Activity-Based Costing 49

CHAPTER 4
Activity-Based Costing
CHAPTER REVI EW
UNIT COSTS
Functional-based and activity-based costing assigns costs to cost objects such as products
and customers. Once costs are assigned to the cost object, the unit cost is calculated by
dividing the total cost assigned to the units produced by the number of units produced.
Unit cost information is used to
value inventory
determine cost of goods sold, !hich affects income
determine bids to give to potential customers
decide !hether to ma"e or buy a product
decide !hether to accept or reject a special order
decide !hether to "eep or drop a product line
decide !hether to introduce a ne! product
#ifferent cost information is needed for different purposes.
For e$ternal reporting, product costs include direct materials, direct labor, and overhead.
Cost measurement involves determining the dollar amount of direct materials, direct labor, and
overhead used in production.
%!o cost measurement systems are
actual costing
normal costing
Cost assignment involves associating costs !ith units produced.
%!o cost assignment systems are
functional-based costing
activity-based costing
Production of Unit Cost Information
Actual costing assigns actual costs of direct materials, direct labor, and overhead to
products.
Actual cost systems are rarely used because they cannot provide accurate unit cost informa-
tion on a timely basis.
Normal costing uses
actual costs for direct materials
actual costs for direct labor
a predetermined rate for manufacturing overhead
50 Chapter &
A normal costing system can supply unit cost information on a timely basis.
%he predetermined overhead rate is calculated as
Predetermined overhead rate =
udgeted !estimated" overhead cost
#stimated activit$ usage
Overhead is assigned to products using the predetermined overhead rate.
%UNCTIONA&'AS#( P)O(UCT COSTIN*
'hen functional-based costing is used, direct materials and direct labor are assigned to prod-
ucts using direct tracing.
Overhead costs are assigned using driver tracing and allocations !ith unit-level activity
drivers.
Unit'level activit$ drivers are factors that cause changes in cost as the units produced
change.
($amples of unit-level drivers include
units produced
direct labor hours
direct labor dollars
machine hours
direct material dollars
An estimate for activity level can be based on
e+,ected activit$ ca,acit$, the expected production level of activity for the next year.
normal activit$ ca,acit$, the average activity that the firm expects in the long term )for
e$ample, average activity for the ne$t three to five years*.
theoretical activit$ ca,acit$, the maximum output possible under perfect operating
conditions.
,ractical activit$ ca,acit$, the output a firm can achieve if it operates efficiently. (fficient
operations allo! for e+uipment brea"do!ns, material shortages, etc.
Using practical or theoretical capacity avoids assigning unused capacity costs to products.
Unit-level activity drivers assign overhead using either
plant!ide rates, or
departmental rates.
Plantwide Rates
A plant!ide overhead rate is calculated as
Plant-ide rate =
udgeted ,lant-ide overhead cost
#stimated activit$ o. unit level driver
Overhead cost assigned to product is calculated as
A,,lied overhead = Plant-ide rate / Actual activit$ used on ,roduct
%he overhead variance is the difference bet!een actual overhead and applied overhead.
'
Activity-Based Costing 50
Undera,,lied overhead occurs !hen applied overhead is less than actual overhead for the
period.
Overa,,lied overhead occurs !hen applied overhead e$ceeds actual overhead for the
period.
%he follo!ing % account for overhead illustrates the relationships
Overhead
Actual overhead costs Applied overhead
),lant!ide rate - Actual activity*
Underapplied overhead Overapplied overhead
.f the overhead variance is relatively small, underapplied or overapplied overhead may be
treated as an adjustment to cost of goods sold. Underapplied overhead is added to cost of
goods sold, and overapplied overhead is subtracted from cost of goods sold.
Departmental Rates
#epartmental rates are calculated as
(e,artmental rate =
udgeted de,artmental overhead cost
#stimated de,artmental activit$
Overhead cost assigned to product is calculated as
A,,lied overhead = (e,artmental rate / Actual de,artmental activit$ used on ,roduct
/ee the summary belo!
Allocation
#irect %racing
#river %racing
/tage One ,ool Formation /tage One ,ool Formation
Unit-0evel #river
Plant-ide rate =
Plant-ide ,ool costs 1
Unit'level driver
Unit-0evel #rivers
(e,artmental rates =
(e,artmental ,ool costs 1
Unit'level drivers
52 Chapter &
/tage %!o
Overhead costs assigned =
Plant-ide overhead rate /
Actual activit$ used 3$ ,roduct
/tage %!o
Overhead costs assigned =
(e,artmental rate /
Actual activit$ used 3$ ,roduct
&I4ITATIONS O% %UNCTIONA&'AS#( COST ACCOUNTIN* S5ST#4S
,lant!ide and departmental rates may cause product cost distortions, !hich can be
damaging for companies operating in an environment characteri1ed by
firms engaged in intense competition
continuous improvement
total +uality management
total customer satisfaction
sophisticated technology
As firms adopt ne! strategies to remain competitive, the cost accounting system must
change to produce more accurate product costs.
/ymptoms of an outdated cost system include the follo!ing
%he outcome of bids is difficult to e$plain.
