Activity-Based Costing
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
1, 2
Exercises
*1.
1, 2, 3, 4,
5, 6, 12,
13
*2.
*3.
*4.
6, 10, 11,
12
*5.
13, 14, 15
*6.
Differentiate between
value-added and nonvalue-added activities.
8, 16, 17
8, 9
*7.
19
10, 11, 12
17, 18
*8.
Apply activity-based
costing to service
industries.
18
9, 10
16
*9.
Explain just-in-time
(JIT) processing.
20
A
Problems
B
Problems
1A, 3A,
4A, 5A
1B, 3B,
4B, 5B
1A, 5A
1B, 5B
5A
5B
7, 8
3, 4, 5, 6,
7, 12
1, 3, 4, 5,
6, 8, 9, 10,
11, 12, 13
11
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix
to the chapter.
4-1
Description
Difficulty
Level
Time
Allotted (min.)
1A
Moderate
3545
2A
Moderate
2535
3A
Moderate
3545
4A
Moderate
4050
5A
Moderate
3545
1B
Moderate
3545
2B
Moderate
2535
3B
Moderate
3545
4B
Moderate
4050
5B
Moderate
3545
4-2
4-3
E4-11
Q4-13
Q4-14
Q4-15
Q4-8
Q4-16
Q4-17
Q4-19
Q4-18
Q4-20
BE4-3
BE4-4
BE4-5
BE4-6
BE4-7
BE4-12
E4-1
E4-13
P4-1A
P4-2A
P4-3A
P4-4A
P4-5A
P4-1B
P4-5A
P4-1B
P4-4B
P4-5B
E4-13 E4-16
E4-14 P4-1A
E4-15 P4-1B
E4-4
E4-5
E4-8
E4-9
E4-10
E4-11
E4-12
E4-5
E4-6
E4-12
E4-13
P4-1A
P4-4A
Application
BE4-9 P4-5A
BE4-10 P4-5B
BE4-10
BE4-11
BE4-12
BE4-8
BE4-9
E4-12
E4-7
E4-8
Q4-7
BE4-1
BE4-2
E4-1
E4-2
E4-3
E4-4
Q4-1
Q4-2
Q4-3
Q4-4
Q4-5
Knowledge Comprehension
Study Objective
P4-2B
P4-3B
P4-4B
P4-5B
E4-15
P4-5A
P4-5B
E4-10
E4-11
E4-12
E4-13
P4-3A
P4-3B
P4-3A
P4-4A
P4-5A
P4-3B
P4-4B
P4-5B
P4-5A
P4-5B
E4-11
P4-1A
P4-2A
P4-3A
P4-4A
P4-1B
P4-2B
P4-3B
P4-4B
Synthesis
P4-5A
P4-5B
P4-2A
P4-3A
P4-4A
P4-2B
P4-3B
P4-4B
Evaluation
E4-16 P4-5B
P4-5A
BE4-10
E4-17
E4-18
BE4-8
BE4-9
E4-14
E4-1
E4-3
E4-4
E4-5
E4-6
E4-8
E4-9
E4-1
E4-2
E4-3
E4-4
E4-5
E4-6
Analysis
Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems
STUDY OBJECTIVES
1. RECOGNIZE THE DIFFERENCE BETWEEN TRADITIONAL
COSTING AND ACTIVITY-BASED COSTING.
2. IDENTIFY THE STEPS IN THE DEVELOPMENT OF AN
ACTIVITY-BASED COSTING SYSTEM.
3. KNOW HOW COMPANIES IDENTIFY THE ACTIVITY
COST POOLS USED IN ACTIVITY-BASED COSTING.
4. KNOW HOW COMPANIES IDENTIFY AND USE COST
DRIVERS IN ACTIVITY-BASED COSTING.
5. UNDERSTAND THE BENEFITS AND LIMITATIONS OF
ACTIVITY-BASED COSTING.
6. DIFFERENTIATE BETWEEN VALUE-ADDED AND NONVALUE-ADDED ACTIVITIES.
7. UNDERSTAND THE VALUE OF USING ACTIVITY
LEVELS IN ACTIVITY-BASED COSTING.
8. APPLY ACTIVITY-BASED COSTING TO SERVICE
INDUSTRIES.
*9. EXPLAIN JUST-IN-TIME (JIT) PROCESSING.
4-4
CHAPTER REVIEW
Traditional Costing And Activity-Based Costing
1.
(S.O. 1) Often the most difficult part of computing accurate unit costs is determining the proper
amount of overhead cost to assign each product, service or job. For job order costing we
assumed the direct labor cost was the relevant activity base for assigning overhead costs to a job
and for process costing we assumed that machine hours was the relevant activity base.
2.
Activity-based costing (ABC) allocates overhead to multiple activity cost pools and assigns the
activity cost pools to products and services by means of cost drivers. In ABC, an activity is any
event, action, transaction, or work sequence that causes the incurrence of cost in producing a
product or providing a service. A cost driver is any factor or activity that has a direct cause-effect
relationship with the resources consumed.
3.
