4-1

ActivityBased
Costing and
Management
Prepared
Preparedby
by

Douglas
DouglasCloud
Cloud

Pepperdine
PepperdineUniversity
University

4-2

Objectives
Objectives
Explain and illustrate the traditional method of
After
After reading
reading
this
calculating average
costs of this
products.
you
chapter,
you should
should
Explain whychapter,
the traditional
method does not
be able
able to:
to:
adequately serve be
modern
organizations.
Explain how complexity and diversity are
important cost drivers.
Explain and illustrate the activity-based costing
method of calculating average costs of products.
Continued
Continued

4-3

Objectives
Objectives
Explain and illustrate activity-based
management.
Prepare ABC-formatted income statements.

4-4

The
The Traditional
Traditional Approach
Approach
A company makes two products, A and B, and
uses machine hours as its cost driver.
A
Machine hours per unit

Total

Total units

100,000

25,000

Total hours

200,000

100,000

Total overhead cost

300,000
$900,000

4-5

The
The Traditional
Traditional Approach
Approach
The overhead rate is $3 ($900,000 300,000),
and the allocations of overhead to products are:
Total hours
Rate
Total overhead

Total

200,000

100,000

300,000

x $3

x $3

x $3

$600,000 $300,000 $900,000

4-6

Activity-Based
Activity-Based Costing
Costing Approach
Approach
Volume is one major driver, measured either
in output (units produced) or input (labor
hours, machine hours, etc.)
Accountants today recognize two other major
influences on cost, complexity and diversity of
operations.
ABC is concerned with resource consumption.

4-7

MultiBrick Cost Determination Data

MultiBrick also makes
10,000,000 total brick, but in a
dozen colors, four textures, and
eight sizes/shapes, a total of 384
possibilities. The firm mixes
and bakes 10 to 18 batches of
bricks per day. MultiBrick sells
to over 1,000 customers whose
orders typically include 15 to 20
different kinds of bricks.

4-8

MultiBrick Cost Determination Data

Total manufacturing overhead $800,000
Total output 10,000,000 bricks
Model A-42
Total production
6,000
Material cost per brick
$0.05
Direct labor cost per brick $0.06

Model A-88 Model C-11

4,000
100,000
$0.04
$0.03
$0.07
$0.04

Overhead rate = $800,000 10,000,000 = $0.08 per brick

4-9

MultiBrick Cost Determination Data

Cost calculations:
Model A-42
Material cost per brick
$0.05
Direct labor cost per brick 0.06
Overhead cost at $0.08
0.08
Total unit cost
$0.19

Model A-88
$0.04
0.07
0.08
$0.19

Model C-11
$0.03
0.04
0.08
$0.15

4-10

Activity-Based
Activity-Based Costing
Costing Terms
Terms
A cost object refers to whatever segment for
which you are estimating the cost.
Examples: Products, customers, geographical
areas, and channel of distribution

Cost drivers are activities that cause costs.

Examples: Sales, production, number of
products, and number of customers.

4-11

Activity-Based
Activity-Based Costing
Costing Terms
Terms
Resource Driver refer to activities that drive resource
requirements, and therefore drive costs.
Examples: People, machinery, space, and
utilities
An activity driver relates resource-driving activities to
products, customers, geographical areas, or other
segments of interest.

4-12

MultiBrick Data for Illustration

Total Amount
Rate
Resource Driver Costs in Pool
of Driver
Setups
$120,000 10,000 setups = $12
Baking time
Customer orders
Total cost

600,000 300,000 hours = $2

80,000 5,000 orders = $18
$800,000

4-13

MultiBrick Data for Illustration

Activity Data per Year
Model A-42
Number of setups
150
baking time, hours
60
Number of customer orders
30

Model A-88
180
50
40

Model C-11
30
300
20

Costs, excluding overhead

Material cost per brick
$0.05
Direct labor cost per brick 0.06

$0.04
0.07

$0.03
0.04

MultiBrick Data for Illustration

4-14

ABC Analysis of Bricks

Model A-42 Model A-88 Model C-11
Material cost

$ 300$ 160$

300

360280

400

Setup-based

1,800960

360

Baking time

120100

600

Customer order based

480

320

Direct labor cost

Overhead:

Total Cost

640

$3,060$3,340$ 8,280

Divided by annual volume 6,000 4,000100,000

Average cost per brick

$ 0.51$0.835$

0.83

Comparison
Comparison of
of Traditional
Traditional Costs
Costs and
and
Activity-Based
Activity-Based Costs
Costs

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Traditional Cost Approach:

Model A-42 Model A-88 Model C-11
Material cost

$ 300

$160

300

Direct labor cost

360

280

400

Overhead

480

320

8,000

Total cost

$1,140

$760

$15,000

Comparison
Comparison of
of Traditional
Traditional Costs
Costs and
and
Activity-Based
Activity-Based Costs
Costs

4-16

Activity-Based Cost Approach:

