C 08

Activity-Based Costing: A
Tool to Aid Decision Making
Chapter Eight
McGrawHill/Irwin Copyright2008,TheMcGrawHillCompanies,Inc.
8-2
Activity Based Costing (ABC)
ABC is a
ABC is designed to good supplement
provide managers with to our traditional
cost system
cost information for I agree!
strategic and other
decisions that
potentially affect
capacity and therefore
affect fixed as well as
variable costs.
8-3
Learning Objective 1
Understand activity-based
costing and how it differs
from a traditional costing
system.
8-4
How Costs are Treated Under
ActivityBased Costing
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Manufacturing Nonmanufacturing
costs costs
Traditional ABC
product costing product costing
ABC assigns both types of costs to products.

8-5
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Manufacturing Nonmanufacturing
costs costs
Some
Mo
st,
not but
All
all
Traditional ABC
product costing product costing
ABC does not assign all manufacturing costs to products.

8-6
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Level of complexity
ActivityBased
ActivityBased
Costing
Costing
Departmental
Departmental
Overhead
Overhead
Rates
Rates
Plantwide
Plantwide
Overhead
Overhead
Rate
Rate
Number of cost pools

ABC uses more cost pools.
8-7
ABC
ABC differs
differs from
from traditional
traditional cost
cost accounting
accounting in
in three
three ways.
ways.
Each
Each ABC
ABC cost
cost pool
pool has
has its
its
own
own unique
unique measure
measure ofof activity.
activity.
Traditional
Traditional cost
cost systems
systems usually
usually rely
rely
on
on volume
volume measures
measures such
such as as direct
direct labor
labor
hours
hours and/or
and/or machine
machine hours
hours to to allocate
allocate
all
all overhead
overhead costs
costs to
to products.
products.
ABC uses more cost pools.
8-8
An event that causes the
Activity consumption of overhead
resources.
A cost bucket in which

Activity costs related to a particular
Cost Pool activity measure are
accumulated.
$$
$
$ $
$
8-9
The
The term
term cost
cost driver
driver is
is
Activity
Activity also
also used
used to
to refer
refer to
to
Measure
Measure an
an activity
activity measure.
measure.
An
An allocation
allocation base
base
in
in an
an activity-based
activity-based
costing
costing system.
system.
8-10
Two common types of activity measures:
Transaction Duration
driver driver
Simple count A measure

of the number of of the amount
times an activity of time needed
occurs. for an activity.
8-11
ABC defines
five levels of activity
that largely do not relate
to the volume of units
produced.
Traditional
Traditional cost
cost systems
systems usually
usually rely
rely on
on volume
volume
measures
measures such
such asas direct
direct labor
labor hours
hours and/or
and/or machine
machine
hours
hours to
to allocate
allocate all
all overhead
overhead costs
costs to
to products.
products.
8-12
Unit-Level Batch-Level
Activity Activity
Manufacturing
companies typically combine
their activities into five
classifications.
Product-Level Customer-Level
Activity Organization- Activity
sustaining
Activity
8-13
Characteristics of Successful
ABC Implementations
Strong
Strong top
top
management
management support
support
Link
Link to
to evaluations
evaluations
and
and rewards
rewards
Cross-functional
Cross-functional
involvement
involvement
8-14
Classic Brass An ABC Example
Manufacturing
Manufacturing overhead
overhead is
is allocated
allocated to
to products
products using
using
aa single
single plantwide
plantwide overhead
overhead rate
rate based
based on
on machine
machine hours.
hours.
Define Activities, Activity Cost Pools,
8-15
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 Activity Measure
Customer orders Number of customer orders
Product design Number of product designs
Order size Machine-hours
Customer relations Number of active customers
Other Not applicable
Define Activities, Activity Cost Pools,
8-16
and Activity Measures
Customer
Customer Orders
Orders -- assigned
assigned allall costs
costs ofof resources
resources
that
that are
are consumed
consumed by by taking
taking and
and processing
processing
customer
customer orders.
orders.
Product
Product Designs
Designs -- assigned
costs ofof resources
resources
consumed
consumed by by designing
designing products.
products.
Order
Order Size
Size -- assigned
assigned all
all costs
costs of
of resources
resources
consumed
consumed as as aa consequence
consequence of of the
the number
number of of units
units
produced.
produced.
Customer
Customer Relations
Relations assigned
costs associated
associated
with
with maintaining
maintaining relations
relations with
with customers.
customers.
Other
Other assigned
assigned all
all overhead
overhead costs
costs that
that are
are not
not
associated
associated with
with the
the other
other cost
cost pools.
pools.
8-17
Assign costs to cost pools