ABC allocates overhead in a two-stage process: In the first stage, overhead costs are allocated to
activity cost pools, rather than to departments. Each is a distinct type of activity. In the second
stage, the overhead allocated to the activity cost pools is assigned to products using cost drivers
which represent and measure the number of individual activities undertaken or performed to
produce products or provide services.
4.
(S.O. 3) A well designed activity-based costing system starts with an analysis of the activities
performed to manufacture a product or provide a service. This analysis should identify all
resource-consuming activities. It requires a detailed, step-by-step walk through of each operation,
documenting every activity undertaken to accomplish a task.
6.
(S.O. 4) After costs are allocated to the activity cost pools, the cost drivers for each cost pool
must be identified. The cost driver must accurately measure the actual consumption of the activity
by the various products. To achieve accurate costing, a high degree of correlation must exist
between the cost driver and the actual consumption of the overhead costs in the cost pool.
7.
An activity-based overhead rate per cost driver is computed by dividing the total estimated
overhead per activity by the number of cost drivers expected to be used per activity. The formula
for this computation is as follows:
Estimated Overhead Per Activity
Expected Use of Cost Driver Per Activity
4-5
Activity Based
Overhead Rate
8.
In assigning overhead costs, it is necessary to know the expected use of cost drivers for each
product. To assign overhead costs to each product, the activity-based overhead rates are
multiplied by the number of cost drivers expected to be used per product.
Benefits of ABC
9.
(S.O. 5) The primary benefit of ABC is more accurate product costing because:
a. ABC leads to more cost pools.
b. ABC leads to enhanced control over overhead costs.
c. ABC leads to better management decisions.
Limits of ABC
10.
Although ABC systems often provide better product cost data than traditional volume-based
systems, there are the following limitations:
a. ABC can be expensive.
b. Some arbitrary allocations continue.
The presence of one or more of the following factors would point to possibly using ABC:
a. Product lines differ greatly in volume and manufacturing complexity.
b. Product lines are numerous, diverse, and require differing degrees of support services.
c. Overhead costs constitute a significant portion of total costs.
d. The manufacturing process or the number of products has changed significantly.
e. Production or marketing managers are ignoring data provided by the existing system and are
instead using bootleg costing data or other alternative data when pricing or making other
product decisions.
13.
The purpose of ABM is to reduce or eliminate the time and cost devoted to non-value-added
activities.
4-6
4-7
LECTURE OUTLINE
A.
B.
a.
b.
Activity-Based Costing.
1. Activity-based costing (ABC) allocates overhead to multiple activity cost
pools, and it then assigns the activity cost pools to products and
services by means of cost drivers.
2. In ABC, an activity is any event, action, transaction, or work sequence
that incurs cost when producing a product or providing a service.
3. ABC allocates overhead in a two-stage process. The first stage allocates
overhead costs to activity cost pools. The second stage assigns the
overhead allocated to the activity cost pools to products, using cost
drivers.
4. Cost drivers measure the number of individual activities undertaken or
performed to produce products or provide services.
4-8
TEACHING TIP
ILLUSTRATION 4-1 provides examples of activities and related cost drivers that
measure each activitys contribution to the finished product.
C.
b.
Identify the cost driver that has a strong correlation to the costs
accumulated in the cost pool.
c.
d.
TEACHING TIP
D.
TEACHING TIP
ILLUSTRATION 4-3 provides formulas for the activity-based overhead rate, the
overhead costs assigned to products, and the overhead cost per unit.
Also available as teaching transparency.
4. In assigning overhead costs, it is necessary to know the expected use of
cost drivers for each product.
5. The company multiplies activity-based overhead rates per cost driver by
the number of cost drivers expected to be used per product to assign
overhead costs to each product.
6. Under ABC, overhead costs are usually shifted from a high-volume
product to a low-volume product. This shift results in more accurate
costing because:
a.
Low-volume products often require more special handling, (i.e.more machine setups and inspections), than high-volume products.
b.
Assigning overhead using ABC will usually increase the cost per
unit for low-volume products (and decrease the cost per unit for
high-volume products).
4-10
E.
Benefits of ABC.
1. The primary benefit of ABC is more accurate product costing because
a.
ABC leads to more cost pools being used to assign overhead costs
to products.
b.
c.
TEACHING TIP
b.
b.
Product lines are numerous and diverse, and they require differing
degrees of support services.
c.
F.
d.
e.
TEACHING TIP
ILLUSTRATION 4-5 provides examples of activities that are classified as valueadded and non-value-added. Point out that not all non-value-added activities are
totally wasteful or easily eliminated.
Also available as teaching transparency.
5. Companies often use activity flowcharts to help identify the ABC activities.
4-12
6. Not all non-value-added activities are totally wasteful, nor can they be
totally eliminated, but managers are motivated to minimize them as
much as possible.
G.
b.
c.
d.
TEACHING TIP
ILLUSTRATION 4-7 provides the types of activities and examples of cost drivers
for each of the four different levels of ABC activities.
Also available as teaching transparency.
2. Companies may achieve greater accuracy in overhead cost allocation by
recognizing the different levels of activities and developing specific
activity cost pools and their related cost drivers.
