Activity Based Costing: A Tool
to Aid Decision Making
UAA – ACCT 202
Principles of Managerial Accounting
Dr. Fred Barbee

...
Cost
Measurement

Cost
Accumulation

Cost
Assignment

Direct
Direct
Materials
Materials
Direct
Direct
Labor
Labor
Mfg.
Mfg...
Actual
Costing
System
Normal
Costing
System
Standard
Costing
System

Actual DM
Actual DL
Actual MOH

Actual DM
Measuring
A...
Cost Accounting Systems
Product Costs
Job-Order Costing

Process Costing

Total/Unit Cost
Assigning Manufacturing Costs

Functional Based
Costing

Activity Based
Costing
Activity Based Costing (ABC)
ABC is designed to
provide managers
with cost information
for strategic and
other decisions t...
Activity Based Costing (ABC)
Both manufacturing
Both manufacturing
and nonmanufacturing
and nonmanufacturing
costs may be
...
How Costs are Treated Under
Activity-Based Costing
Activity Based
Activity Based
Costing
Costing
Departmental
Departmental...
Functional Based
(Traditional) Costing
Departmental Overhead Rates
Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products

Indirect
L...
Peanut-butter costing describes a
cost approach that uniformly
assigns (“spreads” or “smooths
out”) the cost of resources ...
Functional-Based
Management
Model

Cost View

Resources

Operational View

Efficiency
Analysis

Functions

Products

Perfo...
The problem with this approach
is that individual products,
services, etc., may use those
resources in a nonuniform way.
T...
Refining a Cost System
Reclassify

indirect costs as direct

costs.
Define

more cost pools.

Identify
Use

cost drive...
Activity-Based
Management
Model

Cost View

Resources

Operational View

Driver
Analysis

Activities

Products &
Customers...
Designing an ABC System
Cost Objects
(e.g., products
and customers)

Activities

Consumption
of Resources

Cost
Designing an ABC System
1.

Identify and define activities and
activity cost pools.

2.

Whenever possible, directly trace...
Designing an ABC System
5.

Assign costs to cost objects using the
activity rates and activity measures.

6.

Prepare mana...
Identify and Define
Activities and
Activity Cost Pools
Step #1:Identify and Define
Activities and Activity Cost Pools
An Activity Cost
Pool is a “bucket” in
which costs are
accu...
Activity Levels (Step #1)
Batch
Level

Product
Level

Activity
Levels
Unit
Level

Customer
Level
Organization-Sustaining L...
Step #1: Identify and Define
Step #1 For Classic Brass
Activities and Activity Cost Pools
At Classic Brass, the ABC team, ...
Step #1:Identify and Define
Activities and Activity Cost Pools
 Customer

Orders - assigned all costs of
resources that a...
Step #1:Identify and Define
Activities and Activity Cost Pools
 Customer

Relations – assigned all costs
associated with ...
Whenever Possible,
Directly Trace Overhead
Costs to Activities and
Cost Objects.
The overhead costs at Classic Brass

Exhibit 8-2
Assign Costs to
Activity Cost Pools
The overhead costs at Classic Brass

Exhibit 8-2
Assign Costs to Activity Cost Pools
At Classic Brass the following distribution of resource
consumption across activity co...
Assign Costs to Activity Cost Pools
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)

Activity
Custome...
Assign Costs to Activity Cost Pools
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)

Activity
Custome...
Assign Costs to Activity Cost Pools
Activity Cost Pools
Customer
Product
Orders
Design
Production Department
Indirect fact...
Calculate the
Activity Rates
Activity Cost Pools For
Step #1: Identify and Define
Classic Brass Activity Cost Pools
Activities and
At Classic Brass, th...
Calculate Activity Rates
The ABC team determines that Classic Brass will
have these total activities for each activity cos...
Calculate Activity Rates

Computation of Activity Rates
Activity Cost Pools
Customer orders
Product design
Order size
Cust...
Activity-Based Costing at Classic Brass
Direct
Materials

Direct
Labor

Shipping
Costs

Traced

Traced

Traced

Overhead C...
Activity-Based Costing at Classic Brass
Direct
Materials

Direct
Labor

Shipping
Costs

Overhead Costs

First-Stage Alloca...
Activity-Based Costing at Classic Brass
Activity-Based Costing at Classic Brass
Direct
Materials

Direct
Labor

Shipping
C...
Assign Costs to
Cost Objects
Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one
customer – Windward Yachts.
Standar...
Computation of Activity Rates
Activity Cost Pools
Customer orders
Product design
Order size
Customer relations
Other

(a)
...
Custom Compass Housing (requires new design)
1. One order during the year.
2. Each housing required 4 machine-hours .
3. S...
Prepare
Management
Reports
Product Margins

Traditional Cost Accounting System

Sales
Costs
Direct materials
Direct labor
Manufacturing overhead
Prod...
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Identify and Define Activities and Activity Cost Pools