using a first-stage
allocation.
8-18
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
Marketing wages and salaries 250,000
Selling expenses 50,000 300,000
Total overhead costs $ 1,810,000
8-19
Marketing
Direct wagesdirect
materials, and salaries 250,000are excluded
labor, and shipping
because Classic Brass existing cost system can directly
Total overhead costs $ 1,810,000
trace these costs to products or customer orders.
8-20
At Classic Brass the following distribution of resource

consumption across activity cost pools is determined.
Activity Cost Pools
Customer Product Order Customer

Orders Design Size Relations Other Total
Indirect factory wages 25% 40% 20% 10% 5% 100%
Factory equipment depreciation 20% 0% 60% 0% 20% 100%
Factory utilities 0% 10% 50% 0% 40% 100%
Factory building lease 0% 0% 0% 0% 100% 100%
Administrative wages and salaries 15% 5% 10% 30% 40% 100%
Office equipment depreciation 30% 0% 0% 25% 45% 100%
Administrative building lease 0% 0% 0% 0% 100% 100%
Marketing wages and salaries 22% 8% 0% 60% 10% 100%
Selling expenses 10% 0% 0% 70% 20% 100%
8-21
Activity Cost Pools
Customer Factory equipment
Product Orderdepreciation
Customer 300,000
Production Department General Administrative Department
Indirect factory wages $ 125,000 Administrative wages and salaries 400,000
Factory equipment depreciation Office equipment depreciation 50,000
Factory utilities
Factory building lease Marketing wages and salaries 250,000
General Administrative Department Selling expenses 50,000 300,000
Administrative wages and salaries Total overhead costs $ 1,810,000
Office equipment depreciation
Administrative building lease
Marketing wages and salaries
Selling expenses
Total
Indirect
Indirect factory
factory wages
wages $500,000
$500,000
Percent
Percent consumed
consumed byby customer
customer orders
orders 25%
25%
$125,000
$125,000
8-22
Activity Cost Pools
Customer Factory equipment
Product Orderdepreciation
Customer 300,000
Production Department General Administrative Department
Indirect factory wages $ 125,000 Administrative wages and salaries 400,000
Factory equipment depreciation 60,000 Office equipment depreciation 50,000
Factory utilities
Factory building lease Marketing wages and salaries 250,000
General Administrative Department Selling expenses 50,000 300,000
Administrative wages and salaries Total overhead costs $ 1,810,000
Administrative building lease
Marketing wages and salaries
Selling expenses
Total
Factory
Factory equipment
equipment depreciation
depreciation $300,000
$300,000
Percent
Percent consumed
consumed by
by customer
customer orders
orders 20%
20%
$$ 60,000
60,000
8-23
Activity Cost Pools

Indirect factory wages $ 125,000 $ 200,000 $ 100,000 $ 50,000 $ 25,000 $ 500,000
Factory equipment depreciation 60,000 - 180,000 - 60,000 300,000
Factory utilities - 12,000 60,000 - 48,000 120,000
Factory building lease - - - - 80,000 80,000
Administrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000
Office equipment depreciation 15,000 - - 12,500 22,500 50,000
Administrative building lease - - - - 60,000 60,000
Marketing wages and salaries 55,000 20,000 - 150,000 25,000 250,000
Selling expenses 5,000 - - 35,000 10,000 50,000
Total $ 320,000 $ 252,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000
8-24
Compute activity
rates for cost pools.
8-25
Calculate Activity Rates
The ABC team determines that Classic Brass will

have these total activities for each activity cost
pool . . .
1,000 customer orders,
400 new designs,
20,000 machine-hours,
250 customer relations activities.
Now
Now the
the team
team can
can compute
compute the the individual
individual
activity
activity rates
rates by
by dividing
dividing the
the total
total cost
cost for
for
each
each activity
activity by
by the
the total
total activity
activity levels.
levels.
8-26
Calculate Activity Rates
Computation of Activity Rates