Model A-42 Model A-88 Model C-11
Material cost

$ 300

$ 160

360

280

400

Overhead

2,400

2,900

1,200

Total cost

$3,080

$3,340

$8,200

Direct labor cost

300

4-17

Consumption
Consumption Ratios
Ratios
Consumption ratios is the resource utilized by a
given product divided by the total amount of the
resource available.
Since MultiBrick is producing a total of 10,000,000
bricks, the consumption ratio of each model is:
Model A-42: 6,000 bricks 10,000,000 = 0.06%
Model A-88: 4,000 bricks 10,000,000 = 0.04%
Model C-11: 100,000 bricks 10,000,000 = 1.00%

4-18

Consumption
Consumption Ratios
Ratios
Model A-42: 120 setups 10,000 total = 1.50%
Model A-88: 180 setups 10,000 total = 1.80%
Model C-11: 30 setups 10,000 total = 0.30%
Model A-42: 60 hours 300,000 total = 0.0200%
Model A-88: 50 hours 300,000 total = 0.0167%
Model C-11: 300 hours 300,000 total = 0.1000%
Model A-42: 30 orders 5,000 total = 0.60%
Model A-88: 30 orders 5,000 total = 0.80%
Model C-11: 30 orders 5,000 total = 0.40%

4-19

Who
Who Uses
Uses ABC?
ABC?
Primary Objective

Productive/Service Costing
Process Analysis
Performance Management
Profitability Assessment
Value-Based Management

50%
51%
49%
38%
18%

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Who
Who Uses
Uses ABC?
ABC?
Industry

Public Sector
Service
Manufacturing
Consulting

40%
24%
24%
11%

4-21

Kinds
Kinds of
of Variability
Variability
1. Unit level activities
2. Batch level activities
3. Sustaining activities
4. Facility-sustaining or companysustaining activities

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Types
Types of
of Activities
Activities (continued)
(continued)
Unit level activities are those performed each
time a unit is produced or sold.
Examples: Materials, components, drilling and
welding

4-23

Types
Types of
of Activities
Activities (continued)
(continued)
Batch level activities are those that a
company performs when it makes a group of
units, regardless of how many units are in the
batch.
Examples: Machine setups

4-24

Types
Types of
of Activities
Activities (continued)
(continued)
Sustaining activities arise because a company
does particular types of business, or maintains
a particular product or service.
Examples: Advertising devoted to the product,
engineering and development related
to the product.

4-25

Types
Types of
of Activities
Activities (continued)
(continued)
Facility-sustaining or company-sustaining
activities and costs relate to an entire plant,
office, or company as a whole.
Examples: Rent of the corporate headquarters
building

4-26

ABC
ABC and
and Ethics
Ethics
Because some costs are on the
borderline between being direct
or indirect to a product or line,
managerial accountants must use
some judgment in assigning costs
to products. Whenever decisions
involve judgment, the potential
for an ethical conflict exists.

4-27

Activity-Based
Activity-Based Management
Management
(ABM)
(ABM)
Activity-Based
Management (ABM)
is using information
about activities to
manage many aspects
of an organization,
rather than simply
managing costs.

4-28

Activity-Based
Activity-Based Management
Management
(ABM)
(ABM)
Re-engineering describes the development of new
ways to perform existing activities and ways to
stop performing non-value-adding activities.
Benchmarking is the practice of comparing your
company with some of the industry leaders.
Process value analysis (PVA) uses activity analysis
to manage costs. PVA focuses on manufacturing
processes and seeks to reduce or optimize the
activities performed within a process.

4-29

Process
Process Value
Value Analysis
Analysis (PVA)
(PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Value-added: An operation that actually changes
the physical aspects of the part.
Examples: Turning, milling, and drilling

4-30

Process
Process Value
Value Analysis
Analysis (PVA)
(PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Non-Value-added, but necessary: An
operation/activity that does not changes the
physical aspects of the part, but is necessary in
order to do so.
Examples: Setup time and inspecting

4-31

Process
Process Value
Value Analysis
Analysis (PVA)
(PVA)
PVA focuses on manufacturing processes and
seeks to reduce or optimize the activities
performed within a process.
Non-Value-added, and unnecessary: An activity
that does not changes the physical aspects of the
part and is not necessary for value added
operations to be performed.
Examples: Queue time

4-32

ABC/ABM
ABC/ABM and
and World-Class
World-Class
Manufacturing
Manufacturing
ABC is most beneficial for
companies with a great
deal of complexity and
diversity in their products
and operations.

ABC/ABM
ABC/ABM Analysis
Analysis and
and
Income
Income Reporting
Reporting

4-33

Patterson Homewares, Inc.

Income Statement for 20X4, in thousands
Sales
$300.4 $503.5 $623.3 $1,427.2
Unit-level variable costs 190.1 161.1 249.3
600.5
Unit-level C/M
$110.3 $342.4 $374.0 $ 826.7
Batch-level variable costs
9.6
26.4
52.8
88.8
Batch-level C/M
$100.7 $316.0 $321.2 $ 737.9
Product-sustaining costs
89.2
56.7
73.7
219.6
Product margin
$ 11.5 $259.3 $247.5 $ 518.3
Facility-sustaining costs
220.5
Income
$ 297.8

4-34

Chapter 4
The
The End
End

4-35