COST MANAGEMENT

Guan Hansen Mowen

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
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Chapter 4
Activity-Based Costing
2
Study Objectives
1. Describe the basics of plantwide and
departmental overhead costing.
2. Explain why plantwide and departmental
overhead costing may not be accurate.
3. Provide a detailed description of activity-
based product costing.
4. Explain how the activity-based costing
systems can be simplified.
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Functional-Based
Product Costing Model
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Functional-Based Product Costing
Overhead costs are assigned to products using
predetermined overhead rates.

Budgeted Budgeted
Overhead
= annual annual
rate
overhead driver level

Actual
Applied Overhead
= driver
overhead rate
usage

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Overhead Application:
Plantwide Rates
Budgeted overhead $360,000
Expected activity (in direct labor hours) 120,000
Predetermined overhead rate 3.00 $
Pocket
calculator
Currency
translator
Actual activity (in direct labor hours) 40,000 60,000
Predetermined overhead rate $3.00 $3.00
Overhead applied to production $120,000 $180,000
Units produced 80,000 90,000
Overhead per unit $1.50 $2.00
Suncal, Inc.
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Overhead Variances
Overapplied overhead
Applied overhead > actual overhead
Underapplied overhead
Applied overhead < actual overhead

Disposition of overhead variances
Immaterial: assign to cost of goods sold
Material: allocate among inventories and cost
of goods sold
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Overhead Application:
Plantwide Rates
Pocket
calculator
Currency
translator Total
Actual activity (in direct labor hours) 40,000 60,000
Predetermined overhead rate $3.00 $3.00
Overhead applied to production $120,000 $180,000 $300,000
Units produced 80,000 90,000
Overhead per unit $1.50 $2.00
Actual overhead 320,000
Underapplied overhead $20,000
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Overhead Application:
Departmental Rates
Fabrication Assembly Total
Overhead 280,000 $ 80,000 $ 360,000 $
Direct labor hours:
Pocket calculator 10,000 30,000 40,000
Currency translator 10,000 50,000 60,000
Total DL hours 20,000 80,000 100,000
Machine hours:
Pocket calculator 5,000 1,000 6,000
Currency translator 15,000 2,000 17,000
Total machine hours 20,000 3,000 23,000
Application rate 14.00 $ 1.00 $
per machine
hour
per direct labor
hour
Production Departments
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Overhead Application:
Departmental Rates
Pocket
calculator
Currency
translator
Fabrication:
5,000 hr $14.00 $70,000
15,000 hr $14.00 $210,000
Assembly:
30,000 hr $1.00 30,000
50,000 hr $1.00 50,000
$100,000 $260,000
Units produced 80,000 90,000
Overhead per unit $1.25 $2.89
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Limitations of Plantwide and
Departmental Rates
Non-Unit-Related Costs
The use of either plantwide or departmental
rates assumes that the number of units
produced causes overhead costs to increase
Some overhead costs are not driven by the
number of units produced
Product Diversity
Products consume overhead activities in
different proportions
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Limitations of Plantwide and
Departmental Rates
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Unit Cost Based on
Plantwide and Departmental Rates
Scented Regular
PLANT-WIDE RATE
Prime costs 160,000 $ 1,500,000 $
Overhead costs:
$4.00 20,000 80,000
$4.00 160,000 640,000
Total manufacturing costs 240,000 $ 2,140,000 $
Units of production 20,000 200,000
Unit cost 12.00 $ 10.70 $
DEPARTMENTAL RATES
Prime costs 160,000 $ 1,500,000 $
Overhead costs:
Cutting Department:
$1.35 10,000 13,500
$1.35 150,000 202,500
Printing deparment:
$6.30 8,000 50,400
$6.30 72,000 453,600
Total manufacturing costs 223,900 $ 2,156,100 $
Units of production 20,000 200,000
Unit cost 11.20 $ 10.78 $
This schedule uses
the data from exhibit
4-2 to determine unit
cost using department
overhead rates based
on labor (cutting) and
machine (printing)
hours.
This schedule uses
the data from exhibit
4-2 to determine unit
cost using a single
plantwide overhead
rate based on direct
labor hours.
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Limitations of Plantwide and
Departmental Rates
Application of overhead using unit-based
drivers may be inappropriate if
Multiple products are produced
Product diversity exists
Non-unit-level overhead is a significant
percentage of production costs
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Limitations of Plantwide and
Departmental Rates
Scented Regular
ACTIVITY RATES
Prime costs 160,000 $ 1,500,000 $
Overhead costs:
Setting up:
$2,400 60 144,000
$2,400 40 96,000
Machining:
$2.22 10,000 22,200
$2.22 80,000 177,600
Inspecting:
$8.89 2,000 17,780
$8.89 16,000 142,240
Moving materials:
$400 180 72,000
$400 120 48,000
Total manufacturing costs 415,980 $ 1,963,840 $
Units of production 20,000 200,000
Unit cost 20.80 $ 9.82 $
4 Activities:
Setup
Cost $240,000
Qty 100
Machining
Cost $200,000
Qty 90,000
Inspecting
Cost $160,000
Qty 18,000
Moving materials
Cost $120,000
Qty 300
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Design Steps for an ABC System
1. Identify, define, and classify activities
and key attributes
Activity inventory a list of identified
activities
Activity definition financial and
nonfinancial descriptions of the activities
Activity classification primary and
secondary
Activity dictionary activity name,
description, driver, and cost objects
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Design Steps for an ABC System
2. Assign the cost of resources to the
activities
Cost of performing each activity
Use both direct and indirect tracing
General ledger costs are unbundled and
reassigned
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Design Steps for an ABC System
3. Assign the cost of secondary activities
To those activities that consume their
output
Total cost of the secondary activity is the
sum of the direct and assigned costs
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Design Steps for an ABC System
4. Identify cost objects and specify the
amount of each activity consumed by
specific cost objects
Cost objects are identified
Activity drivers are used to measure the
demands placed on activities.
Transaction drivers measure demand by
quantity of events
Duration drivers measure demand by
elapsed time
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Design Steps for an ABC System
5. Calculate primary activity rates
Budgeted activity costs
Practical activity capacity



6. Assign activity costs to cost objects
Multiply activity rate by activity measure
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Reducing the Size and Complexity
of an ABC System
Approximately Relevant ABC Systems
Use only the most expensive activities for
ABC assignment.
Assign using cause-and-effect drivers
All other activity costs are added to cost pools
of the expensive activities
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Reducing the Size and Complexity
of an ABC System
Time-Driven ABC System
Overcomes the drawback of traditional ABC
systems: few people report idle or unused
time
1) Managers estimate practical capacity as a
percentage of theoretical capacity
2) Determine a per-time-unit rate
3) Determine the time required for one unit of
activity
4) Multiply rate by time
COST MANAGEMENT

Guan Hansen Mowen
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End Chapter 4