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Activity Based Costing:
A Tool to Aid Decision Making
Overhead rates mayOverhead rates may
be based on activitybe based on activity
at capacity.at capacity.
Overhead rates mayOverhead rates may
be based on activitybe based on activity
at capacity.at capacity.
Activity Based Costing (ABC)
Both manufacturingBoth manufacturing
and nonmanufacturingand nonmanufacturing
costs may becosts may be
assigned toassigned to
products.products.
Both manufacturingBoth manufacturing
and nonmanufacturingand nonmanufacturing
costs may becosts may be
assigned toassigned to
products.products.
Some manufacturingSome manufacturing
costs may be excludedcosts may be excluded
from productfrom product
costs.costs.
Some manufacturingSome manufacturing
costs may be excludedcosts may be excluded
from productfrom product
costs.costs.
A numberA number
of cost pools eachof cost pools each
allocated to a productallocated to a product
or cost object.or cost object.
A numberA number
of cost pools eachof cost pools each
allocated to a productallocated to a product
or cost object.or cost object.
Allocation bases oftenAllocation bases often
differ fromdiffer from
traditional costingtraditional costing
systems.systems.
Allocation bases oftenAllocation bases often
differ fromdiffer from
traditional costingtraditional costing
systems.systems.
How Costs are Treated Under
Activity-Based Costing
Level of Com
plexity
Overhead Allocation
PlantwidePlantwide
OverheadOverhead
RateRate
PlantwidePlantwide
OverheadOverhead
RateRate
DepartmentalDepartmental
OverheadOverhead
RatesRates
DepartmentalDepartmental
OverheadOverhead
RatesRates
Activity BasedActivity Based
CostingCosting
Activity BasedActivity Based
CostingCosting
Cost of Idle Capacity
Traditional CostTraditional Cost
AccountingAccounting
The predeterminedThe predetermined
overhead rate is basedoverhead rate is based
on budgeted activity.on budgeted activity.
This results in applyingThis results in applying
overhead costs ofoverhead costs of
unused, or idle,unused, or idle,
capacity.capacity.
Traditional CostTraditional Cost
AccountingAccounting
The predeterminedThe predetermined
overhead rate is basedoverhead rate is based
on budgeted activity.on budgeted activity.
This results in applyingThis results in applying
overhead costs ofoverhead costs of
unused, or idle,unused, or idle,
capacity.capacity.
Activity BasedActivity Based
CostingCosting
Products are charged forProducts are charged for
the costs of capacitythe costs of capacity
they use – not for thethey use – not for the
costs of capacity theycosts of capacity they
don’t use.don’t use.
Activity BasedActivity Based
CostingCosting
Products are charged forProducts are charged for
the costs of capacitythe costs of capacity
they use – not for thethey use – not for the
costs of capacity theycosts of capacity they
don’t use.don’t use.
Difference Between ABC and
Traditional Product Costs
Batch-level or product-Batch-level or product-
level costs willlevel costs will
ordinarily shiftordinarily shift
overhead costs fromoverhead costs from
high-volumehigh-volume
products producedproducts produced
in large batches toin large batches to
low-volume productslow-volume products
produced in smallproduced in small
batches.batches.
Batch-level or product-Batch-level or product-
level costs willlevel costs will
ordinarily shiftordinarily shift
overhead costs fromoverhead costs from
high-volumehigh-volume
products producedproducts produced
in large batches toin large batches to
low-volume productslow-volume products
produced in smallproduced in small
batches.batches.
Under ABC bothUnder ABC both
manufacturing andmanufacturing and
nonmanufacturingnonmanufacturing
costs may becosts may be
assigned to products.assigned to products.
Organization-Organization-
sustaining costs andsustaining costs and
the costs of idlethe costs of idle
capacity are notcapacity are not
assigned to products.assigned to products.
Under ABC bothUnder ABC both
manufacturing andmanufacturing and
nonmanufacturingnonmanufacturing
costs may becosts may be
assigned to products.assigned to products.
Organization-Organization-
sustaining costs andsustaining costs and
the costs of idlethe costs of idle
capacity are notcapacity are not
assigned to products.assigned to products.