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    1. 1. Activity Based Costing: A Tool to Aid Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee Chapter
    2. 2. Cost Measurement Cost Accumulation Cost Assignment Direct Direct Materials Materials Direct Direct Labor Labor Mfg. Mfg. Overhead Overhead Work-inWork-inProcess Process Finished Finished Goods Goods Cost-of Cost-of Goods Sold Goods Sold Goal: Accurately costed products.
    3. 3. Actual Costing System Normal Costing System Standard Costing System Actual DM Actual DL Actual MOH Actual DM Measuring Actual DL Costs Estimated MOH Standard DM Standard DL Standard MOH
    4. 4. Cost Accounting Systems Product Costs Job-Order Costing Process Costing Total/Unit Cost
    5. 5. Assigning Manufacturing Costs Functional Based Costing Activity Based Costing
    6. 6. Activity Based Costing (ABC) ABC is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” costs. ABC is a good supplement to our traditional cost system I agree!
    7. 7. Activity Based Costing (ABC) Both manufacturing Both manufacturing and nonmanufacturing and nonmanufacturing costs may be costs may be assigned to assigned to products. products. A number A number of cost pools each of cost pools each allocated to a product allocated to a product or cost object. or cost object. Some manufacturing Some manufacturing costs may be excluded costs may be excluded from product from product costs. costs. Allocation bases often Allocation bases often differ from differ from traditional costing traditional costing systems. systems. Overhead rates may Overhead rates may be based on activity be based on activity at capacity. at capacity.
    8. 8. How Costs are Treated Under Activity-Based Costing Activity Based Activity Based Costing Costing Departmental Departmental Overhead Overhead Rates Rates Plantwide Plantwide Overhead Overhead Rate Rate lo ve Le om fC it y x le p Overhead Allocation
    9. 9. Functional Based (Traditional) Costing
    10. 10. Departmental Overhead Rates Stage One: Costs assigned to pools Cost pools Stage Two: Costs applied to products Indirect Labor Indirect Materials Other Overhead Department 1 Department 2 Department 3 Direct Labor Hours Machine Hours Raw Materials Cost Products Departmental Allocation Bases
    11. 11. Peanut-butter costing describes a cost approach that uniformly assigns (“spreads” or “smooths out”) the cost of resources to cost objects.
    12. 12. Functional-Based Management Model Cost View Resources Operational View Efficiency Analysis Functions Products Performance Analysis
    13. 13. The problem with this approach is that individual products, services, etc., may use those resources in a nonuniform way. The end result is that some products will be overcosted while others will be undercosted.
    14. 14. Refining a Cost System Reclassify indirect costs as direct costs. Define more cost pools. Identify Use cost drivers. Activity-Based Costing.
    15. 15. Activity-Based Management Model Cost View Resources Operational View Driver Analysis Activities Products & Customers Performance Analysis
    16. 16. Designing an ABC System Cost Objects (e.g., products and customers) Activities Consumption of Resources Cost
    17. 17. Designing an ABC System 1. Identify and define activities and activity cost pools. 2. Whenever possible, directly trace costs to activities and cost objects. 3. Assign costs to activity cost pools. 4. Calculate activity rates.
    18. 18. Designing an ABC System 5. Assign costs to cost objects using the activity rates and activity measures. 6. Prepare management reports.
    19. 19. Identify and Define Activities and Activity Cost Pools
    20. 20. Step #1:Identify and Define Activities and Activity Cost Pools An Activity Cost Pool is a “bucket” in which costs are accumulated that relate to a single activity measure in the ABC system. $$ $ $$$
    21. 21. Activity Levels (Step #1) Batch Level Product Level Activity Levels Unit Level Customer Level Organization-Sustaining Level
    22. 22. Step #1: Identify and Define Step #1 For Classic Brass Activities and Activity Cost Pools 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
    23. 23. Step #1:Identify and Define Activities and Activity Cost Pools  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.
    24. 24. Step #1:Identify and Define Activities and Activity Cost Pools  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.
    25. 25. Whenever Possible, Directly Trace Overhead Costs to Activities and Cost Objects.
    26. 26. The overhead costs at Classic Brass Exhibit 8-2
    27. 27. Assign Costs to Activity Cost Pools
    28. 28. The overhead costs at Classic Brass Exhibit 8-2
    29. 29. Assign Costs to Activity Cost Pools At Classic Brass the following distribution of resource consumption across activity cost pools is determined. Activity Cost Pools Customer Product Order Orders Design Size Production Department Indirect factory wages Factory equipment depreciation Factory utilities Factory building lease Shipping costs ** General Administrative Department Administrative wages and salaries Office equipment depreciation Administrative building lease Marketing Department Marketing wages and salaries Selling expenses Customer Relations Other Total 25% 20% 0% 0% 40% 0% 10% 0% 20% 60% 50% 0% 10% 0% 0% 0% 5% 20% 40% 100% 100% 100% 100% 100% 15% 30% 0% 5% 0% 0% 10% 0% 0% 30% 25% 0% 40% 45% 100% 100% 100% 100% 20% 10% 10% 0% 0% 0% 60% 70% 10% 20% 100% 100% **Not included because they are directly traced to customer orders.
