Chapter 4-1 CHAPTER Activity-Based Costing Managerial Accounting, Fifth Edition Chapter 4-2 Study Study Objectives Objectives Recognize the difference between traditional costing and activity based costing Identify the steps in the development of an activity-based costing system Know how companies identify the activity cost pools used in activity-based costing Know how companies identify and use cost drivers in activity-based costing Chapter 4-3 Study Study Objectives Objectives Understand the benefits and limitations of activity-based costing Differentiate between value-added and non-value-added activities Understand the value of using activity levels in activity-based costing Apply activity-based costing to service industries Chapter 4-4 Traditional Traditional Costing Costing To allocate as fairly as possible the true costs of the products When management has more accurate costs, better decisions can be made Direct Materials and Direct Labor costs are easiest to trace through: Material requisitions Payroll time sheets Chapter 4-5 SO 1: Recognize the differences between traditional costing and activity-based costing Hard Hard Part Part of of Determining Determining Product Product Costs Costs is? is? Determining the proper amount of overhead to assign to each product, service or job Chapter 4-6 Traditional Traditional Costing Costing and and ABC ABC Chapter 4-7 Traditional Traditional Costing Costing Allocates overhead using a single predetermined rate Job order costing: Direct labor cost is assumed to be the relevant activity base Assumption was satisfactory when direct labor was a major portion of total manufacturing costs There should be of a high correlation between direct labor costs and overhead costs Chapter 4-8 SO 1: Recognize the differences between traditional costing and activity-based costing Traditional Traditional Costing Costing Allocates overhead using a single predetermined rate Process Costing: Machine hours is assumed to be the relevant activity base Assumption was satisfactory when machine hours was a major portion of total manufacturing costs There should be of a high correlation between machine hours and overhead costs Chapter 4-9 SO 1: Recognize the differences between traditional costing and activity-based costing Why Why Do Do Companies Companies Need Need aa New New Approach? Approach? Tremendous change in manufacturing and service industries Decrease in amount of direct labor usage Significant increase in total overhead costs May be inappropriate to use plant-wide predetermined overhead rates based on direct labor or machine hours when a lack of correlation exists Complex manufacturing processes may require multiple allocation bases; this approach is called Activity-Based Costing (ABC) Chapter 4-10 SO 1: Recognize the differences between traditional costing and activity-based costing Activity-Based Activity-Based Costing Costing Budget Budget CHECK AND DOUBLECHECK, CPAs Annual Overhead Budget Expected Use of Activity-Based Estimated Cost Drivers Overhead Activity Cost Pools Cost Drivers Overhead Per Activity Rates Secretarial support Direct Prof hours $ 210,000 30,000 $7 per hour Direct labor Fringe benefits Direct labor cost 240,000 $ 600,000 $0.40 per $1 labor Printing and photocopying Working paper pages 20,000 20,000 $1 per page Computer support CPU minutes 200,000 50,000 $4 per minute Telephone and postage None (traced directly) 71,000 N/A Based on usage Legal support Hours used 129,000 860 $150 per hour Insurance (professional liability, etc.) Revenue billed 120,000 $2,000,000 $0.06 per $1 rev Recruiting and training Direct Prof Hours 210,000 30,000 $7 per hour $1,200,000 Illustration 4-16 Chapter 4-41 SO Apply activity-based costing to service industries Assigning Assigning Overhead Overhead in in aa Service Service Company Company CHECK AND DOUBLECHECK, CPAs Plano Molding Company Audit ActivityActual Based Use of Overhead Cost Activity Cost Pools Cost Drivers Drivers Rates Secretarial support Direct Professional hours 3,800 Direct labor Fringe benefits Direct labor cost $ 70,000 Printing and photocopying Working paper pages Computer support CPU minutes 8,600 $ 4.00 Telephone and postage None (traced directly) Legal support Hours used 156 $150.00 Insurance Revenue billed $260,000 $ 0.06 Recruiting and training Direct Prof Hours 3,800 $165,100 Assigned $ 7.00 $ 26,600 $ 0.40 28,000 1,800 $ 1.00 1,800 34,400 8,700 23,400 15,600 $ 7.00 26,600 Illustration 4-17 Chapter 4-42 SO Apply activity-based costing to service industries Comparison Comparison of of Traditional Traditional and and ABC ABC CHECK AND DOUBLECHECK, CPAs Plano Molding Company Audit Traditional Costing ABC Revenues Expenses $260,000 Direct professional labor Applied overhead Operating income Profit Margin $ 70,000 140,000 Total expenses 235,100 $ 50,000 19.2% $260,000 $ 70,000 165,100 210,000 $ 24,900 9.6% Illustration 4-18 Chapter 4-43 SO Apply activity-based costing to service industries Review Review Recognize the difference between traditional and activity-based costing Traditional system allocates overhead to products using predetermined unit-based output rate ABC allocates overhead to activity cost pools and assigns cost to products using cost drivers Identify the steps in the development of an activitybased costing system Step 1: Identify the major activities and allocate the overhead costs to cost pools Step 2: Identify the cost driver highly correlated to the cost pool Step 3: Compute the overhead rate per cost driver Step 4: Assign cost pools to products or services using the overhead rates Chapter 4-44 Review Review Know how companies identify cost pools used in ABC Analyze each operation or process, document and time every task, action, or transaction Know how companies identify and use cost drivers in ABC Cost drivers identified for assigning activity cost pools must: Accurately measure the consumption of the activity Have related data easily available Understand the benefits and limitations of ABC: Benefits: Enhanced control over overhead costs Better management decisions Limitations: Higher costs accompany multiple activity centers and cost drivers Some costs must still be allocated arbitrarily Chapter 4-45 Review Review Differentiate between value-added and non-value-added activities Value-added activities increase the worth of a product or service Non-value-added activities add cost to, or increase the time spent on, a product or service without increasing its market value Understand the value of using activity levels in ABC Activities may be classified as: Unit-level Batch-level Product-level Facility-level Failure to recognize this classification can result in distorted product costing Chapter 4-46 Review Review Apply ABC to service industries Same objective – improved costing of services provided The general approach to costing is also the same: Analyze operations Identify activities Accumulate overhead costs by activity cost pools Identify and use cost drivers to assign cost to services Chapter 4-47 Just-in-Time Just-in-Time A processing system dedicated to having the right amount of materials, products, or parts arrive as they are needed, thereby reducing the amount of inventory Chapter 4-48 JUST-in-TIME JUST-in-TIME PROCESSING PROCESSING 100 pairs of sneakers got it! Send rubber and shoe laces directly to the factory Sales Order Received ’s Susane Socc sr r Sneake Chapter 4-49 Goods Manufactured stomer u C o t d hippe Go o d s S Illustration 4-A1 Just-in-Time Just-in-Time Objective of JIT: Eliminate all manufacturing inventories Elements of JIT: Dependable suppliers Multi-skilled work force Total quality control system Benefits of JIT: Reduced inventory Enhanced product quality Reduced rework and storage costs Savings from improved flow of goods Chapter 4-50 Let’s Let’s Review Review An activity that adds costs to the product but does not increase market value is a: a Value-added activity b Cost driver c Cost-benefit activity d Non-value-added activity Chapter 4-51 ALL ALL ABOUT ABOUT YOU YOU Chapter 4-52 ALL ALL ABOUT ABOUT YOU YOU Chapter 4-53 ALL ALL ABOUT ABOUT YOU YOU Chapter 4-54 COPYRIGHT COPYRIGHT Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 4-55 ... 50,000 Number of Inspections Illustration 4-5 Chapter 4-22 SO Know how companies identify and use cost drivers in activity-based costing Formula Formula for for Computing Computing Activity-Based Activity-Based... consumed Chapter 4-12 SO 1: Identify the steps in management’s decision- making process Activity-Based Activity-Based Costing Costing Products consume activities, and Activities consume resources Chapter. . .CHAPTER Activity-Based Costing Managerial Accounting, Fifth Edition Chapter 4-2 Study Study Objectives Objectives Recognize the difference