Designing an ABC System
Cost ObjectsCost Objects
(e.g., products(e.g., products
and customers)and customers)
Cost ObjectsCost Objects
(e.g., products(e.g., products
and customers)and customers)
ActivitiesActivitiesActivitiesActivities
ConsumptionConsumption
of Resourcesof Resources
ConsumptionConsumption
of Resourcesof Resources
CostCostCostCost
Designing of an ABC System
Steps for Implementing ABCSteps for Implementing ABC
 Identify and define activities and activityIdentify and define activities and activity
cost pools.cost pools.
 Trace costs to activities and costTrace costs to activities and cost
objects.objects.
 Assign costs to activity cost pools.Assign costs to activity cost pools.
 Calculate activity rates.Calculate activity rates.
 Assign costs to cost objects.Assign costs to cost objects.
Identify and Define Activities
and Activity Cost Pools
A part of the productionA part of the production
process for which managementprocess for which management
wants a separate reporting of thewants a separate reporting of the
costs of the activity involved.costs of the activity involved.
Unit-LevelUnit-Level
ActivityActivity
Batch-LevelBatch-Level
ActivityActivity
Product-LevelProduct-Level
ActivityActivity
Customer-LevelCustomer-Level
ActivityActivityOrganization-Organization-
sustainingsustaining
ActivityActivity
Identify and Define Activities
and Activity Cost Pools
Activity CostActivity Cost
PoolPool is a “bucket”
in which costs are
accumulated that
relate to a single
activity measure
in the ABC
system.
$
$
$ $
$
$
Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Materials
Direct
Labor
Direct
Labor
Shipping
Costs
Shipping
Costs
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Activity 1Activity 1Activity 1Activity 1 Activity 2Activity 2Activity 2Activity 2 Activity 3Activity 3Activity 3Activity 3 Activity 4Activity 4Activity 4Activity 4 OtherOtherOtherOther
Overhead CostsOverhead Costs
First-Stage AllocationFirst-Stage Allocation
Assign Costs to Activity Cost Pools
Customer
Orders
Product
Design
Order
Size
Customer
Relations Other Total
Production Department
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%
Shipping costs **
General Administrative Department
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 Department
Marketing wages and salaries 20% 10% 0% 60% 10% 100%
Selling expenses 10% 0% 0% 70% 20% 100%
Activity Cost Pools
At Classic Brass the following distribution of resource
consumption across activity cost pools is determined.
**Not included because they are directly traced to customer orders.
Customer
Orders
Product
Design
Order
Size
Customer
Relations Other Total
Production Department
Indirect factory wages 125,000$
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
Activity Cost Pools
Indirect factory wages $500,000Indirect factory wages $500,000
Percent consumed by customer orders 25%Percent consumed by customer orders 25%
$125,000$125,000
Indirect factory wages $500,000Indirect factory wages $500,000
Percent consumed by customer orders 25%Percent consumed by customer orders 25%
$125,000$125,000
Assign Costs to Activity Cost Pools
Production Department
Indirect factory wages 500,000$
Factory equipment depreciation 300,000
Factory utilities 120,000
Factory building lease 80,000 1,000,000$
Shipping costs traced to customer orders 40,000
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 1,850,000$
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)
Customer
Orders
Product
Design
Order
Size
Customer
Relations Other Total
Production Department
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
General Administrative Department
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 Department
Marketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000
Selling expenses 5,000 - - 35,000 10,000 50,000
Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$
Activity Cost Pools
Assign Costs to Activity Cost Pools
Calculate Activity Rates
The ABC team determines that Classic Brass
will have these total activities for each activity
cost pool . . .

1,000 customer orders1,000 customer orders

200 new designs200 new designs

20,000 machine-hours20,000 machine-hours

100 customer relations activities100 customer relations activities
Now the team can compute the individualNow the team can compute the individual
activity rates by dividing the total cost foractivity rates by dividing the total cost for
each activity by the total activity levels.each activity by the total activity levels.