Competitors2 prices appear unrealistically lo!.
,roducts that are difficult to produce sho! high profits.
Operational managers !ant to drop products that appear profitable.
,rofit margins are hard to e$plain.
%he company has a highly profitable niche all to itself.
Customers do not complain about price increases.
%he accounting department spends a lot of time on special projects.
/ome departments are using their o!n cost accounting system.
,roduct costs change because of changes in financial reporting regulations.
,lant!ide and departmental rates using unit-level drivers may not assign overhead costs
accurately if
the proportion of nonunit-level overhead costs to total overhead costs is large, and
the degree of product diversity is great.
Nonunit-Related Overhead Costs
%he main problem !ith the traditional approach of using plant!ide and departmental
overhead rates is that a product2s consumption of overhead resources may not be strictly
related to units produced. For e$ample, setup costs are related to the number of setups.
Nonunit'level activit$ drivers are factors, other than the number of units produced, that
measure use of overhead resources. For e$ample, setup costs are not driven by the number of
units, but by the number of setups, a nonunit-level activity driver.
Using only unit-level activity drivers to assign nonunit-related overhead costs can create dis-
torted product costs. .f nonunit-level overhead costs are only a small percentage of total over-
head costs, the distortion of product costs !ould be small and the use of unit-level cost
drivers might be acceptable.
Cost
Assignment
Assign
Costs
(e,artment A
Pool
Plant-ide
Pool
Assign
Costs
(e,artment
Pool
Products Products
%unctional'ased Costing
Overhead Assignment
Products
(e,artmental
)ates
Plant-ide
)ate
Overhead
Costs
Overhead
Costs
Assign
Costs
Assign
Costs
Activity-Based Costing 56
Product Diversity
Product diversit$ occurs !hen products consume overhead activities in different proportions.
3easons !hy products might consume overhead in different proportions include
differences in product si1e
product comple$ity
setup time
si1e of batches
Consum,tion ratio is the proportion of each activity consumed by a product.
,roduct costs can be distorted if a unit-level cost driver is used and
nonunit-level overhead costs are a significant proportion of total overhead, and
the consumption ratios differ bet!een unit-level and nonunit-level input categories.
ACTI7IT5'AS#( P)O(UCT COSTIN*
An activit$'3ased costing !AC" s$stem traces
4. overhead costs to activities, and
5. then traces costs to products.
(irect Tracing )esource (rivers
Stage One8
Activit$ Pools
Activit$ (rivers
Stage T-o8
Costs Assigned
Functional-based costing also involves t!o stages6 ho!ever, overhead costs are traced to
departments )instead of activities*, and then traced to products.
Functional-based costing and activity-based costing are compared belo!
%irst stage8 traces costs to plant or department traces costs to activities
Second stage8 assigns costs to products assigns costs to products
Cost tracing8 usually allocation-intensive emphasi1es direct tracing and driver tracing
Activit$ drivers8 unit-level unit-level and nonunit-level
Activit$'ased Costing %unctional'ased Costing
Activit$ 6 Activit$ 4 Activit$ 2 Activit$ 0
Assign Costs Assign Costs Assign Costs
Cost o.
)esources
Assign Costs
Assign Costs
Products Products Products Products
54 Chapter &
Activity-based cost assignment consists of the follo!ing steps
4. Identify and define activities using interviews and surveys, then build an activity
dictionary.7An activit$ dictionar$ lists activities and activit$ attri3utes8financial and
nonfinancial information that describes the activities. .nformation includes
activity name8usually consists of an action verb and an object
a description of the tas"s that ma"e up the activity
classification as a ,rimar$ activit$ )activity consumed by a product or customer* or a
secondar$ activit$ )activity consumed by other primary or secondary activities*
activity driver8a measure of activity output
5. Assign costs to activities.7#etermine the cost of resources )such as materials, labor, and
capital* consumed by each activity.
.f the resource is e$clusive to the activity )such as materials*, use direct tracing.
.f the resource is shared by several activities, use driver tracing to assign costs to the
activities. )esource drivers are factors that measure the consumption of resources by
activities.
%he costs of secondary activities are ultimately assigned to primary activities using
activity drivers.
9. Assign costs to products.7After the cost of primary activities is calculated, assign the cost
of these activities to products based on usage of the activity as measured by activity
drivers. Costs assigned to products are calculated as follo!s
Cost assigned to ,roduct = Predetermined activit$ rate / Actual usage o. activit$
9O4O*#N#OUS POO&S O% ACTI7ITI#S
%o reduce the number of predetermined overhead activity rates, activities can be grouped into
homogeneous pools.
A homogeneous cost ,ool is a collection of overhead costs associated !ith each set of
activities. Only one activity driver need be used to assign the pool2s costs, thus the number of
rates re+uired can be reduced.
A ,ool rate is calculated as follo!s
Pool rate = Pool costs:Practical ca,acit$ o. activit$ driver
%o build homogeneous sets of related activities, activities are classified into one of four
general activity categories
Unit'level activities are activities performed each time a unit is produced. For e$ample,
po!er is used each time a unit is produced.
atch'level activities are activities performed each time a batch of products is produced.
