9-1

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 Activity-Based Costing

Chapter 9

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

Copyright © 2017 by McGraw-Hill Education . All rights reserved.

 9-3

Learning Objectives
LO 9-1 Understand the potential effects of using externally reported
product costs for decision making.
LO 9-2 Explain how a two-stage product costing system works.
LO 9-3 Compare and contrast plantwide and department
allocation methods.
LO 9-4 Explain how activity-based costing and a two-stage product
system are related.
LO 9-5 Compute product costs using activity-based costing.
LO 9-6 Compare activity-based product costing to traditional
department product costing methods.
LO 9-7 Demonstrate the flow of costs through accounts using
activity-based costing.
LO 9-8 Apply activity-based costing to marketing and administrative
services.
 Product Costs and Decision
LO
9-4
9-1

Making
LO 9-1 Understand the potential effects of using externally
reported product costs for decision making.

C-27s C-20s Total

Units produced 10 30 40
Direct labor-hours 2,000 3,000 5,000
Costs:
Direct materials $ 40,000 $ 36,000 $ 76,000
Direct labor 72,000 78,000 150,000
Manufacturing overhead
(@ 120%) 86,400 93,600 180,000
Total $198,400 $207,600 $406,000
Cost per unit $ 19,840 $ 6,920

Grange is considering dropping C-27s.

 Product Costs and Decision
LO
9-5
9-1

Making
The accountant estimated that overhead
will be $163,800.
Original C-20s only
Manufacturing overhead:
Utilities $ 2,400 $ 1,800
Supplies 2,500 1,300
Training 30,000 15,600
Supervision 54,900 54,900
Machine depreciation 29,550 29,550
Plant depreciation 40,050 40,050
Miscellaneous 20,600 20,600
Total overhead $180,000 $163,800
 Product Costs and Decision
LO
9-6
9-1

Making
Original C-20s only

Direct materials $ 76,000 $ 36,000

Direct labor 150,000 78,000
Manufacturing overhead 180,000 163,800
Total costs $406,000 $277,800
Burden rate 210%
Unit cost $9,260

The cost per unit for the C-20s will

increase from $6,920 to $9,260.
LO
9-7
9-1

The Death Spiral

This is a process that begins by

attempting to increase price to
meet reported product cost.

The process may result in demand

for even fewer units.
LO
9-8
9-2

Two-Stage Cost Allocation

LO 9-2 Explain how a two-stage product costing system works.

Allocate overhead costs to departments.

Allocate department overhead costs

to the products or services.
LO
9-9
9-2

Two-Stage Cost Allocation

Cost
pools
Direct Materials Direct Labor Overhead

First stage

Cost
Direct Direct Machine-related Direct labor-
allocation
cost cost costs related costs
rule
Second
stage

Indirect costs Indirect costs

allocated by allocated by
machine direct labor
hours costs

Cost C-27s C-20s

objects
LO
9-10
9-2

Two-Stage Cost Allocation

Third Quarter – Production and Cost Data
J25P J40X Total
Number of units 100,000 40,000 140,000
Machine hours – Assembly 6,000 30,000 36,000

Direct materials $1,500,000 $2,400,000 $3,900,000

Direct labor – Assembly $ 750,000 $ 600,000 $1,350,000
Direct labor – Packaging 990,000 360,000 1,350,000
Total direct labor $1,740,000 $ 960,000 $2,700,000
Total direct cost $3,240,000 $3,360,000 $6,600,000
Overhead costs:
Assembly $1,620,000
Packaging 810,000
Total overhead $2,430,000
Total costs $9,030,000

The cost system allocates manufacturing overhead

to products based on direct labor costs.
LO
9-11
9-2

Two-Stage Cost Allocation

Third Quarter – Unit Cost Report – One allocation rate
J25P J40X
Units produced 100,000 40,000

Direct material $ 15.00 $ 60.00

Direct labor:
Assembly $ 7.50 $ 15.00
Packaging 9.90 9.00
Total direct labor $ 17.40 $ 24.00
Direct cost $ 32.40 $ 84.00
Applied overhead
(@ 90% of direct labor costs) 15.66 21.60
$ 48.06 $105.60

$2,430,000 ÷ $2,700,000 = 90% (Total overhead ÷ Total direct labor costs

LO
9-12
9-2

Two-Stage Cost Allocation

Third Quarter – Unit Cost Report –Two Stage Allocation
J25P J40X

Units produced 100,000 40,000

Direct material $ 15.00 $ 60.00

Direct labor:
Assembly $ 7.50 $ 15.00
Packaging 9.90 9.00
Total direct labor $ 17.40 $ 24.00
Direct cost $ 32.40 $ 84.00
Applied overhead:
Assembly @ $45/machine hour $ 2.70 $ 33.75
Packaging @ 60% of direct labor cost 5.94 5.40
Total overhead $ 8.64 $ 39.15
Unit costs $ 41.04 $123.15
Assembly = Budgeted overhead $1,620,000
= $45 per MH
Budgeted machine-hours 36,000 MH

Packing = Budgeted overhead $1,810,000

= 60% of DL costs
Budgeted direct labor costs $1,350,000
 Plantwide versus
LO
9-13
9-3

Department-Specific Rates
LO 9-3 Compare and contrast plantwide and
department allocation methods.