Calculate Activity Rates
(a) (b) (a) (b)
Activity Cost Pools Total Cost Total Activity Activity Rate
Customer orders 315,000$ 1,000 orders $315 per order
Product design 257,000 200 designs $1,285 per design
Order size 380,000 20,000 MHs $19 per MH
Customer relations 367,500 100 customer $3,675 per customer
Other 490,500 Not applicable Not applicable
Computation of Activity Rates
÷
TracedTracedTracedTraced TracedTracedTracedTraced TracedTracedTracedTraced
Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Materials
Direct
Labor
Direct
Labor
Shipping
Costs
Shipping
Costs
Overhead CostsOverhead Costs
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Materials
Direct
Labor
Direct
Labor
Shipping
Costs
Shipping
Costs
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
Cost Objects:Cost Objects:
Products, Customer Orders, CustomersProducts, Customer Orders, Customers
OrderOrder
SizeSize
OrderOrder
SizeSize
CustomerCustomer
OrdersOrders
CustomerCustomer
OrdersOrders
ProductProduct
DesignDesign
ProductProduct
DesignDesign
CustomerCustomer
RelationsRelations
CustomerCustomer
RelationsRelations
OtherOtherOtherOther
Overhead CostsOverhead Costs
First-Stage AllocationFirst-Stage Allocation
Second-Stage AllocationsSecond-Stage AllocationsSecond-Stage AllocationsSecond-Stage Allocations
$/MH$/MH$/MH$/MH $/Order$/Order$/Order$/Order $/Design$/Design$/Design$/Design $/Customer$/Customer$/Customer$/Customer
UnallocatedUnallocatedUnallocatedUnallocated
Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one
customer – Windward Yachts.
Standard Stanchions (no design required)
1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders.
2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours .
3. Selling price is $34 each.3. Selling price is $34 each.
4. Direct materials total $2,110.4. Direct materials total $2,110.
5. Direct labor totals $1,850.5. Direct labor totals $1,850.
6. Shipping costs total $180.6. Shipping costs total $180.
Custom Compass Housing (requires new design)
1. One order during the year.1. One order during the year.
2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours .
3. Selling price is $650 each.3. Selling price is $650 each.
4. Direct materials total $13.4. Direct materials total $13.
5. Direct labor totals $50.5. Direct labor totals $50.
6. Shipping costs total $25.6. Shipping costs total $25.
Assigning Costs to Cost Objects
(a) (b) (a) (b)
Activity Cost Pools Activity Rate Activity ABC Cost
Customer orders 315$ 2 630$
Product design 1,285 0 -
Order size 19 200 3,800
Customer relations 3,675 N/A
Overhead Cost for the Standard Stanchions
(a) (b) (a) (b)
Activity Cost Pools Activity Rate Activity ABC Cost
Customer orders 315$ 1 315$
Product design 1,285 1 1,285
Order size 19 4 76
Customer relations 3,675 N/A
Overhead Cost for the Custom Housing
The customer-levelThe customer-level
cost is assigned tocost is assigned to
customers directly;customers directly;
it is not assigned toit is not assigned to
products.products.
Limitations of ABC
ABC systems are aABC systems are a
major project requiringmajor project requiring
substantial resources.substantial resources.
The benefits ofThe benefits of
increased accuracyincreased accuracy
must outweigh thesemust outweigh these
additional costs.additional costs.
ABC systems are aABC systems are a
major project requiringmajor project requiring
substantial resources.substantial resources.
The benefits ofThe benefits of
increased accuracyincreased accuracy
must outweigh thesemust outweigh these
additional costs.additional costs.
ABC producesABC produces
numbers, like productnumbers, like product
margins, that are atmargins, that are at
odds with numbersodds with numbers
produced by traditionalproduced by traditional
costing system. Somecosting system. Some
managers find itmanagers find it
difficult to adjust to thisdifficult to adjust to this
change.change.
ABC producesABC produces
numbers, like productnumbers, like product
margins, that are atmargins, that are at
odds with numbersodds with numbers
produced by traditionalproduced by traditional
costing system. Somecosting system. Some
managers find itmanagers find it
difficult to adjust to thisdifficult to adjust to this
change.change.