%he costs of batch-level activities vary !ith the number of batches but are fi$ed !ith
respect to the number of units in each batch. ($amples include setups, inspections,
production scheduling, and materials handling.
Product'level !sustaining" activities are activities performed as needed to support the prod-
ucts. ($amples include engineering changes and e+uipment maintenance.
%acilit$'level activities are activities that support a factory2s general manufacturing
process. ($amples include plant management and security.
Activity-Based Costing 55
All unit-level activities that have the same cost driver !ould be grouped into homogeneous
cost pools. For e$ample, the unit-level category might have the follo!ing cost pools
labor-related overhead cost pool
machine-related overhead cost pool
material-related overhead cost pool
All batch-level activities that use the same cost driver !ould be grouped into homogeneous
cost pools, and all product-level activities that use the same cost driver !ould be grouped into
homogeneous cost pools.
Unit-level costs vary as the number of units change6 therefore, a unit-level cost driver can be
used.
Batch-level and product-level costs vary in proportion to factors other than changes in the
number of units6 therefore, they are assigned using nonunit-level cost drivers.
Facility-level activities and costs are common to several products, and it is impossible to iden-
tify individual products that consume these activities. A pure ABC system !ould treat facility-
level costs as period costs and !ould not assign them to products. .n practice, facility-level
costs might be allocated to individual products using unit-level, batch-level, or product-level
cost drivers.
Comparison with Functional-Based Costin
.n a functional-based cost system, the demand for overhead is assumed to be e$plained only
by unit-level cost drivers.
ABC produces more accurate product costs by more accurately tracing the consumption of
overhead resources to products.
!ctivity-Based Customer Costin
Activity-based costing can be used to trace costs to specific customers. %he cost of serving
different customers can affect pricing decisions and profitability.
Customer Costing versus Product Costing
Customer costing involves three steps
4. Activities, such as order entry, shipping, and sales calls, are listed in an activity dictionary.
#ifferent levels include order level, customer level, and channel level.
5. Cost of resources used are assigned to activities.
9. Cost of the activities are assigned to customers.
/ee the cost assignment summary belo!
Cost Assignment
Customer Costing
&ist customer activities
(etermine cost o. activities
*rou, into homogeneous
customer'driven cost ,ools
Assign costs to customers
Product Costing
&ist activities
(etermine cost o. activities
*rou, into homogeneous
cost ,ools
Assign costs to ,roducts
5; Chapter &
!ctivity-Based "upplier Costin
Activity-based supplier costing uses activity-based costing to identify the true costs of
suppliers. Activity-based costing traces costs related to purchase, +uality, reliability, and
delivery performance to specific suppliers.
Activity-Based Costing 5<
KEY TERMS TEST
#est your recall of the $ey terms as follows% #ry to recall as many $ey terms as possi&le without
assistance% If you need assistance' refer to the list of $ey terms at the end of this section%
0= Activities that are performed each time a batch is produced are :::::::::-:::::::::
:::::::::::::.
2= A)n* ::::::::::: ::::::::::::: is a list of activities described by specific attributes such
as name, definition, classification as primary or secondary, and activity driver.
6= %he proportion of an overhead activity consumed by a product is the ::::::::::::::
:::::::::.
4= :::::::::: :::::::::: assigns actual costs of direct materials, direct labor, and
overhead to products.
5= :::::::::: :::::::::: assigns actual costs of direct materials and direct labor to
products and uses a predetermined overhead rate to assign overhead costs.
;= A)n* :::::::::::::::::: ::::::::: ::::::::: is a collection of overhead costs associ -
ated !ith activities that have the same level and use the same cost driver to assign costs to
products.
<= A)n* :::::::::::::::::: ::::::::::::: :::::::: is an overhead rate computed using
estimated data.
>= :::::::::::-::::::::: ::::::::::::: :::::::::: are factors, other than the number
of units produced, that measure the demands that cost objects place on activities.
9= Activities performed to enable the production of each different type of product are
::::::::::-:::::::: :::::::::::::.
00= ::::::::::: ::::::::::::: occurs !hen products consume overhead in different
proportions.
00= A cost system that first traces costs to activities and then traces costs from activities to
products is a)n* :::::::::::-::::::::: :::::::::: ::::::::::.
02= :::::::::::::::: ::::::::::::: is overhead assigned to production using
predetermined rates.
06= :::::::::::::::: ::::::::::::: is the amount by !hich applied overhead e$ceeds
actual overhead.
04= :::::::::::::::: ::::::::::::: is the amount by !hich actual overhead e$ceeds
applied overhead.
05= ::::::::::::: ::::::::::::: is the difference bet!een actual overhead and applied
overhead.
0;= Activities that sustain a facility2s general manufacturing process are ::::::::::-::::::::
:::::::::::::.
0<= ::::::::-::::::::: ::::::::::::: ::::::::: are factors that cause changes in cost
as the number of units produced change.
5> Chapter &
0>= ::::::::::::: ::::::::::::: are nonfinancial and financial information items that
describe individual activities.
09= ::::::::::::: ::::::::::::: measure the consumption of activities by products and
other cost objects.