(a) (b) (a) (b)
Activity Cost Pools Total Cost Total Activity Activity Rate
Customer orders $ 320,000 1,000 orders $320 per order
Product design 252,000 400 designs $630 per design
Order size 380,000 20,000 MHs $19 per MH
Customer relations 367,500 250 customer $1,470 per customer
Other 490,500 Not applicable Not applicable
8-27
Activity-Based Costing at Classic Brass
Direct Direct Shipping

Overhead Costs
Materials Labor Costs
Traced Traced Traced
Cost Objects:
Products,
Products, Customer
Customer Orders,
Orders, Customers
Customers
8-28

Overhead Costs
First-Stage Allocation
Order Customer Product Customer

Other
Size Orders Design Relations
Cost Objects:
Products,
Products, Customer
Customer Orders,
Orders, Customers
Customers
8-29

Overhead Costs
First-Stage Allocation

Other
Orders Design Size Relations
Second-Stage Allocations
$/Order $/Design $/MH $/Customer
Cost Objects:
Unallocated
Products,
Products, Customer
Customer Orders,
Orders, Customers
Customers
8-30
Assign costs to a cost

object using a second-
stage allocation.
8-31
Assigning Overhead to Products
Classic Brass Information
Standard
Standard Stanchions
Stanchions
1.
1. Requires
Requires no no new
new design
design resources.
resources.
2.
2. 30,000
30,000 units
units ordered
ordered with
with 600
600 separate
separate orders.
orders.
3.
3. Each
Each stanchion
stanchion requires
requires 35
35 minutes
minutes of
of machine
machine
time
time for
for aa total
total of
of 17,500
17,500 machine-hours.
machine-hours.
Custom
Custom Compass
Compass Housing
Housing
1.
1. Requires
Requires new
new design
design resources.
resources.
2.
2. 400
400 separate
separate orders.
orders.
3.
3. 400
400 custom
custom designs
designs prepared.
prepared.
4.
4. 1,250
1,250 compass
compass housings
housings produced,
produced, requiring
requiring 22
machine-hours
machine-hours each
each for
for aa total
total of
of 2,500
2,500 machine-hours.
machine-hours.
8-32
Assigning Overhead to Products
Overhead Cost for the Standard Stanchions

(a) (b) (a) (b)
Activity Cost Pools Activity Rate Activity ABC Cost
Customer orders $ 320 600 $ 192,000
Product design 630 0 -
Order size 19 17500 332,500
Total $ 524,500
Overhead Cost for the Custom Housing

(a) (b) (a) (b)
Customer orders $ 320 400 $ 128,000
Product design 630 400 252,000
Order size 19 2500 47,500
Total $ 427,500
8-33
Assigning Overhead to Customers
Lets 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
Orders
1.
1. Two
Two orders
orders for
for 150
150 standard
standard stanchions
stanchions per
per order.
order.
2.
2. One
One order
order for
for aa custom
custom compass
compass housing.
housing.
Machine-hours
Machine-hours
1.
1. The
The 300
300 standard
standard stanchions
stanchions required
required 175
175 machine-hours.
machine-hours.
2.
2. The
The custom
custom compass
compass housing
housing required
required 22 machine
machine hours.
hours.
8-34
Assigning Overhead to Customers
Overhead Cost for Winward Yachts

