total 225 1000 5,750 10,000

(227000/225) = (190000/1000)= (40000/5750)= (470000/10000)=

$1,008.89 $190 $6.96 $47

per part type per order per test per MH

Bi-Relay – 10,000 units

(a) Determine the total amount of manufacturing overhead costs that would be applied to each product using the activity-based costing system. After these totals have been computed, determine the amount of manufacturing overhead cost per unit of each product. (Round your answer to 2 decimal places). Overhead per unit of Mono- Relay Overhead per unit of Bi- Relay

$______________ $______________

(b) Compute the unit product cost of each product. (Round your answer to 2 decimal places). Unit product cost for Mono-Relay Unit product cost for Bi-Relay

$______________ $______________

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CHAPTER 3 – ACTIVITY BASED COSTING !

Maintaining inventory: Processing purchase orders: Quality Control: Machine-Related

(227000/225) = (190000/1000)= (40000/5750)= (470000/10000)= Mono Relay

a)

Part Types Purchase Orders Tests Run Machine-Hours Total Overhead

75 800 2500 4000

x x x x

Activity Rate $1,008.89 $190 $6.96 $47

150 200 3250 6000

x x x x

Activity Rate $1,008.89 $190 $6.96 $47

Bi Relay Part Types Purchase Orders Tests Run Machine-Hours Total Overhead

$1,008.89 $190 $6.96 $47

Overhead per unit of Mono-Relay = $433,067 / 40,000 units =

$10.83

Overhead per unit of Bi-Relay = $493,953.50/ 10,000 units =

$49.40

per part type per order per test per MH

$75,666.75 $152,000.00 $17,400.00 $188,000.00 $433,066.75 $151,333.50 $38,000.00 $22,620.00 $282,000.00 $493,953.50

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CHAPTER 3 – ACTIVITY BASED COSTING !

Direct Materials Direct Labor (0.75 hours @ 12 per hour and 1.0 hours @ 12 per hours)

Mono-Relay $32

Bi-Relay $49

$9

$12

Overhead per unit of Mono-Relay = $433,067 / 40,000 units =

$10.83

Overhead per unit of Bi-Relay = $493,953.50/ 10,000 units =

$49.40

b) Product Cost = DM + DL + Applied OH Unit product cost for Mono-Relay

=

$32 + $9 + $10.83

=

$51.83

Unit product cost for Bi-Relay

=

$49 + $12 + $49.40

=

$110.40

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CHAPTER 3 – ACTIVITY BASED COSTING !

Jordan's Lakeside is a popular restaurant located on Lake Washington in Seattle. The owner of the restaurant has been trying to better understand costs at the restaurant and has hired a student intern to conduct an activity-based costing study. The intern, in consultation with the owner, identified the following major activities: Activity Cost Pool Serving a party of diners Serving a diner Serving drinks

Activity Measure Number of parties served Number of diners served Number of drinks ordered

A group of diners who ask to sit at the same table are counted as a party. Some costs, such as the costs of cleaning linen, are the same whether one person is at a table or the table is full. Other costs, such as washing dishes, depend on the number of diners served. Total cost Total activity

Serving a Party $33,000 6,000 parties

Serving a Diner $218,000 15,000 diners

Serving a Drink $69,000 10,000 drinks

Total $320,000

Prior to the activity-based costing study, the owner knew very little about the costs of the restaurant. She knew that the total cost for the month was $320,000 and that 15,000 diners had been served. Therefore, the average cost per diner was $21.33 ($320,000 ÷ 15,000 diners = $21.33 per diner). Requirement 1: Compute the activity rates for each of the three activities. Cost per unit of activity Serving a Party Serving a Diner Serving Drinks

$_______ per party $_______ per diner $_______ per drink

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CHAPTER 3 – ACTIVITY BASED COSTING !

Total cost Total activity

Serving a Party $33,000 6,000 parties

Serving a Diner $218,000 15,000 diners

Serving a Drink $69,000 10,000 drinks

Total $320,000

Prior to the activity-based costing study, the owner knew very little about the costs of the restaurant. She knew that the total cost for the month was $320,000 and that 15,000 diners had been served. Therefore, the average cost per diner was $21.33 ($320,000 ÷ 15,000 diners = $21.33 per diner).

Serving a Party = $33,000/6,000 parties =

$5.50 per party

Serving a Diner = $218,000/15,000 diners =

$14.53 per diner

Serving Drinks = $69,000/10,000 drinks =

$6.90 per drink

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CHAPTER 3 – ACTIVITY BASED COSTING !

Serving a Party = $33,000/6,000 parties = Serving a Diner = $218,000/15,000 diners = Serving Drinks = $69,000/10,000 drinks =

$5.50 per party $14.53 per diner $6.90 per drink

According to the activity-based costing system, what is the total cost of serving each of the following parties of diners? a. A party of four diners who order three drinks in total. b. A party of two diners who do not order any drinks. c. A lone diner who orders two drinks. Requirement 2: A. Party of four diners who order three drinks B. Party of two diners who order no drinks C. Party of one diner who orders two drinks

Total $ ___________ $ ___________ $ ___________

Convert the total costs you computed in Requirement 2 above to costs per diner. In other words, what is the average cost per diner for serving each of the following parties? d. A party of four diners who order three drinks in total. e. A party of two diners who do not order any drinks. f. A lone diner who orders two drinks. Requirement 3: D. Party of four diners who order three drinks E. Party of two diners who order no drinks F. Party of one diner who orders two drinks

Average cost $ ___________per diner $ ___________per diner $ ___________per diner

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CHAPTER 3 – ACTIVITY BASED COSTING !

Requirement 2: a. A party of four diners who order three drinks in total. b. A party of two diners who do not order any drinks. c. A lone diner who orders two drinks. Requirement 3: a. A party of four diners who order three drinks in total. b. A party of two diners who do not order any drinks. c. A lone diner who orders two drinks *The charge for a party is similar to a fixed cost. Whether there is one diner or four diners at the table, there is a fixed cost of $5.5. That is the cost to clean the table. Serving a Party = $33,000/6,000 parties = Serving a Diner = $218,000/15,000 diners = Serving Drinks = $69,000/10,000 drinks = Requirement 2: a. (5.5) + (14.53 X 4) + (6.9 X 3 )

$5.50 per party $14.53 per diner $6.90 per drink

=

$84.32

b. (5.5) + (14.53 X 2) + (0)

=

$34.56

c. (5.5) + (14.53) + (6.9 X 2)

=

$33.83

Requirement 3: Average cost per diner. The average is the total cost divided by number of diners. a. $84.32/ 4

=

$21.08 per diner

b. $34.56/2

=

$17.28 per diner

c. $33.83/1

=

$33.83 per diner

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