20= ::::::::-::::::::: ::::::::::::: are performed each time a unit is produced.
20= %he :::::::: :::::::: e+uals overhead costs for a homogeneous cost pool divided by
the activity driver for the pool.
22= ::::::::::::::: ::::::::::::: are activities consumed by products or customers.
26= ::::::::::::::: ::::::::::::: are activities consumed by primary activities and;or
other secondary activities.
?#5 T#)4S8
activity attributes
activity-based costing system
activity dictionary
activity drivers
actual costing
applied overhead
batch-level activities
consumption ratio
facility-level activities
homogeneous cost pool
nonunit-level activity drivers
normal costing
overapplied overhead
overhead variance
pool rate
predetermined overhead rate
primary activities
product diversity
product-level activities
secondary activities
underapplied overhead
unit-level activities
unit-level activity drivers
Com,are $our ans-ers -ith those at the end o. the cha,ter= )evie- an$ @e$ terms missed=
Activity-Based Costing 59
CHAPTER QUI Z
(rite your answers in the spaces provided%
0= Complete the follo!ing
%irst stage8
Second stage8
Cost tracing8
Activit$ drivers8
2= %he t!o types of overhead rates used in functional-based costing are
a= ::::::::::::::::::::::::::::::::::::::::::::
3= ::::::::::::::::::::::::::::::::::::::::::::
6= %he overhead rates of functional-based product costing use ::::::::::::-
::::::::: activity drivers.
4= Activity-based cost systems use ::::::::::::-::::::::: cost drivers.
5= 'hen activity-based costing is used, activities are classified into one of four categories
a= ::::::::::::::::::::::::::: activities
3= ::::::::::::::::::::::::::: activities
c= ::::::::::::::::::::::::::: activities
d= ::::::::::::::::::::::::::: activities
;= 'hen activity-based costing is used, the first-stage procedure involves identifying cost pools
and calculating a pool rate for each cost pool. %he pool rate is calculated as follo!s
,ool rate < ::::::::::::::::::::::::: ; ::::::::::::::::::::::::::::::::
<= %he second stage of activity-based costing involves tracing the costs of each overhead cost
pool to products. %he overhead assigned to each product is calculated as follo!s
Applied overhead < :::::::::::::::::: -::::::::::::::::::::::::::::::::::::::::
Activit$'ased Costing %unctional'ased Costing
Costing S$stems
;0 Chapter &
Circle the sinle &est answer%
>= Unit-level costs are assigned using )a* unit-level activity drivers6 )b* nonunit-level activity
drivers
9= Batch-level costs are assigned using )a* unit-level activity drivers6 )b* nonunit-level activity
drivers
00= ,roduct-level costs are assigned using )a* unit-level activity drivers6 )b* nonunit-level activity
drivers
00= A functional-based product costing system uses a t!o-stage procedure of )4* tracing overhead
to activities, and )5* then tracing the costs to products )a* true6 )b* false
02= %he use of unit-level activity drivers, such as direct labor hours or machine hours, can produce
distorted product costs )a* true6 )b* false
06= A product2s consumption of overhead al!ays increases in proportion to increases in produc-
tion volume )a* true6 )b* false
04= 'hen customer costing is used, both manufacturing and nonmanufacturing costs are traced
to customers to produce more accurate cost information for decision ma"ing )a* true6
)b* false
Use the followin information to answer )uestions *+ throuh ,-.
%he follo!ing data is available for the t!o products, =odel ( and =odel >, that ,ac", .nc., manu-
factures
Item Auantit$ Prime Costs 4achine 9ours 4aterial 4oves Setu,s
=odel ( 9?@,@@@ AB@@,@@@ C@,@@@D C@@,@@@ 4E?
=odel > 4@@,@@@ A5?@,@@@ 4?,@@@D &@@,@@@ E?
#ollar value A4,4?@,@@@ A&@@,@@@D A?@@,@@@ AC@@,@@@
D%he cost of maintenance
,ac" currently uses a functional-based costing system that assigns the costs of maintenance,
material handling, and setups to the models based on machine hours, a unit-level driver. )3ound
numbers to t!o decimal places.*
05= %he plant!ide overhead rate is )a* A45.@@6 )b* A4&.CE6 )c* A5@.@@6 )d* A5?.@@
0;= Overhead assigned to =odel ( is )a* A4,?@@,@@@6 )b* A4,5@@,@@@6 )c* AFF@,5@@6
)d* AE5@,@@@
0<= Overhead assigned to =odel > is )a* A9@@,@@@6 )b* A9E?,@@@6 )c* A55@,@?@6 )d* A95@,@@@
0>= %he unit cost of =odel ( is )a* A?.&@6 )b* AC.@@6 )c* A?.?@6 )d* AC.FC
09= %he unit cost of =odel > is )a* A&.?F6 )b* A?.&@6 )c* AC.@@6 )d* A?.?@
20= .f activity-based costing is used, overhead assigned to =odel ( is )a* A4,@9B,F@@6
)b* AB9B,F@@6 )c* AEBB,F@@6 )d* AE9B,F@@
20= .f activity-based costing is used, overhead assigned to =odel > is )a* A9?B,B?@6 )b* A5EB,B?@6
)c* A9F@,@@@6 )d* A&?B,B?@
Activity-Based Costing ;0
22= .f activity-based costing is used, the unit cost of =odel ( is )a* A?.5C6 )b* A?.?&6 )c* A&.946
)d* A&.FC
26= .f activity-based costing is used, the unit cost of =odel > is )a* AC.9@6 )b* A&.5F6 )c* AE.4@6
)d* A&.C@
(rite your answers in the spaces provided%
Use the followin information to answer )uestions ,/ throuh ,0.
