Managerial Accounting

Wild and Shaw

2010 Edition
McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All

Chapter 4
Activity-Based Costing and
Analysis

Conceptual Learning Objectives

C1: Distinguish between the plantwide
overhead rate method, the departmental
overhead rate method, and activity-based
costing method.
C2: Explain cost flows for the plant wide
overhead rate method.
C3: Explain cost flows for the departmental
overhead rate method.
C4: Explain cost flows for activity-based
costing.
4-3

Analytical Learning Objectives

A1: Identify and assess advantages and
disadvantages of the plantwide overhead
rate method.
A2: Identify and assess advantages and
disadvantages of the departmental
overhead rate method.
A3: Identify and assess advantages and
disadvantages of activity-based costing.

4-4

Procedural Learning Objectives

P1: Allocate overhead costs to products
using the plantwide overhead rate
method.
P2: Allocate overhead costs to products
using departmental overhead rate
method.
P3: Allocate overhead costs to products
using activity-based costing.
4-5

C1

Assigning Overhead Costs

Indirect

Materials

Direct

Indirect

Factory Allocate
Overhead

Labor

Direct

Goods in
Process

Finished
Goods

Cost of
Goods
Sold
4-6

C1

Assigning Overhead Costs

Overhead can be assigned to production in
one of three ways:

Single plantwide rate

Departmental
overhead
rates

Activity-based
costing

4-7

C2

Plant Wide Overhead Rate Method

Indirect
Costs

Overhead Cost

Cost
Allocation
Base

Single Plant-Wide
Overhead Rate

Cost
Objects

Product 1 Product 2

Product 3

4-8

P1

Plant Wide Overhead Rate Method

Illustration

4-9

P1

Plant Wide Overhead Rate

Method Illustration

Plantwide
Total budgeted overhead costs
overhead =
Total budgeted DLH
rate

4-10

P1

Plant Wide Overhead Rate

Method Illustration

Plantwide
overhead =
rate
=

$4,800,000
100,000 DLH
$48/DLH

4-11

P1

Plant Wide Overhead Rate

Method Illustration

4-12

P1

Plant Wide Overhead Rate Method

Advantages and Disadvantages
Advantages
Information is
readily available
Easy to implement
Often sufficient to
meet external
financial reporting
needs

Disadvantages
Overhead costs
may not bear any
relationship with
direct labor hours
All products may
not use overhead
costs in the same
proportion
4-13

C3

Departmental Overhead Rate

Method
Overhead Cost

First
Stage

Second
Stage

Department
A
Department A
Overhead Rate
Product 1

Department
B
Department B
Overhead Rate

Product 2

Product 3

Indirect
Costs

Cost
Objects
Allocation
Base
Cost
Objects
4-14

P2

Departmental Overhead Rate

Method: First Stage
Overhead Cost
$4,800,000
First
Stage

Machining Dept.
$4,200,000

Assembly Dept.
$600,000

4-15

P2

Departmental Overhead Rate

Method: Second Stage

Second
Stage

Department A
Overhead Rate

Product 1

Product 2

Department B
Overhead Rate
Product 3

4-16

P2

Departmental Overhead Rate

Method: Second Stage

4-17

P2

Departmental Overhead Rate

Method: Second Stage

Departmental
Overhead =
Rate

Total departmental overhead costs

Total unit number in departmental
allocation base

4-18

P2

Departmental Overhead Rate

Method: Second Stage

Machining
Department =
Overhead
Rate
Assembly
Department =
Overhead
Rate

$4,200,000

= $60/MH

70,000 MH

$600,000
30,000 DLH

$20/DLH

4-19

P2

Departmental Overhead Rate

Method: Second Stage

4-20

A2

Advantages and Disadvantages of

Departmental Overhead Rate Method
Advantages

Disadvantages

More accurate overhead

allocations

Can distort product

costs

More refined than the

plantwide overhead rate
method

Assumes that products

are similar in volume,
complexity, batch size
Assumes that
departmental overhead
costs are proportional to
the allocation base
4-21

