Activity Based Costing concept and it's benefits

1. Activity Based Costing
Acct 310
Professor Rick S. Hayes, Ph.D., CPA

2. MicroMash CPE Course Example

4. • Make sure that costing done correctly, reduce
costs
• Direct labor and materials costs [prime costs]–
easy to trace to product
• Manufacturing overhead is indirect cost – hard
to trace, control – estimate, calculate cost per
unit

6. Traditional Unit Based Cost (UBC)
Accounting

7. • Standard costing is about assigning overhead costs
based upon one predetermined rate based on
volume
• Easier, less accurate; Works best with one
product;
• Could be misleading

10. • Standard costing – steps
1. Accumulate total overhead costs
2. Identify activity and total amount of activity that
best applies overhead costs to the product (base),
e.g. labor hours
3. Calculate application base rate
(total overhead/ total amount of the activity)
$20,000 total oh/ 1,000 labor hrs = $20 base rate
per hour worked
4. Apply overhead rate - Multiply base rate by total
base activity used for each product. A product
that takes 2 hours at $20 base rate would be
allocated $40 of overhead (2 x $20)

11. Standard Costing Method
Total manufacturing overhead $10,000,000
Direct labor hours 500,000
10,000,000/50,000 = $20/labor hour application base
rate
$20 * 2 hours per product to mfg. = $40 overhead cost
per unit
Product A = manufacturing overhead cost per unit- $40
Product B = manufacturing overhead cost per unit- $40
Product A = total manufacturing cost /unit - $150
Product B = total manufacturing cost/unit - $110

12. Standard Costing Method
A B
Direct Materials $90 $50
Direct Labor @ $10/hr $20 $20
Manufacturing OH $40 $40
Total per unit cost $150 $110
Standards costing example total
cost per unit

19. The organization is viewed as a pool of activities. Many of these
activities will cut across deparments with departments often
participating in many different activities

20. ABC costing – steps
1.Re-categorize overhead costs into activity pools
2.Calculate total costs and total physical base for each
activity
3.Calculate application base rate for each category (total
overhead/ total physical base)
4.Calculate proportion of physical base for each category
5.Multiply rate by base for each product
6.Calculate total overhead cost for each product
7.Divide total cost for each product by total products
manufactured = overhead cost per unit
8.Add overhead cost per unit to direct labor cost per unit
and direct material cost per unit = total cost per unit

21. Activity Based Costing
• Two stage allocation process
– Assign costs to pools, then assign to products using cost
drivers
• I.e. Sell 50,000 units – Product A, 200,000 units –
Product B = 250,000 units total
– Both require two direct labor hours to complete =
500,000 direct labor-hours
– Total manufacturing overhead = $10,000,000

22. ABC Costing
Table 1 Expected activity
Activity Center and Costs Costs Total Product A Product B
Labor related (labor hours) $800,000 500,000 100,000 400,000
Machine related (machine hours) $2,100,000 1,000,000 300,000 700,000
Machine setups (# of setups) $1,600,000 4,000 3,000 1,000
Production orders (# orders) $450,000 1,200 400 800
Material receipts (# of receipts) $1,000,000 5,000 1,800 3,200
Parts administration ( part types) $350,000 700 400 300
Product testing (# of tests) $1,700,000 20,000 16,000 4,000
General overhead (machine
hours) $2,000,000 1,000,000 300,000 700,000
Total $10,000,000

23. Table 2 Estimated
Total
Expected Overhead
Overhead
Costs Activity Rate
Labor related $800,000 500,000 $1.60
Machine related $2,100,000 1,000,000 $2.10
Machine setups $1,600,000 4,000 $400.00
Production orders $450,000 1,200 $375.00
Material receipts $1,000,000 5,000 $200.00
Parts administration $350,000 700 $500.00
Product testing $1,700,000 20,000 $85.00
General Factory $2,000,000 1,000,000 $2.00

24. Table 3 Product A Product B
Labor related Rate * activity $160,000 $640,000
Machine related $630,000 $1,470,000
Machine setups $1,200,000 $400,000
Production orders $150,000 $300,000
Material receipts $360,000 $640,000
Parts administration $200,000 $150,000
Product testing $1,360,000 $340,000
General Factory $600,000 $1,400,000
Total $4,660,000 $5,340,000
Units produced 50,000 200,000
Overhead per unit $93.20 $26.70
Product A - manufacturing overhead costs = $93.20
Product B - manufacturing overhead costs = $26.70

25. A B
Direct Materials $90 $50
Direct Labor @ $10/hr $20 $20
Manufacturing OH $93.20 $26.70
Total per unit cost $203.20 $96.70

28. QUESTIONS?

31. ABC Hierarchical Production Model

32. Facility Support Activities not ABC