Classify each of the follo!ing activities as a
unit-level activity
batch-level activity
product-level activity
facility-level activity
24= /etups7::::::::::::::::::::::::::::::::::::::::::::::::
25= (lectricity7::::::::::::::::::::::::::::::::::::::::::::::
2;= ,lant management7::::::::::::::::::::::::::::::::::::::
2<= (ngineering changes7:::::::::::::::::::::::::::::::::::::
2>= .nspections7::::::::::::::::::::::::::::::::::::::::::::
29= ,lant security7:::::::::::::::::::::::::::::::::::::::::::
Com,are $our ans-ers -ith those at the end o. the cha,ter= )evie- an$ Buestions missed=
PRACTI CE TEST
P)O&#4 0
,aul2s ,lastics uses an activity-based cost system. %he company produces ,roduct G and ,roduct
>. .nformation concerning the t!o products is given belo!
Product C Product D
Units produced................................................. ?@,@@@ E?,@@@
=achine hours.................................................. 55,@@@ 4F,@@@
#irect labor hours............................................. &@,@@@ &@,@@@
=aterial handling )number of moves*............... 4@,@@@ 4?,@@@
(ngineering labor )hours*................................. C,@@@ &,@@@
/etups.............................................................. &@ 5@
=aintenance )hours used*............................... 4,?@@ 4,@@@
Hilo!att hours................................................... 4C,@@@ 4&,@@@
.nspections....................................................... 4F,@@@ 45,@@@
%he follo!ing overhead costs are reported
=aterial handling.............................................. A7E@,@@@
=aintenance..................................................... ?@,@@@
;2 Chapter &
,o!er............................................................... 5&,@@@
(ngineering...................................................... C@,@@@
/etups.............................................................. E?,@@@
0abor-related overhead.................................... C@,@@@
=achine-related overhead............................... 45@,@@@
.nspection......................................................... 4@F,@@@
Activity-Based Costing ;6
P)O&#4 0 1Continued2
Instructions.
0= Using the format belo!, classify the overhead activities as unit-level activities, batch-level
activities, or product-level activities.
Unit'level activities8
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
atch'level activities8
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
Product'level activities8
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
:::::::::::::::::::::::::::::::::::::::::
2= Iroup all overhead costs into homogeneous cost pools. /elect an activity driver for each cost
pool and compute a pool rate.
9omogeneous Cost Pool Activit$ (river Pool )ate
; <
; <
; <
; <
; <
; <
; <
; <
;4 Chapter &
P)O&#4 0 1Continued2
6= Using the pool rates, assign overhead costs to the t!o products and compute the overhead
cost per unit for each. 3ound ans!ers to t!o decimal places.
Product C Product D
Unit'level activities8
atch'level activities8
Product'level activities8
Activity-Based Costing ;5
Overhead cost per unit A A
P)O&#4 2
,each, .nc., has identified the follo!ing overhead costs and cost drivers for ne$t year
#+,ected Actual
Overhead Item #+,ected Cost Cost (river Transactions
/etup costs........................... A7B@,@@@ Jumber of setups.................. &@@
Ordering costs....................... ?@,@@@ Jumber of orders.................. &,@@@
=aintenance costs................ 4?@,@@@ =achine hours....................... 5?,@@@
,o!er.................................... 9@,@@@ Hilo!att hours....................... E?,@@@
%he follo!ing are t!o of the jobs completed during the year
Eo3 <00 Eo3 <00
#irect materials................................. A4,5@@ AC@@
#irect labor....................................... AB@@ A&@@
Units completed................................ 5?@ 4@@
#irect labor hours............................. &@ 5@
Jumber of setups............................. 5 4
Jumber of orders.............................. 4@ &
=achine hours.................................. ?@ &@
Hilo!att hours................................... C@ 5?
%he company2s practical activity is ?,@@@ direct labor hours.
Instructions.
0= #etermine the unit cost for each job using direct labor hours to apply overhead. 3ound
ans!ers to t!o decimal places.
;; Chapter &
P)O&#4 2 1Continued2
2= #etermine the unit cost for each job using the four activity drivers. 3ound ans!ers to t!o
decimal places.
6= 'hich method produces the more accurate cost assignmentK 'hyK
Activity-Based Costing ;<
P)O&#4 6
Lanover =anufacturing has four categories of overhead. %he four categories and e$pected over-
head costs for each category for ne$t year are listed belo!
