Scribd
Upload
375 views11 pages

Activity Based Costing

1. The activities were classified as: unit-level (labor-related), batch-level (machine setups, production orders, material receipts), product-level (parts administration), and facility-level (general factory). 2. The predetermined overhead rate was 800,000/50,000 DLHs = $16 per DLH. The unit product costs were $85 for Deluxe and $64 for Tourist. 3. Under ABC, overhead rates ranged from $1.60 to $3.33 per measure. Unit product costs were $86.60 for Deluxe and $65.33 for Tourist, providing a

Uploaded by

Amie Jane Miranda
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
375 views11 pages

Activity Based Costing

1. The activities were classified as: unit-level (labor-related), batch-level (machine setups, production orders, material receipts), product-level (parts administration), and facility-level (general factory). 2. The predetermined overhead rate was 800,000/50,000 DLHs = $16 per DLH. The unit product costs were $85 for Deluxe and $64 for Tourist. 3. Under ABC, overhead rates ranged from $1.60 to $3.33 per measure. Unit product costs were $86.60 for Deluxe and $65.33 for Tourist, providing a

Uploaded by

Amie Jane Miranda
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 11

ACTIVITY-BASED COSTING

Coverage of discussion:
•Assigning overhead costs to products
•Plantwide overhead rate
•Departmental overhead rates
•Activity-Based Costing (ABC)
ASSIGNING OVERHEAD COSTS TO
PRODUCTS
 Companies use three common approaches to assign costs
to products.
 Plantwide overhead rate – simplest method
 Single overhead rate used throughout the entire factory
 Departmental overhead rates – different predetermined
overhead rate in each production department. The nature of
the work performed in a department will determine the
department’s allocation base.
 Unfortunately, even departmental overhead rates will not
correctly assign overhead costs in situations where a company
has a range of products and complex overhead costs. The
reason is that the departmental approach usually relies on a
single measure of activity as the base for allocating overhead
cost to products.
ACTIVITY-BASED COSTING (ABC)
 Is a technique that attempts to assign overhead costs
more accurately to products than the simpler methods.
 In activity-based costing, an attempt is made to trace
these costs directly to the products that cause them.
 Rather than a single cost allocation base such as direct
labor-hours or machine-hours, in activity-based costing
a company uses a number of allocation bases for
assigning costs to products. Each allocation base in an
activity-bases costing system represents a major activity
that causes overhead costs. An activity in activity-based
costing is an event that causes the consumption of
overhead resources.
EXAMPLES OF ACTIVITIES IN VARIOUS
ORGANIZATIONS
 Setting up machines
 Admitting patients to a hospital

 Scheduling production

 Performing blood tests at a clinic

 Billing customers

 Maintaining equipment

 Ordering materials or supplies

 Stocking shelves at a store

 Meeting with clients at a law firm

 Preparing shipments

 Inspecting materials for defects

 Opening an account at a bank


 Activity-based costing focuses on these activities. Each
major activity has its own overhead cost pool (also
known as an activity cost pool), its own activity
measures and its own overhead rate (also known as
activity rate)
 Activity cost pool – is a “cost bucket” in which costs
related to a particular activity measure are accumulated.
 Activity measure – expresses how much of the activity is
carried out and it is used as the allocation base for
assigning overhead costs to products and services.
 Activity rate – is an overhead rate in an activity-based
costing system. Each activity has its own activity rate
that is used to assign overhead costs to cost objects.
DESIGNING AN ACTIVITY-BASED
COSTING SYSTEM
 The most important decisions in designing an activity-
based costing system concern what activities will be
included in the system and how the activities will be
measured.
 These activities range from taking a telephone order to
training new employees.
 The challenge in designing an activity-based costing
system is to identify reasonably small number of
activities that explain the bulk of the variation in
overhead costs.
HIERARCHY OF ACTIVITIES
 Unit-level Activities – are performed each time a unit is
produced. The costs of unit-level activities should be
proportional to the number of units produced.
 Batch-level activities – consists of task that are performed each
time a batch is processed, such as processing purchase orders,
setting up equipment, packing shipments to customers and
handling material.
 Product-level activities (product-sustaining activities) – relate to
specific products and typically must be carried out regardless of
how many batches or units of the product are manufactured.
 Facility-level activities (organization-sustaining activities) – are
activities that are carried out regardless of which products are
produced, how many batches are run, or how many units are
made.
FOUR-LEVEL OF HIERARCHY
Level Activities Activity Measures
Unit-level Processing units on machines Machine-hours
Processing units by hand Direct labor-hours
Consuming factory supplies Units produced
Batch-level Processing purchase orders Purchase orders processed
Processing production orders Production orders processed
Setting up equipment Number of setups, setup hrs
Handling material Pounds of material handled;
number of times material moved
Product-level Testing new products Hours of testing time
Administering parts inventories Number of part types
Designing products Hours of design time
Facility-level General factory administration Direct labor-hours
Plant building and grounds Direct labor-hours
ILLUSTRATION:
 Aerodec, Inc., manufactures and sells two types of wooden deck
chairs: Deluxe and Tourist. Annual sales in units, direct labor-hours
(DLHs) per unit, and total direct labor-hours per year are provided
below:
Deluxe deck chair: 2,000 units x 5 DLHs per unit 10,000
Tourist deck chair: 10,000 units x 4 DLHs per unit 40,000
Total direct labor-hours 50,000
Costs for direct materials and direct labor for one unit of each product
are given below:
Deluxe Tourist
Direct materials 25 17
Direct labor (at 12 per DLH) 60 48
Manufacturing overhead cost total 800,000 each year. The breakdown
of these costs among the company’s six activity cost pools is given
below. The activity measures are shown in parenthesis:
Expected Activity
Activities and Activity Estimated Deluxe Tourist Total
Measures Overhead Cost
Labor-related (Direct labor- 80,000 10,000 40,000 50,000
hours)
Machine setups (number of 150,000 3,000 2,000 5,000
setups)
Parts administration (number 160,000 50 30 80
of parts)
Production orders (number of 70,000 100 300 400
orders)
Material receipts (number of 90,000 150 600 750
receipts)
General factory (machine- 250,000 12,000 28,000 40,000
hours)
800,000
 Required:
1. Classify each of Aerodec’s activities as either a unit-level, batch-level,
product-level or facility-level activity.
2. Assume that the company applies overhead cost to products on the basis
of direct labor-hours.
a. Compute the predetermined overhead rate.
b. Determine the unit product cost of each product, using the
predetermined overhead rate computed in (2a) above,
3. Assume that the company uses activity-based costing to compute
overhead rates.
a. Compute the activity rate for each of the six activities listed above.
b. Using the rates developed in (3a) above, determine the amount of
overhead cost that would be assigned to a unit of each product.
c. Determine the unit product cost of each product and compare this
cost to the cost computed in (2b) above.

You might also like