(a) (b) (a) (b)
Customer orders $ 320 3 $ 960
Product design 630 1 630
Order size 19 177 3,363
Customer relations 1,470 1 1,470
Total $ 6,423
8-35
Use activity-based costing

to compute product and
customer margins.
8-36
Prepare Management Reports
Product Margin Calculations

The first step in computing product margins is to
gather each products sales and direct cost data.
Custom
Standard Compass
Stanchions Housings Total
Sales $ 2,660,000 $ 540,000 $ 3,200,000
Direct costs
Direct material 905,500 69,500 975,000
Direct labor 263,750 87,500 351,250
Shipping 60,000 5,000 65,000
8-37

The second step in computing product margins is to
incorporate the previously computed activity-based
cost assignments pertaining to each product.
Custom
Standard Compass
Sales $ 2,660,000 $ 540,000 $ 3,200,000
Direct costs
Direct material 905,500 69,500 975,000
Direct labor 263,750 87,500 351,250
Shipping 60,000 5,000 65,000
ABC cost assignments
Customer orders 192,000 128,000 320,000
Product design 252,000 252,000
Order size 332,500 47,500 380,000
8-38

The third step in computing product
margins is to deduct each products
direct and indirect costs from sales.
Custom
Standard Stanchions Compass Housings
Sales $ 2,660,000 $ 540,000
Costs
Direct material $ 905,500 $ 69,500
Direct labor 263,750 87,500
Shipping 60,000 5,000
Customer orders 192,000 128,000
Product design 252,000
Order size 332,500 47,500
Total cost 1,753,750 589,500
Product margin $ 906,250 (49,500)
8-39

The product margins can be reconciled with
the companys net operating income as follows:
8-40
Customer Profitability Analysis

The first step in computing Windward Yachts customer
margin is to gather its sales and direct cost data.
Windward
Yachts
Sales $ 11,350
Direct costs
Direct material 2,123
Direct labor 1,900
Shipping 205
8-41

The second step is to incorporate Windward Yachts
previously computed activity-based cost assignments.
Windward
Yachts
Sales $ 11,350
Direct costs
Direct material 2,123
Direct labor 1,900
Shipping 205
ABC cost assignments
Customer orders 960
Product design 630
Order size 3,363
Customer relations 1,470
8-42

The third step is to compute Windward Yachts customer margin
($699) by deducting all its direct and indirect costs from its sales.
Windward Yachts
Sales $ 11,350
Direct costs
Direct material $ 2,123
Direct labor 1,900
Shipping 205
Customer orders 960
Product design 630
Order size 3,363
Customer relations 1,470 10,651
Customer margin $ 699
8-43
Product Margins Computed Using
the Traditional Cost System
The first step in computing product margins is to
gather each products sales and direct cost data.
Custom
Standard Compass
Sales $ 2,660,000 $ 540,000 $ 3,200,000
Direct costs
Direct material 905,500 69,500 975,000
Direct labor 263,750 87,500 351,250
8-44
The second step in computing product margins
is to compute the plantwide overhead rate.
Manufacturing Overhead Costs at Classic Brass
Factory building lease 80,000
Total manufacturing overhead $ 1,000,000
Plantwide manufacturing $1,000,000

= = $50 per machine-hour
overhead rate 20,000 MH
Machine-hours
Standard Stanchions 17,500
Custom compass Housings 2,500
Total machine-hours 20,000
8-45
The third step in computing product margins is
allocate manufacturing overhead to each product.
Machine Overhead Overhead
Hours Rate Allocated
Standard Stanchions 17,500 $ 50.00 $ 875,000
Custom Compass Housings 2,500 50.00 125,000
Total overhead allocated to products $ 1,000,000
17,500
17,500 hours
hours $50
$50 per
per hour
hour == $875,000
$875,000
8-46
The fourth step is to actually
compute the product margins.
Shipping expenses $ 65,000