=aintenance................................... A5@@,@@@
=aterials handling........................... 95,@@@
/etups............................................ 4@@,@@@
.nspection....................................... 45@,@@@
Currently, overhead is applied using a predetermined overhead rate based upon budgeted direct
labor hours. For ne$t year, ?@,@@@ direct labor hours are budgeted.
%he company has been as"ed to submit a bid for a proposed job. %he plant manager thin"s getting
this job !ould result in ne! business in future years. Usually bids are based upon full
manufacturing cost plus 5@ percent.
(stimates for the proposed job )Mob Jo. ,B@5* are as follo!s
#irect materials............................... AC,@@@
#irect labor )4,@@@ hours*............... A4@,@@@
=achine hours................................ ?@@
Jumber of material moves.............. 45
Jumber of setups........................... 5
Jumber of inspections.................... 4@
.n the past, full manufacturing cost has been calculated by allocating overhead using a volume-
based cost driver )direct labor hours*. %he plant manager has heard of a ne! !ay of applying
overhead that uses cost pools and cost drivers.
($pected activity for the four activity-based cost drivers that !ould be used are
=achine hours................................ 5@,@@@
=aterial moves............................... 4,C@@
/etups............................................ 5,?@@
Nuality inspections.......................... &,@@@
Instructions.
0= a= #etermine the amount of overhead that !ould be allocated to the proposed job if a plant-
!ide rate !ith direct labor hours used the unit-level driver.
;> Chapter &
P)O&#4 6 1Continued2
3= #etermine the total cost of the proposed job.
c= #etermine the company2s bid if the bid is based upon full manufacturing cost plus 5@ percent.
2= a= #etermine the amount of overhead that !ould be applied to the proposed project if
activity-based drivers are used.
3= #etermine the total cost of the proposed job if activity-based costing is used.
c= #etermine the company2s bid if activity-based costing is used and the bid is based upon
full manufacturing cost plus 5@ percent.
Activity-Based Costing ;9
P)O&#4 6 1Continued2
6= ,repare a memorandum to the plant manager !ith your recommendation regarding the bid
the company should submit. .nclude the reasons for your recommendation as !ell as any
supporting calculations.
MEMORANDUM
DATE:
TO:
FROM:
SUBJECT:
__________________________________________________________________________
<0 Chapter &
P)O&#4 4
Ortegren, .nc., has t!o producing departments Assembly and Finishing. %he company has been
using a plant!ide predetermined overhead rate based on direct labor cost. %he follo!ing
amounts are for the current year
Assem3l$ %inishing
Actual overhead............................................... A55@,@@@ A54?,@@@
Budgeted overhead.......................................... A5&@,@@@ A4F@,@@@
Budgeted direct labor hours............................. 9@,@@@ 45,@@@
Budgeted machine hours................................. F,@@@ 4@,@@@
Actual activity in direct labor hours................... 94,@@@ 49,@@@
Activity-Based Costing <0
Actual activity in machine hours....................... B,@@@ 44,@@@
Instructions.
0= a= Calculate a plant!ide predetermined overhead rate using direct labor hours.
3= Calculate applied overhead.
c= Calculate the amount of underapplied or overapplied overhead.
2= a= Calculate separate departmental overhead rates using direct labor hours for Assembly
and machine hours for Finishing.
3= Calculate the total amount of applied overhead for each department.
c= Calculate the amount of underapplied or overapplied overhead for each department.
<2 Chapter &
ANSWERS
?#5 T#)4S T#ST
0= batch-level activities
2= activity dictionary
6= consumption ratio
4= Actual costing
5= Jormal costing
;= homogeneous cost pool
<= predetermined overhead rate
>= Jonunit-level activity drivers
9= product-level activities
00= ,roduct diversity
00= activity-based costing system
02= Applied overhead
06= Overapplied overhead
04= Underapplied overhead
05= Overhead variance
0;= facility-level activities
0<= Unit-level activity drivers
0>= Activity attributes
09= Activity drivers
20= Unit-level activities
20= pool rate
22= ,rimary activities
26= /econdary activities
C9APT#) AUID
0= /ee page ?9.
2= a= a plant!ide overhead rate
3= departmental overhead rates
6= unit-level
4= nonunit-level
5= a= unit-level
3= batch-level
c= product-level
d= facility-level
;= Cost pool;Activity driver
<= ,ool rate - Activity driver consumed by product
>= a
9= b
00= b
00= b False Functional-based product costing
uses a t!o-stage procedure )4* costs are
traced to the plant or departments )instead of
activities*, and then )5* costs are traced to
products.
02= a %rue
06= b False A product2s consumption of overhead
does JO% al!ays increase in proportion to
increases in production volume. For e$ample,
setup costs are related to the number of
setups instead of production volume.