    30. 30. Assign Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and NonManufacturing) 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 Production Department $ CostIndirect factory wages Pools Factory equipment depreciation Product utilities Order Customer Factory Design Size Factory building lease Relations Shipping costs traced to customer orders 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 Other $ 80,000 Total 1,000,000 40,000 400,000 50,000 60,000 510,000 250,000 50,000 $ 300,000 1,850,000 Indirect factory wages $500,000 Indirect factory wages $500,000 Percent consumed by customer orders 25% Percent consumed by customer orders 25% $125,000 $125,000
    31. 31. Assign Costs to Activity Cost Pools Overhead Costs at Classic Brass (Manufacturing and NonManufacturing) 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 Production Department $ CostIndirect factory wages Pools Factory equipment depreciation Product utilities Order Customer Factory Design Size Factory building lease Relations Shipping costs traced to customer orders 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 Other $ 80,000 Total 1,000,000 40,000 400,000 50,000 60,000 510,000 250,000 50,000 $ 300,000 1,850,000 Factory equipment depreciation $300,000 Factory equipment depreciation $300,000 Percent consumed by customer orders 20% Percent consumed by customer orders 20% $ 60,000 $ 60,000
    32. 32. Assign 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 Other Total $ 125,000 60,000 - $ 200,000 12,000 - $ 100,000 180,000 60,000 - $ 50,000 - $ 25,000 60,000 48,000 80,000 $ 500,000 300,000 120,000 80,000 60,000 15,000 - 20,000 - 40,000 - 120,000 12,500 - 160,000 22,500 60,000 400,000 50,000 60,000 50,000 5,000 $ 315,000 25,000 $ 257,000 $ 380,000 150,000 35,000 $ 367,500 25,000 10,000 $ 490,500 250,000 50,000 $ 1,810,000
    33. 33. Calculate the Activity Rates
    34. 34. Activity Cost Pools For Step #1: Identify and Define Classic Brass Activity Cost Pools Activities and 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
    35. 35. Calculate Activity Rates The ABC team determines that Classic Brass will have these total activities for each activity cost pool . . .  1,000 customer orders  200 new designs  20,000 machine-hours  100 customer relations activities Now the team can compute the individual activity rates by dividing the total cost for each activity by the total activity levels.
    36. 36. Calculate Activity Rates Computation of Activity Rates Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost $ 315,000 257,000 380,000 367,500 490,500 (b) Total Activity 1,000 orders 200 designs 20,000 MHs 100 customer Not applicable ÷ (a) (b) Activity Rate $315 per order $1,285 per design $19 per MH $3,675 per customer Not applicable
    37. 37. Activity-Based Costing at Classic Brass Direct Materials Direct Labor Shipping Costs Traced Traced Traced Overhead Costs Cost Objects: Products, Customer Orders, Customers
    38. 38. 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 Cost Objects: Products, Customer Orders, Customers Other
    39. 39. Activity-Based Costing at Classic Brass 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 Second-Stage Allocations $/MH $/Order $/Design $/Customer Cost Objects: Products, Customer Orders, Customers Unallocated
    40. 40. Assign Costs to Cost Objects
    41. 41. 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. 2. Each stanchion required 0.5 machine-hours . 3. Selling price is $34 each. 4. Direct materials total $2,110. 5. Direct labor totals $1,850. 6. Shipping costs total $180. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours . 3. Selling price is $650 each. 4. Direct materials total $13. 5. Direct labor totals $50. 6. Shipping costs total $25.
    42. 42. Computation of Activity Rates Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost $ 315,000 257,000 380,000 367,500 490,500 (b) Total Activity 1,000 orders 200 designs 20,000 MHs 100 customer Not applicable Standard Stanchions (no design required) 1. 400 units ordered with 2 separate orders. 2. Each stanchion required 0.5 machine-hours . 3. Selling price is $34 each. 4. Direct materials total $2,110. 5. Direct labor totals $1,850. 6. Shipping costs total $180. (a) (b) Activity Rate $315 per order $1,285 per design $19 per MH $3,675 per customer Not applicable
    43. 43. Custom Compass Housing (requires new design) 1. One order during the year. 2. Each housing required 4 machine-hours . 3. Selling price is $650 each. 4. Direct materials total $13. 5. Direct labor totals $50. 6. Shipping costs total $25. Computation of Activity Rates Activity Cost Pools Customer orders Product design Order size Customer relations Other (a) Total Cost $ 315,000 257,000 380,000 367,500 490,500 (b) Total Activity 1,000 orders 200 designs 20,000 MHs 100 customer Not applicable (a) (b) Activity Rate $315 per order $1,285 per design $19 per MH $3,675 per customer Not applicable
    44. 44. Prepare Management Reports
    45. 45. Product Margins Traditional Cost Accounting System Sales Costs Direct materials Direct labor Manufacturing overhead Product margin Standard Stanchions $ 13,600 $ (2,110) (1,850) (10,000) (360) Compass Housing $ 650 $ (13) (50) (200) 387 400 units x 0.5 MH/unit x $50/MH = $10,000 400 units x 0.5 MH/unit x $50/MH = $10,000 Predetermined manufacturing = overhead rate $1,000,000 20,000 MH = $50/MH

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