Marketing expenses 300,000
General administrative expenses 510,000
$ 875,000
8-47
The Differences Between ABC
and Traditional Product Costs
Standard Custom
Stanchions Compass Housings
Product margins traditional $ 615,750 $ 258,000
Product margins ABC 906,250 (49,500)
Change in reported margins $ 290,500 $ (307,500)
The traditional cost The traditional cost

system overcosts the system undercosts the
standard stanchions custom compass
and reports a lower housings and reports
product margin a higher product
for this product. margin for this product.
8-48
Differences Between ABC and
Traditional Product Costs
There are three reasons why the
reported product margins for the two
costing systems differ from one another.
Traditional costing allocates all manufacturing

overhead to products. ABC costing only assigns
manufacturing overhead costs consumed by
products to those products.
8-49
Traditional costing allocates all manufacturing

overhead costs using a volume-related allocation
base. ABC costing also uses non-volume related
allocation bases.
8-50
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.
8-51
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
Benchmarking can
can be
be used
used to
to compare
compare activity
activity cost
cost
information
information with
with world-class
world-class standards
standards of
of performance
performance
achieved
achieved by
by other
other organizations.
organizations.
8-52
Activity-Based Costing and External Reporting
Most companies do not use ABC

for external reporting because . . .
1.
1. External
External reports
reports are
are less
less detailed
detailed than
than internal
internal
reports.
reports.
2.
2. ItIt may
may be
be difficult
difficult to
to make
make changes
changes to
to the
the companys
companys
accounting
accounting system.
system.
3.
3. ABC
ABC does
does not
not conform
conform to
to GAAP.
GAAP.
4.
4. Auditors
Auditors may
may be
be suspect
suspect ofof the
the subjective
subjective allocation
allocation
process
process based
based on
on interviews
interviews with
with employees.
employees.
8-53
ABC Limitations
Substantial resources Resistance to

required to implement unfamiliar numbers
and maintain. and reports.
Desire to fully Potential

allocate all costs misinterpretation of
to products. unfamiliar numbers.
Does not conform to

GAAP. Two costing
systems may be needed.
ABC Action Analysis
Appendix 8A
8-55
Prepare an action analysis

report using activity-based
costing data and interpret
the report.
(Appendix 8A)
8-56
Appendix 8A: ABC Action Analysis
Conventional
Conventional ABC ABC analysis
analysis does
does notnot
identify
identify potentially
potentially relevant
relevant costs.
costs. AnAn
action
action analysis
analysis report
report helps
helps because
because it: it:
Shows
Shows what
what costs
costs have
have beenbeen
assigned
assigned to to aa cost
cost object.
object.
Indicates
Indicates how
how difficult
difficult itit would
would bebe to
to
adjust
adjust those
those costs
costs in in response
response to to
changes
changes in in the
the level
level of
of activity.
activity.
8-57
Constructing an action analysis report

begins with the first-stage allocation
process. In addition to computing an
overall activity rate for each activity cost
pool, an activity rate is computed for each
type of overhead cost that is consumed
supporting a given activity.
Lets revisit the stage-one allocations
from the Classic Brass example that we
discussed earlier.
8-58
Appendix 8A: ABC Action Analysis Activity Cost Pools

Orders Design Size Relations Other
Total Activity 1,000 400 20,000 250 N/A
Indirect factory wages $ 125 $ 500 $ 5 $ 200
Factory
Activity Cost Pools equipment depreciation 60 - 9 -
Factory utilities - 30 3 -
Customer Product Order
Factory building lease
Customer - - - -
Orders Design
General Size
Administrative DepartmentRelations Other Total
Production Department Administrative wages and salaries 60 50 2 480
Indirect factory wages $ 125,000 $ 200,000 $ 100,000 $ 50,00015 $ -25,000- $ 50
500,000
Administrative building lease - - - -
Factory equipment depreciation 60,000 Marketing- Department 180,000 - 60,000 300,000
Factory utilities - 12,000 wages and
Marketing 60,000
salaries - 55 48,000-
50 120,000
600
Factory building lease - Selling- expenses - - 5 -80,000- 140
80,000
Total $ 320 $ 630 $ 19 $ 1,470
Administrative wages and salaries 60,000 20,000 40,000 120,000 160,000 400,000
Office equipment depreciation 15,000 - - 12,500 22,500 50,000
Administrative building lease - - - - 60,000 60,000
Marketing wages and salaries 55,000 20,000 - 150,000 25,000 250,000
Selling expenses 5,000 - - 35,000 10,000 50,000
Total $ 320,000 $ 252,000 $ 380,000 $ 367,500 $ 490,500 $ 1,810,000
$125,000 1,000 orders = $125 per order