04= a %rue
05= c )A&@@,@@@ O A?@@,@@@ O AC@@,@@@*;E?,@@@
machine hours < A5@.@@
0;= b )A5@ - C@,@@@ machine hours* < A4,5@@,@@@
0<= a )A5@ - 4?,@@@ machine hours* < A9@@,@@@
0>= b )AB@@,@@@ O A4,5@@,@@@*;9?@,@@@ units <
AC.@@
09= d )A5?@,@@@ O A9@@,@@@*;4@@,@@@ units < A?.?@
20= a =aintenance A&@@,@@@;E?,@@@ machine
hours < A?.99;machine hour
=aterials handling A?@@,@@@;4,@@@,@@@
moves < A@.?@;move
/etups AC@@,@@@;5?@ setups < A5,&@@;setup
=odel (
A?.99 - C@,@@@ < A 94B,F@@
A@.?@ - C@@,@@@ < A 9@@,@@@
A5,&@@ - 4E? < A &5@,@@@
%otal A4,@9B,F@@
20= d
=odel >
A?.99 - 4?,@@@ < A EB,B?@
A@.?@ - &@@,@@@ < A5@@,@@@
A5,&@@ - E? < A4F@,@@@
%otal A&?B,B?@
22= b )AB@@,@@@ O A4,@9B,F@@*;9?@,@@@ units <
A?.?&
26= c )A5?@,@@@ O A&?B,B?@*;4@@,@@@ units < AE.4@
24= batch-level activity
25= unit-level activity
2;= facility-level activity
2<= product-level activity
2>= batch-level activity
29= facility-level activity
P)ACTIC# T#ST
P)O&#4 0
0= Unit'level activities8 atch'level activities8 Product'level activities8
0abor-related overhead =aterial handling (ngineering
=achine-related overhead /etups =aintenance
,o!er .nspection
2= 9omogeneous Cost Pool Activit$ (river Pool )ate
0abor-related overhead8AC@,@@@ ; #irect labor hours8F@,@@@ < A@.E?
=achine-related overhead8A45@,@@@ ; =achine hours8&@,@@@ < A9.@@
,o!er8A5&,@@@ ; Hilo!att hours89@,@@@ < A@.F@
=aterial handling8AE@,@@@ ; Jumber of moves85?,@@@ < A5.F@
/etups8AE?,@@@ ; Jumber of setups8C@ < A4,5?@.@@
.nspection8A4@F,@@@ ; Jumber of inspections89@,@@@ < A9.C@
(ngineering8AC@,@@@ ; (ngineering labor hours84@,@@@ < AC.@@
=aintenance8A?@,@@@ ; =aintenance hours used85,?@@ < A5@.@@
6= Product C Product D
Unit'level activities8
0abor-related overhead
)A@.E? - &@,@@@*;?@,@@@ units A@.C@
)A@.E? - &@,@@@*;E?,@@@ units A@.&@
=achine-related overhead
)A9.@@ - 55,@@@*;?@,@@@ units A4.95
)A9.@@ - 4F,@@@*;E?,@@@ units A@.E5
,o!er
)A@.F@ - 4C,@@@*;?@,@@@ units A@.5C
)A@.F@ - 4&,@@@*;E?,@@@ units A@.4?
atch'level activities8
=aterial handling
)A5.F@ - 4@,@@@*;?@,@@@ units A@.?C
)A5.F@ - 4?,@@@*;E?,@@@ units A@.?C
/etups
)A4,5?@ - &@*;?@,@@@ units A4.@@
)A4,5?@ - 5@*;E?,@@@ units A@.99
.nspections
)A9.C@ - 4F,@@@*;?@,@@@ units A4.9@
)A9.C@ - 45,@@@*;E?,@@@ units A@.?F
Product'level activities8
(ngineering
)AC.@@ - C,@@@*;?@,@@@ units A@.E5
)AC.@@ - &,@@@*;E?,@@@ units A@.95
=aintenance
)A5@.@@ - 4,?@@*;?@,@@@ units A@.C@
)A5@.@@ - 4,@@@*;E?,@@@ units A@.5E
Overhead cost per unit AC.9C A9.99
P)O&#4 2
0= %otal overhead costs < AB@,@@@ O A?@,@@@ O A4?@,@@@ O A9@,@@@
< A95@,@@@
,lant!ide overhead rate < A95@,@@@;?,@@@
< AC& per direct labor hour
Eo3 <00 Eo3 <00
#irect materials............................................ A4,5@@ A C@@
#irect labor.................................................. B@@ &@@
Overhead assigned
)AC& - &@ direct labor hours*.................. 5,?C@
)AC& - 5@ direct labor hours*.................. 4,5F@
%otal cost...................................................... A&,CC@ A5,5F@
Cost per unit
)A&,CC@;5?@ units*................................... A4F.C&
)A5,5F@;4@@ units*................................... A55.F@
2= Activity-based overhead rates
/etup costs AB@,@@@;&@@ setups < A55? per setup
Ordering costs A?@,@@@;&,@@@ orders < A45.?@ per order
=aintenance costs A4?@,@@@;5?,@@@ machine hours < AC per machine hour
,o!er A9@,@@@;E?,@@@ "ilo!att hours < A@.&@ per "ilo!att hour
Eo3 <00 Eo3 <00
#irect materials............................................ A4,5@@ A C@@
#irect labor.................................................. B@@ &@@
Overhead applied
)A55? - 5 setups*.................................... &?@
)A45.?@ - 4@ orders*............................... 45?
)AC.@@ - ?@ machine hours*................... 9@@
)A@.&@ - C@ "ilo!att hours*..................... 5&
)A55? - 4 setup*...................................... 55?