ABC data can be misinterpreted and mustABC data can be misinterpreted and must
be used with care when making decisions.be used with care when making decisions.
ABC data can be misinterpreted and mustABC data can be misinterpreted and must
be used with care when making decisions.be used with care when making decisions.

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Activity based costing

  • 1. Activity Based Costing: A Tool to Aid Decision Making
  • 2. Overhead rates mayOverhead rates may be based on activitybe based on activity at capacity.at capacity. Overhead rates mayOverhead rates may be based on activitybe based on activity at capacity.at capacity. Activity Based Costing (ABC) Both manufacturingBoth manufacturing and nonmanufacturingand nonmanufacturing costs may becosts may be assigned toassigned to products.products. Both manufacturingBoth manufacturing and nonmanufacturingand nonmanufacturing costs may becosts may be assigned toassigned to products.products. Some manufacturingSome manufacturing costs may be excludedcosts may be excluded from productfrom product costs.costs. Some manufacturingSome manufacturing costs may be excludedcosts may be excluded from productfrom product costs.costs. A numberA number of cost pools eachof cost pools each allocated to a productallocated to a product or cost object.or cost object. A numberA number of cost pools eachof cost pools each allocated to a productallocated to a product or cost object.or cost object. Allocation bases oftenAllocation bases often differ fromdiffer from traditional costingtraditional costing systems.systems. Allocation bases oftenAllocation bases often differ fromdiffer from traditional costingtraditional costing systems.systems.
  • 3. How Costs are Treated Under Activity-Based Costing Level of Com plexity Overhead Allocation PlantwidePlantwide OverheadOverhead RateRate PlantwidePlantwide OverheadOverhead RateRate DepartmentalDepartmental OverheadOverhead RatesRates DepartmentalDepartmental OverheadOverhead RatesRates Activity BasedActivity Based CostingCosting Activity BasedActivity Based CostingCosting
  • 4. Cost of Idle Capacity Traditional CostTraditional Cost AccountingAccounting The predeterminedThe predetermined overhead rate is basedoverhead rate is based on budgeted activity.on budgeted activity. This results in applyingThis results in applying overhead costs ofoverhead costs of unused, or idle,unused, or idle, capacity.capacity. Traditional CostTraditional Cost AccountingAccounting The predeterminedThe predetermined overhead rate is basedoverhead rate is based on budgeted activity.on budgeted activity. This results in applyingThis results in applying overhead costs ofoverhead costs of unused, or idle,unused, or idle, capacity.capacity. Activity BasedActivity Based CostingCosting Products are charged forProducts are charged for the costs of capacitythe costs of capacity they use – not for thethey use – not for the costs of capacity theycosts of capacity they don’t use.don’t use. Activity BasedActivity Based CostingCosting Products are charged forProducts are charged for the costs of capacitythe costs of capacity they use – not for thethey use – not for the costs of capacity theycosts of capacity they don’t use.don’t use.
  • 5. Difference Between ABC and Traditional Product Costs Batch-level or product-Batch-level or product- level costs willlevel costs will ordinarily shiftordinarily shift overhead costs fromoverhead costs from high-volumehigh-volume products producedproducts produced in large batches toin large batches to low-volume productslow-volume products produced in smallproduced in small batches.batches. Batch-level or product-Batch-level or product- level costs willlevel costs will ordinarily shiftordinarily shift overhead costs fromoverhead costs from high-volumehigh-volume products producedproducts produced in large batches toin large batches to low-volume productslow-volume products produced in smallproduced in small batches.batches. Under ABC bothUnder ABC both manufacturing andmanufacturing and nonmanufacturingnonmanufacturing costs may becosts may be assigned to products.assigned to products. Organization-Organization- sustaining costs andsustaining costs and the costs of idlethe costs of idle capacity are notcapacity are not assigned to products.assigned to products. Under ABC bothUnder ABC both manufacturing andmanufacturing and nonmanufacturingnonmanufacturing costs may becosts may be assigned to products.assigned to products. Organization-Organization- sustaining costs andsustaining costs and the costs of idlethe costs of idle capacity are notcapacity are not assigned to products.assigned to products.