Other entries in the table are computed similarly.
8-59

Action Analysis Cost Matrix for Standard Stanchions
Activity Cost Pools
Orders Design Size Relations Total
Total activity for stanchions 600 - 17,500 N/A
Indirect factory wages $ 75,000 $ - $ 87,500 $ 162,500
Factory equipment depreciation 36,000 - 157,500 193,500
Factory utilities - - 52,500 52,500
Factory building lease - - - -
General Administrative Department - -
Administrative wages and salaries 36,000 - 35,000 71,000
Office equipment depreciation 9,000 - - 9,000
Administrative building lease - - - -
Marketing Department - -
Marketing wages and salaries 33,000 - - 33,000
Selling expenses 3,000 - - 3,000
Total $192,000 $ - $ 332,500 $ 524,500
$125 per order 600 orders = $75,000

8-60
$125 per order 400 orders = $50,000

8-61
Next,
Next, label
label each
each cost
cost using
using an
an ease
ease ofof adjustment
adjustment
code:
code:
Green
Green costs
costs adjust
adjust more
more or
or less
less automatically
automatically to to
changes
changes in in activity
activity level
level without
without any
any action
action by
by
managers.
managers.
Yellow
Yellow costs
costs cancan be
be adjusted
adjusted toto changes
activity
level,
level, but
but itit would
would require
require management
management action action to
to
realize
realize the
the change
change in in cost.
cost.
Red
Red costs
costs cancan bebe adjusted
adjusted to to changes
activity
level
level only
only with
with aa great
great deal
deal difficulty
difficulty and
and with
with
management
management intervention.
intervention.
8-62

Action Analysis of Custom Compass Housing
Sales $ 540,000
Green costs
Direct materials $ 69,500
Shipping costs 5,000 74,500
Green margin $ 465,500
Yellow costs
Direct labor 87,500
Indirect factory wages 262,500
Marketing wages and salaries 42,000
Yellow margin $ (3,000)
Red costs
Factory building lease -
Administrative building lease - 46,500
Red margin $ (49,500)
Using a Modified form of
Activity-Based Costing to
Determine Product costs for
External Reports
Appendix 8B
8-64
Use activity-based costing

techniques to compute
unit product costs for
external reports.
(Appendix 8B)
8-65
Appendix 8B
AA modified
modified form
form of
of activity-based
activity-based
costing
costing can
can bebe used
used toto develop
develop product
product
costs
costs for
for external
external financial
financial reports.
reports.
ABC
ABC product
product costs:
costs:
Include
Include organization-sustaining
organization-sustaining costs
costs
and
and unused
unused capacity
capacity costs.
costs.
Exclude
Exclude nonmanufacturing
nonmanufacturing costs
costs even
even
ifif they
they are
are caused
caused by
by the
the products.
products.
8-66
Appendix 8B
Maxtar
Maxtar Industries
Industries provides
provides the
the following
following information
information
for
for the
the company
company asas aa whole
whole and
and for
for its
its only
only two
two
productspremium
productspremium and and standard
standard smoker/barbecue
smoker/barbecue units. units.
Total
Total estimated
estimated manufacturing
manufacturing overhead
overhead $$ 1,520,000
1,520,000
Total
Total estimated
estimated direct
direct labor
labor hours
hours 400,000
400,000
Premium
Premium Standard
Standard
Direct
Direct materials
materialscost
cost per
per unit
unit $$ 40.00
40.00 $$ 30.00
30.00
Direct
Direct labor
labor cost
cost per
per unit
unit $$ 24.00
24.00 $$ 18.00
18.00
Direct
Direct labor
labor hours
hoursper
per unit
unit 2.0
2.0 1.5
1.5
Units
Unitsproduced
produced 50,000
50,000 200,000
200,000
8-67
Appendix 8B
Assuming that Maxtars traditional cost system relies