)A45.?@ - & orders*................................. ?@
)AC.@@ - &@ machine hours*................... 5&@
)A@.&@ - 5? "ilo!att hours*..................... 4@
%otal cost...................................................... A5,BBB A4,?5?
Cost per unit
)A5,BBB;5?@ units*................................... A45.@@
)A4,?5?;4@@ units*................................... A4?.5?
6= Activity-based costing produces the more accurate cost assignment because it uses multiple drivers that are
related to overhead consumption. A product or job2s consumption of overhead does not al!ays increase in
proportion to a single volume-based cost driver, such as direct labor hours.
/etup costs are related to the number of setups, ordering costs are related to the number of orders,
maintenance costs are related to the number of machine hours, and po!er costs are related to the number of
"ilo!att hours.
P)O&#4 6
0= a= %otal overhead < A5@@,@@@ O A95,@@@ O A4@@,@@@ O A45@,@@@
< A&?5,@@@
Overhead rate < A&?5,@@@;?@,@@@ direct labor hours
< AB.@& per direct labor hour
Overhead assigned to proposed job< AB.@& - 4,@@@ direct labor hours
< AB,@&@
3= %otal cost of proposed job
#irect materials............................................ A C,@@@
#irect labor.................................................. 4@,@@@
Overhead applied......................................... B,@&@
Activity-Based Costing <5
%otal cost...................................................... A5?,@&@
c= Company2s bid < Full manufacturing cost - 45@P
< A5?,@&@ - 45@P
< A9@,@&F
2= a= =aintenance A5@@,@@@;5@,@@@ machine hours < A4@ per machine hour
=aterials handling A95,@@@;4,C@@ material moves < A5@ per move
/etups A4@@,@@@;5,?@@ setups < A&@ per setup
.nspection A45@,@@@;&,@@@ inspections < A9@ per inspection
Overhead assigned to proposed job
=aintenance )A4@ - ?@@*............................ A?,@@@
=aterials handling )A5@ - 45*..................... 5&@
/etups )A&@ - 5*......................................... F@
.nspections )A9@ - 4@*................................ 9@@
%otal overhead assigned to job.................... A?,C5@
3= %otal cost of proposed project
#irect materials............................................ A C,@@@
#irect labor.................................................. 4@,@@@
Overhead applied......................................... ?,C5@
%otal cost...................................................... A54,C5@
c= Company2s bid < Full manufacturing cost - 45@P
< A54,C5@ - 45@P
< A5?,B&&
6= Qour memorandum should contain the follo!ing
)a* A brief introductory sentence to inform the reader of the purpose of the memorandum.
($ample %his memorandum regards the recommended bid price for proposed Mob Jo. ,B@5.
)b* A concise and specific recommendation.
($ample . recommend that Lanover =anufacturing submit a bid of A5?,B&& for Mob Jo. ,B@5.
)c* A discussion of the reasons !hy your recommendation should be follo!ed.
($ample %his bid price !as developed using activity-based costing )ABC* because ABC produces more accu-
rate product costs and more competitive bids.
)d* /upporting calculations included in the body of the memorandum or attached on a separate page.
($ample %he bid price of A5?,B&& !as determined as follo!s
#irect materials............................................ A C,@@@
#irect labor.................................................. 4@,@@@
Overhead assigned
=aintenance )A4@ - ?@@*....................... A?,@@@
=aterials handling )A5@ - 45*................ 5&@
/etups )A&@ - 5*.................................... F@
.nspections )A9@ - 4@*........................... 9@@
%otal overhead assigned to job............... ?,C5@
%otal cost...................................................... A54,C5@
=ar"up......................................................... - 45@ P
Bid price....................................................... A5?,B&&
)e* A closing sentence.
($ample .f you have any +uestions, please contact me at ($tension EC.
P)O&#4 4
0= a= ,lant!ide rate < Budgeted plant overhead;Budgeted direct labor hours
< )A5&@,@@@ O A4F@,@@@*;)9@,@@@ O 45,@@@*
< A4@ per direct labor hour
3= Applied overhead < ,lant!ide overhead rate - Actual activity
< A4@ - )94,@@@ O 49,@@@*
< A&&@,@@@
c= Overhead
Actual overhead Applied overhead
A55@,@@@ A&&@,@@@
54?,@@@
A ?,@@@ overapplied
2= a= Assembly departmental rate< A5&@,@@@;9@,@@@ direct labor hours
< AF.@@ per direct labor hour
Finished departmental rate< A4F@,@@@;4@,@@@ machine hours
< A4F.@@ per machine hour
3= Applied overhead Assembly < AF.@@ - 94,@@@ direct labor hours
< A5&F,@@@
Applied overhead Finishing < A4F.@@ - 44,@@@ machine hours
< A4BF,@@@
c= Overhead8 Assem3l$ Overhead8 %inishing
Actual overhead Applied overhead Actual overhead Applied overhead
A55@,@@@ A5&F,@@@ A54?,@@@ A4BF,@@@
A 5F,@@@ overapplied A 4E,@@@ underapplied