All overhead costs are recorded in one

cost pool and applied to products using
one overhead allocation rate for the
entire plant.
 Plantwide versus
LO
9-14
9-3

Department-Specific Rates

Overhead costs are traced to separate

departments and applied to products
using a department allocation rate.
LO
9-15
9-3

Choice of Allocation Methods

Similar products using Plantwide

same resources allocation

Multiple products using Department

resources differently allocation
LO
9-16
9-4

Activity-Based Costing (ABC)

LO 9-4 Explain how activity-based costing and
a two-stage product system are related.

ABC is a costing method that first assigns costs

to activities and then assigns them to products
based on the products’ consumption of activities.

Assign costs to activities.

Assign costs to products based

on the use of each activity
LO
9-17
9-4

Activity-Based Costing (ABC)

Products Activities
consume consume
activities resources
LO
9-18
9-4

Developing Activity-Based Costs

Step 1: Identify the activities that consume resources

and assign costs to them.

Step 2: Identify the cost driver(s) associated with

each activity.

Step 3: Compute a cost rate per cost driver unit

or transaction.

Step 4: Assign costs to products by multiplying the

cost driver rate by the volume of cost driver
units consumed by the product.
LO

Identifying Activities that Use

9-19
9-4

Resources
Cost drivers are factors that cause or “drive”
an activity’s costs.

Identified Activity Identified Cost Driver

Setting up machines
Handling material
Machining
Packaging and shipping
?
 9-20

ABC Cost Flow Diagram

LO
9-21
9-4

Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level Cost Example Cost Driver Example
LO
9-22
9-4

Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level Cost Example Cost Driver Example
Volume related Supplies Direct labor cost
Lubricating oil Machine-hours
Machine repair Number of units
LO
9-23
9-4

Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level Cost Example Cost Driver Example
Volume related Supplies Direct labor cost
Lubricating oil Machine-hours
Machine repair Number of units
Batch related Setup costs Setup hours
Material handling Production runs
Shipping costs Number of shipments
LO
9-24
9-4

Cost Hierarchies
This is the classification of cost drivers into general
levels of activity; volume, batch, product, and so on.
Hierarchy Level Cost Example Cost Driver Example
Volume related Supplies Direct labor cost
Lubricating oil Machine-hours
Machine repair Number of units
Batch related Setup costs Setup hours
Material handling Production runs
Shipping costs Number of shipments
Product related Compliance costs Number of products
Design and
specification costs
LO
9-25
9-4

Cost Hierarchies
The cost hierarchy in any ABC system depends on
the cost category and its cost driver.
Hierarchy Level Cost Example Cost Driver Example
Volume related Supplies Direct labor cost
Lubricating oil Machine-hours
Machine repair Number of units
Batch related Setup costs Setup hours
Material handling Production runs
Shipping costs Number of shipments
Product related Compliance costs Number of products
Design and
specification costs
Facility related General plant costs Direct costs
Plant admin. costs Value added
LO
9-26
9-5

ABC Illustrated
LO 9-5 Compute product costs using activity-based costing.
Third Quarter – Production and Cost Data
J25P J40X Total
Number of units 100,000 40,000 140,000
Machine hours – Assembly 6,000 30,000 36,000

Direct materials $1,500,000 $2,400,000 $3,900,000

Direct labor – Assembly $ 750,000 $ 600,000 $1,350,000
Direct labor – Packaging 990,000 360,000 1,350,000
Total direct labor $1,740,000 $ 960,000 $2,700,000
Total direct cost $3,240,000 $3,360,000 $6,600,000
Overhead costs:
Assembly $1,620,000
Packaging 810,000
Total overhead $2,430,000
Total costs $9,030,000
 ABC Illustrated
LO
9-27
9-5

Step 1: Identify the Activities

Assembly Department Packaging Department

Setting up machines Inspection
Handling material Packing
Product assembly Shipping
 ABC Illustrated
LO
9-28
9-5

Step 2: Identify the Cost Drivers

Cost Driver Volume
Activity Cost Driver J25P J40X Total

Assembly building:
Assembling Machine-hours 6,000 30,000 36,000
Setting up machines Setup hours 40 400 440
Handling material Production runs 8 40 48
Packaging building:
Inspecting and packing Direct labor hours 60,000 22,800 82,800
Shipping No. of shipments 100 200 300
LO