on one predetermined plantwide overhead rate with
direct labor-hours (DLHs) as the allocation base, then
its plantwide overhead rate is computed as follows:
Predetermined $1,520,000
= = $3.80 per DLH
overhead rate 400,000 DLHs
8-68
Appendix 8B
Maxtars
Maxtars traditional
traditional cost
cost system
system would
would
report
report unit
unit product
product costs
costs as
as follows:
follows:
Premium
Premium Standard
Standard
Direct
Direct materials
materialscost
cost per
per unit
unit $$ 40.00
40.00 $$ 30.00
30.00
Direct
Direct labor
labor cost
cost per
per unit
unit 24.00
24.00 18.00
18.00
Manufacturing
overhead perper unit
unit 7.60
7.60 5.70
5.70
Unit
Unit product
product cost
cost $$ 71.60
71.60 $$ 53.70
53.70
2.0 DLH $3.80 per DLH
1.5 DLH $3.80 per DLH
8-69
Appendix 8B
The ABC project team at Maxtar has

developed the following basic information.
Estimated
Estimated
Overhead
Overhead
Activity
Activityand
andActivity
ActivityMeasures
Measures Cost
Cost Expected
ExpectedActivity
Activity
Premium
Premium Standard
Standard Total
Total
Direct
Directlabor
laborsupport
support(DLHs)
(DLHs) $$ 800,000
800,000 100,000
100,000 300,000
300,000 400,000
400,000
Machine
Machinesetups
setups(setups)
(setups) 480,000
480,000 600
600 200
200 800
800
Parts
Partsadministration
administration(part
(parttypes)
types) 240,000
240,000 140
140 60
60 200
200
Total
Totalmanufacturing
manufacturingoverhead
overhead $$ 1,520,000
1,520,000
8-70
Appendix 8B
We can calculate the following activity rates:
Estimated Total
Overhead Expected
Activity and Activity Measures Cost Activity Activity Rate
Direct labor support (DLHs) $ 800,000 400,000 = $ 2 per DLH
Machine setups (setups) 480,000 800 = $ 600 per setup
Parts administration (part types) 240,000 200 = $ 1,200 per part type
Total manufacturing overhead $ 1,520,000
Using the new activity rates, lets assign overhead