3. Nonrecognition of this classification of activities is one of the reasons
that volume-based cost allocation causes distortions in product costing.
4. The resources consumed by batch-, product-, and facility-level supporting
activities do not vary at the unit level, nor can managers control them at
the unit level.
4-13
H.
*I.
Just-in-Time Processing.
1. Traditionally, continuous process manufacturing has been based on a
just-in-case philosophy: inventories of raw materials are maintained just
in case some items are of poor quality or a key supplier is shut down by
a strike. This philosophy results in a push approach, in which raw
materials are pushed through each process and often results in the
buildup of extensive manufacturing inventories.
2. Many U.S. firms have switched to just-in-time (JIT) processing. Under
JIT processing, companies receive raw materials just in time for use in
production, they complete subassembly parts just in time for use in
finished goods, and they complete finished goods just in time to be sold.
3. JIT strives to eliminate inventories by using a pull approach in manufacturing.
This approach begins with the customer placing an order with the
company which starts the process of pulling the product through the
manufacturing process.
4-14
b.
c.
The company must establish total quality control throughout the manufacturing operations, which tolerates no defects. Continuous monitoring
by both employees and supervisors at each work station is required.
TEACHING TIP
ILLUSTRATION 4-6 presents the elements in JIT processing. Point out that JITs
primary objective is to eliminate all manufacturing inventories.
5. The major benefits of JIT processing include:
a.
b.
c.
d.
4-15
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. In todays automated environment, direct labor is sometimes the appropriate basis for
assigning overhead cost to products.
True
False
2. In the first stage of activity-based costing, overhead is assigned to products using cost
drivers.
True
False
3. The first step in activity-based costing is to identify and classify the major activities
involved in the manufacture of specific products, and allocate manufacturing overhead to
the appropriate cost pools.
True
False
4. Before costs are allocated to the cost pools, the cost drivers for each cost pool must be
identified.
True
False
5. Under ABC, overhead costs are shifted from the high-volume product to the low-volume
product.
True
False
6. Activity-based costing does not change the amount of overhead costs, but it does
allocate those costs in a more accurate manner.
True
False
7. Overhead costs are not allocated by means of arbitrary volume-based cost drivers under
ABC.
True
False
False
False
False
4-16
Multiple Choice
1.
2.
3.
4.
The level of ABC activities performed in support of an entire product line are classified as
a. batch-level activities.
b. facility-level activities.
c. product-level activities.
d. unit-level activities.
*5.
4-17
ANSWERS TO QUIZ
True/False
1.
2.
3.
4.
5.
True
False
True
False
True
6.
7.
8.
9.
*10.
True
False
True
False
True
Multiple Choice
1.
2.
3.
4.
*5.
d.
c.
a.
c.
b.
4-18
ILLUSTRATION 4-1
ACTIVITIES AND COST DRIVERS
Activities
Assembling
Inspecting
Machining
Ordering
Setting up machines
Storing
Supervising
Cost Drivers
Number of parts
Number of inspections
Machine hours
Number of purchase orders
Number of setups
Amount of square footage
Number of employees
4-19
ILLUSTRATION 4-2
STEPS IN ACTIVITY-BASED COSTING SYSTEM
4-20
Activity-Based
Overhead Rate
Overhead Cost
Assigned
Overhead Cost
Per Unit
4-21
Total Overhead
Cost Assigned
Activity-Based
Overhead Rate
Total Units
Produced
ILLUSTRATION 4-3
COMPUTING ACTIVITY-BASED OVERHEAD RATE
ILLUSTRATION 4-4
BENEFITS OF ABC
Benefits:
1. ABC leads to more cost pools being
used to assign overhead costs.
2. ABC leads to enhanced control over
overhead costs.
3. ABC leads to better management
decisions.
4-22
ILLUSTRATION 4-5
VALUE-ADDED AND NON-VALUE-ADDED ACTIVITIES
ACTIVITIES
Value-added
Assembly
Engineering design
Machining
Packaging
Painting
Non-value-added
Building maintenance
Inspections
Moving of materials
Repair of machines
Storage of inventory
4-23
ILLUSTRATION 4-6
CLASSIFICATION OF ACTIVITY LEVELS
Four Levels
Unit-Level Activities
Batch-Level Activities
Types of Activities
Machine-related:
Drilling, cutting,
milling, trimming,
pressing
Machine hours
Labor-related:
Assembling, painting,
sanding, sewing
Equipment setups
Purchase ordering
Inspection
Material handling
Product-Level Activities Product design
Engineering changes
Facility-Level Activities
Number of employees
managed
Square footage
Square footage
Square footage
Plant management
salaries
Plant depreciation
Property taxes
Utilities
4-24
ILLUSTRATION 4-7
ELEMENTS OF JIT PROCESSING
Elements:
1. Suppliers must be willing to deliver
on short notice exact quantities of
materials according to precise quality
specifications.
2. A multiskilled work force to operate
and maintain different types of machines.
3. The company must establish total
quality control throughout the
manufacturing process.
4-25