ABC Illustrated
9-29
9-5

Step 3: Compute the Cost Driver Rates

Overhead Cost Driver Cost Driver
Building and Activity Cost Volume Rate
Assembly building:
Assembling $1,080,000 ÷ 36,000 machine hour = $ 30/machine hour
Setting up machines 396,000 ÷ 440 hours = $ 900/setup hour
Handling material 144,000 ÷ 48 runs = $3,000/run
Total assembly overhead $1,620,000
Packaging building:
Inspecting and packing $ 414,000 ÷82,800 direct labor hr = $ 5/direct labor hour
Shipping 396,000 ÷ 300 shipments = $ 1,320/shipment
Total packaging overhead $ 810,000

Total overhead $2,430,000

 ABC Illustrated
LO
9-30
9-5

Step 4: Assign Costs Using ABC

Overhead J25P J40X

Assembly building:
Assembling @ $30/machine hour $180,000 $ 900,000
Machine setup @ $900/setup hour 36,000 360,000
Handling material @ $3,000/run 24,000 120,000

Packaging building:
Inspection and packaging @ $5/direct labor hour 300,000 114,000
Shipping @ $1,320/ shipment 132,000 264,000
Total ABC overhead $672,000 $1,758,000
 Cost Flow Diagram – ABC
LO
9-31
9-5

System
Direct Manufacturing
costs overhead

Directly
assigned
Assembly building Packaging building

Handling Inspecting/
Assembling Setup Shipping
material packaging

Machine Setup Direct Ship-

Runs
hours hours LH ments

J25P J40X
 Activity Based Costing –
LO
9-32
9-5

Illustrated
J25P J40X
Direct material $1,500,000 $2,400,000
Direct labor:
Assembly $ 750,000 $ 600,000
Packaging 990,000 360,000
Total direct labor $1,740,000 $ 960,000
Direct costs $3,240,000 $3,360,000
Overhead:
Assembly building:
Assembling @ $30 per machine hour $ 180,000 $ 900,000
Machine setup @ $900 per setup hour 36,000 360,000
Handling material @ $3,000 per run 24,000 120,000
Package building:
Inspecting and packing @ $5 per direct labor hour 300,000 114,000
Shipping @ $1,320 per shipment 132,000 264,000
Total ABC overhead $ 672,000 $1,758,000
Total ABC cost $3,912,000 $5,118,000
Number of units 100,000 40,000
Unit cost $ 39.12 $ 127.95
LO
9-33
9-6

Unit Costs Compared

LO 9-6 Compare activity-based product costing to
traditional department product costing methods.

Comparison of Reported Unit Product Costs

J25P J40X

Plantwide rate $48.06 $105.60

Department (building) rate $41.04 $123.15
Activity-based costing $39.12 $127.95
LO
9-34
9-7

Cost Flows through Accounts

LO 9-7 Demonstrate the flow of costs through
accounts using activity-based costing.

Let’s see ABC cost flow for the Assembly Department.

It's T-account time!

LO
9-35
9-7

Direct Materials Costs

Materials Inventory Assembly WIP J25P

1,500,000 DM 1,500,000

2,400,000

Assembly WIP J40X

DM 2,400,000
LO
9-36
9-7

Direct Labor Costs

Wages Payable Assembly WIP J25P

750,000 DM 1,500,000

600,000 DL 750,000

Assembly WIP J40X

DM 2,400,000

DL 600,000
LO
9-37
9-7

Overhead Costs

Assembling Assembly WIP J25P

1,080,000 180,000 DM 1,500,000

900,000 DL 750,000
OH 240,000
Setting Up
396,000 36,000
360,000 Assembly WIP J40X
DM 2,400,000
Handling Material
DL 600,000
144,000 24,000
OH 1,380,000
120,000
 Transfer from Assembly to
LO
9-38
9-7

Packaging
Assembly WIP J25P Packaging WIP J25P
DM 1,500,000 2,490,000 2,490,000
DL 750,000
OH 240,000

Assembly WIP J40X Packaging WIP J40X

DM 2,400,000 4,380,000 4,380,000
DL 600,000
OH1,380,000
LO
9-39
9-8

ABC Costing in Administration

LO 9-8 Apply activity-based costing to marketing
and administrative services.

Step 1: Identify the activities that consume resources.

Step 2: Identify the cost driver associated with each activity.
Step 3: Compute a cost rate per cost driver for each unit
or transaction.
Step 4: Assign costs to the marketing or administration
activity by multiplying the cost driver rate by the
volume of cost driver units consumed for that activity.
 9-40

End of Chapter 9