to the two products based upon expected activity.
8-71
Appendix 8B
Premium Product
Expected
Expected Activity
Activity
Activity
Activity and
and Activity
Activity Measures
Measures Activity
Activity Rate
Rate Amount
Amount
Direct
Directlabor
laborsupport
support(DLHs)
(DLHs) 100,000
100,000 $$ 22 == $$ 200,000
200,000
Machine
Machine setups
setups (setups)
(setups) 600
600 $$ 600600 == 360,000
360,000
Parts
Parts administration
administration (part
(parttypes)
types) 140
140 $$ 1,200
1,200 == 168,000
168,000
Total
Totaloverhead
overhead cost
costassigned
assigned $$ 728,000
728,000
Standard Product
Expected
Expected Activity
Activity
Activity
Activity and
and Activity
Activity Measures
Measures Activity
Activity Rate
Rate Amount
Amount
Direct
Directlabor
laborsupport
support(DLHs)
(DLHs) 300,000
300,000 $$ 22 == $$ 600,000
600,000
Machine
Machine setups
setups (setups)
(setups) 200
200 $$ 600
600 == 120,000
120,000
Parts
Parts administration
administration (part
(parttypes)
types) 60
60 $$ 1,200
1,200 == 72,000
72,000
Total
Totaloverhead
overhead cost
costassigned
assigned $$ 792,000
792,000
8-72
Appendix 8B
Activity-based
Activity-based unit
unit product
product costs
costs for
for both
both product
product lines
lines
Premium
Premium Standard
Standard
Direct
Direct materials
materialscost
cost per
per unit
unit $$ 40.00
40.00 $$ 30.00
30.00
Direct
Direct labor
labor cost
cost per
per unit
unit 24.00
24.00 18.00
18.00
Manufacturing
unit 14.56
14.56 3.96
3.96
Unit
Unit product
product cost
cost $$ 78.56
78.56 $$ 51.96
51.96
8-73
Appendix 8B
Activity-based
Activity-based unit
unit product
product costs
costs for
for both
both product
product lines
lines
Premium
Premium Standard
Standard
Direct
Direct materials
materialscost
cost per
per unit
unit $$ 40.00
40.00 $$ 30.00
30.00
Direct
Direct labor
labor cost
cost per
per unit
unit 24.00
24.00 18.00
18.00
Manufacturing
unit 14.56
14.56 3.96
3.96
Unit
Unit product
product cost
cost $$ 78.56
78.56 $$ 51.96
51.96
$728,000 50,000 units
$792,000 200,000 units
8-74
Appendix 8B
Comparing the two approaches
Activity-Based
Activity-Based Costing
Costing Traditional
TraditionalCosting
Costing
Premium
Premium Standard
Standard Premium
Premium Standard
Standard
Direct
Directmaterial
material $$ 40.00
40.00 $$ 30.00
30.00 $$ 40.00
40.00 $$ 30.00
30.00
Direct
Directlabor
labor 24.00
24.00 18.00
18.00 24.00
24.00 18.00
18.00
Manufacturing
overhead 14.56
14.56 3.96
3.96 7.60
7.60 5.70
5.70
Unit
Unitproduct
productcost
cost $$ 78.56
78.56 $$ 51.96
51.96 $$ 71.60
71.60 $$ 53.70
53.70
Note that the unit product cost of a Standard unit

decreased from $53.70 to $51.96 . . . . .
. . . . . while the unit cost of a Premium unit increased

from $71.60 to $78.56.
8-75
End of Chapter 8

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Activity-Based Costing: A

Tool to Aid Decision Making

Activity Based Costing (ABC)

ABC assigns both types of costs to products.

ABC does not assign all manufacturing costs to products.

Number of cost pools

A cost bucket in which

Two common types of activity measures:

Simple count A measure

Classic Brass An ABC Example

and Activity Measures

At Classic Brass, the ABC team, selected the following

Activity Cost Pools at Classic Brass

and Activity Measures

Assign costs to cost pools

At Classic Brass the following distribution of resource

Customer Product Order Customer

Activity Cost Pools

Calculate Activity Rates

The ABC team determines that Classic Brass will

Calculate Activity Rates

Computation of Activity Rates

Activity-Based Costing at Classic Brass

Direct Direct Shipping

Traced Traced Traced

Activity-Based Costing at Classic Brass

Direct Direct Shipping

Order Customer Product Customer

Activity-Based Costing at Classic Brass

Direct Direct Shipping

Customer Product Order Customer

$/Order $/Design $/MH $/Customer

Assign costs to a cost

Assigning Overhead to Products

Classic Brass Information

Assigning Overhead to Products

Overhead Cost for the Standard Stanchions

Overhead Cost for the Custom Housing

Assigning Overhead to Customers

Lets take a look at how Classic Brass system works

Assigning Overhead to Customers

Overhead Cost for Winward Yachts

Use activity-based costing

Prepare Management Reports

Product Margin Calculations

Prepare Management Reports

Product Margin Calculations

Prepare Management Reports

Product Margin Calculations

Prepare Management Reports

Product Margin Calculations

Prepare Management Reports

Customer Profitability Analysis

Prepare Management Reports

Customer Profitability Analysis

Prepare Management Reports

Customer Profitability Analysis

Plantwide manufacturing $1,000,000

Shipping expenses $ 65,000

The traditional cost The traditional cost

Traditional costing allocates all manufacturing

Traditional costing allocates all manufacturing

Traditional costing disregards selling and