  • 6. Designing an ABC System Cost ObjectsCost Objects (e.g., products(e.g., products and customers)and customers) Cost ObjectsCost Objects (e.g., products(e.g., products and customers)and customers) ActivitiesActivitiesActivitiesActivities ConsumptionConsumption of Resourcesof Resources ConsumptionConsumption of Resourcesof Resources CostCostCostCost
  • 7. Designing of an ABC System Steps for Implementing ABCSteps for Implementing ABC  Identify and define activities and activityIdentify and define activities and activity cost pools.cost pools.  Trace costs to activities and costTrace costs to activities and cost objects.objects.  Assign costs to activity cost pools.Assign costs to activity cost pools.  Calculate activity rates.Calculate activity rates.  Assign costs to cost objects.Assign costs to cost objects.
  • 8. Identify and Define Activities and Activity Cost Pools A part of the productionA part of the production process for which managementprocess for which management wants a separate reporting of thewants a separate reporting of the costs of the activity involved.costs of the activity involved. Unit-LevelUnit-Level ActivityActivity Batch-LevelBatch-Level ActivityActivity Product-LevelProduct-Level ActivityActivity Customer-LevelCustomer-Level ActivityActivityOrganization-Organization- sustainingsustaining ActivityActivity
  • 9. Identify and Define Activities and Activity Cost Pools Activity CostActivity Cost PoolPool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system. $ $ $ $ $ $
  • 10. Activity-Based Costing at Classic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Activity 1Activity 1Activity 1Activity 1 Activity 2Activity 2Activity 2Activity 2 Activity 3Activity 3Activity 3Activity 3 Activity 4Activity 4Activity 4Activity 4 OtherOtherOtherOther Overhead CostsOverhead Costs First-Stage AllocationFirst-Stage Allocation
  • 11. Assign Costs to Activity Cost Pools Customer Orders Product Design Order Size Customer Relations Other Total Production Department 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% Shipping costs ** General Administrative Department 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 Department Marketing wages and salaries 20% 10% 0% 60% 10% 100% Selling expenses 10% 0% 0% 70% 20% 100% Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. **Not included because they are directly traced to customer orders.
  • 12. Customer Orders Product Design Order Size Customer Relations Other Total Production Department Indirect factory wages 125,000$ 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 Activity Cost Pools Indirect factory wages $500,000Indirect factory wages $500,000 Percent consumed by customer orders 25%Percent consumed by customer orders 25% $125,000$125,000 Indirect factory wages $500,000Indirect factory wages $500,000 Percent consumed by customer orders 25%Percent consumed by customer orders 25% $125,000$125,000 Assign Costs to Activity Cost Pools Production Department Indirect factory wages 500,000$ Factory equipment depreciation 300,000 Factory utilities 120,000 Factory building lease 80,000 1,000,000$ Shipping costs traced to customer orders 40,000 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 1,850,000$ Overhead Costs at Classic Brass (Manufacturing and NonManufacturing)
  • 13. Customer Orders Product Design Order Size Customer Relations Other Total Production Department 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 General Administrative Department 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 Department Marketing wages and salaries 50,000 25,000 - 150,000 25,000 250,000 Selling expenses 5,000 - - 35,000 10,000 50,000 Total 315,000$ 257,000$ 380,000$ 367,500$ 490,500$ 1,810,000$ Activity Cost Pools Assign Costs to Activity Cost Pools
  • 14. Calculate Activity Rates The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .  1,000 customer orders1,000 customer orders  200 new designs200 new designs  20,000 machine-hours20,000 machine-hours  100 customer relations activities100 customer relations activities Now the team can compute the individualNow the team can compute the individual activity rates by dividing the total cost foractivity rates by dividing the total cost for each activity by the total activity levels.each activity by the total activity levels.