C4

Cost Flows Under Activity-Based

Costing Method
Overhead Cost

First
Stage

Second
Stage

Indirect Costs

Activity
Cost
Pool X

Activity
Cost
Pool Y

Activity Overhead
rate

Activity Overhead
rate

Activity Overhead
rate

Product 2

Product 3

Product 1

Activity
Cost
Pool Z

Cost Objects

Cost Allocation
Base
Cost Objects
4-22

P3

Applying Activity-Based
Costing
4 steps:
1.
Identify activities and the costs they cause.
2.
Group similar activities into activity pools.
3.
Determine an activity rate for each activity
cost pool.
4.
Allocate overhead costs to products using
those activity rates.

4-23

P3

Levels of types of activities

Unit level
Batch level
Product level
Facility level
4-24

P3

Levels of activities
Unit level
Unit level activities are performed
on each product unit; for
example, providing electricity to
power machinery in the
machining department is needed
to produce each unit of product.
4-25

P3

Levels of Activities
Batch level
Batch level activities are performed
only on each batch or group of
units.

4-26

P3

Levels of Activities
Product level
Product level activities are
performed on each product line
and are not affected by either
numbers of units or batches.

4-27

P3

Facility Level Activities

Facility level
Facility level activities are
performed to sustain facility
capacity as a whole and are not
caused by any specific product.

4-28

P3

Step Two: Trace Overhead

Costs to Cost Pools
Overhead Cost

Activity
Cost
Pool X

Activity
Cost
Pool Y

Activity
Cost
Pool Z

4-29

P3

Step Two: Trace Overhead Costs

to Cost Pools

4-30

P3

Step Two: Assigning Overhead to

Activity Cost Pools

4-31

P3

Step Three: Determine

Activity Rate
Activity
Cost
Pool X

Activity
Cost
Pool Y

Activity Overhead
rate

Activity Overhead
rate

Activity
Cost
Pool Z

Activity Overhead
rate

Step 3 is to compute the activity rates

used to assign overhead costs to final
cost objects such as products.
4-32

P3

Step Three: Determine

Activity Rate
Proper determination of activity
rates depends on:
Proper
identification
of the factor
that drives
the cost

and

Proper
measures of
activities

4-33

P3

Step Three: Determine

Activity Rate
Activity
rate

Total cost in activity pool

Measure of the activity

For example:
Set-up cost pool activity rate = $2,000,000 / 200 batches
= $10,000 per batch
Craftsmanship cost pool activity rate = $600,000/30,000 DLH
= $20 per DLH

4-34

P3

Step Three: Determine

Activity Rate

4-35

P3

Step Four: Assign Overhead

Costs to Cost Objects
Activity Overhead
rate

Product 1

Activity Overhead
rate

Activity Overhead
rate

Product 2

Product 3

Step 4 is to assign overhead costs in

each activity cost pool to final cost
objects using activity rates.

4-36

P3

Step Four: Assign Overhead

Costs to Cost Objects

To illustrate, the overhead costs in

the craftsmanship pool are
allocated to standard go-karts as
follows:

Overhead allocated to standard go-kart =

Activities consumed X Activity rate =
25,000 DLH x $20 / DLH = $500,000
4-37

P3

Step Four: Assign Overhead

Costs to Cost Objects

4-38

P3

Step Four: Assign Overhead

Costs to Cost Objects

4-39

C1

Comparison of Overhead
Allocations by Method

4-40

A3

Advantages and Disadvantages of

Activity-Based Costing
Advantages:

Disadvantages:

More accurate
overhead cost allocation

Costs to implement and

maintain

More effective overhead

cost control

Uncertainty with
decisions still remains

Focus on relevant
factors
Better management of
activities
4-41

End of Chapter 4

4-42