  • 15. Calculate Activity Rates (a) (b) (a) (b) Activity Cost Pools Total Cost Total Activity Activity Rate Customer orders 315,000$ 1,000 orders $315 per order Product design 257,000 200 designs $1,285 per design Order size 380,000 20,000 MHs $19 per MH Customer relations 367,500 100 customer $3,675 per customer Other 490,500 Not applicable Not applicable Computation of Activity Rates ÷
  • 16. TracedTracedTracedTraced TracedTracedTracedTraced TracedTracedTracedTraced Activity-Based Costing at Classic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Overhead CostsOverhead Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers
  • 17. Activity-Based Costing at Classic Brass Direct Materials Direct Materials Direct Labor Direct Labor Shipping Costs Shipping Costs Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers Cost Objects:Cost Objects: Products, Customer Orders, CustomersProducts, Customer Orders, Customers OrderOrder SizeSize OrderOrder SizeSize CustomerCustomer OrdersOrders CustomerCustomer OrdersOrders ProductProduct DesignDesign ProductProduct DesignDesign CustomerCustomer RelationsRelations CustomerCustomer RelationsRelations OtherOtherOtherOther Overhead CostsOverhead Costs First-Stage AllocationFirst-Stage Allocation Second-Stage AllocationsSecond-Stage AllocationsSecond-Stage AllocationsSecond-Stage Allocations $/MH$/MH$/MH$/MH $/Order$/Order$/Order$/Order $/Design$/Design$/Design$/Design $/Customer$/Customer$/Customer$/Customer UnallocatedUnallocatedUnallocatedUnallocated
  • 18. Assigning Costs to Cost Objects Let’s take a look at how our system works for just one customer – Windward Yachts. Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders.1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours .2. Each stanchion required 0.5 machine-hours . 3. Selling price is $34 each.3. Selling price is $34 each. 4. Direct materials total $2,110.4. Direct materials total $2,110. 5. Direct labor totals $1,850.5. Direct labor totals $1,850. 6. Shipping costs total $180.6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year.1. One order during the year. 2. Each housing required 4 machine-hours .2. Each housing required 4 machine-hours . 3. Selling price is $650 each.3. Selling price is $650 each. 4. Direct materials total $13.4. Direct materials total $13. 5. Direct labor totals $50.5. Direct labor totals $50. 6. Shipping costs total $25.6. Shipping costs total $25.
  • 19. Assigning Costs to Cost Objects (a) (b) (a) (b) Activity Cost Pools Activity Rate Activity ABC Cost Customer orders 315$ 2 630$ Product design 1,285 0 - Order size 19 200 3,800 Customer relations 3,675 N/A Overhead Cost for the Standard Stanchions (a) (b) (a) (b) Activity Cost Pools Activity Rate Activity ABC Cost Customer orders 315$ 1 315$ Product design 1,285 1 1,285 Order size 19 4 76 Customer relations 3,675 N/A Overhead Cost for the Custom Housing The customer-levelThe customer-level cost is assigned tocost is assigned to customers directly;customers directly; it is not assigned toit is not assigned to products.products.
  • 20. Limitations of ABC ABC systems are aABC systems are a major project requiringmajor project requiring substantial resources.substantial resources. The benefits ofThe benefits of increased accuracyincreased accuracy must outweigh thesemust outweigh these additional costs.additional costs. ABC systems are aABC systems are a major project requiringmajor project requiring substantial resources.substantial resources. The benefits ofThe benefits of increased accuracyincreased accuracy must outweigh thesemust outweigh these additional costs.additional costs. ABC producesABC produces numbers, like productnumbers, like product margins, that are atmargins, that are at odds with numbersodds with numbers produced by traditionalproduced by traditional costing system. Somecosting system. Some managers find itmanagers find it difficult to adjust to thisdifficult to adjust to this change.change. ABC producesABC produces numbers, like productnumbers, like product margins, that are atmargins, that are at odds with numbersodds with numbers produced by traditionalproduced by traditional costing system. Somecosting system. Some managers find itmanagers find it difficult to adjust to thisdifficult to adjust to this change.change. ABC data can be misinterpreted and mustABC data can be misinterpreted and must be used with care when making decisions.be used with care when making decisions. ABC data can be misinterpreted and mustABC data can be misinterpreted and must be used with care when making decisions.be used with care when making decisions.

Editor's Notes

  1. Presented by Tahir Mahmood