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Activity-Based Costing
Chapter 9

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

LO
9-1

Product Costs and Decision


Making
LO 9-1 Understand the potential effects of using externally
reported product costs for decision making.
C-27s
10
2,000

C-20s
30
3,000

Total
40
5,000

Units produced
Direct labor-hours
Costs:
Direct materials
Direct labor
Manufacturing overhead
(@ 120%)
Total

$ 40,000
72,000

$ 36,000
78,000

$ 76,000
150,000

86,400
$198,400

93,600
$207,600

180,000
$406,000

Cost per unit

$ 19,840

6,920

Grange is considering dropping C-27s.


9-3

LO
9-1

Product Costs and Decision


Making
The accountant estimated that overhead
will be $163,800.
Original
Manufacturing overhead:
Utilities
Supplies
Training
Supervision
Machine depreciation
Plant depreciation
Miscellaneous
Total overhead

2,400
2,500
30,000
54,900
29,550
40,050
20,600
$180,000

C-20s only
$

1,800
1,300
15,600
54,900
29,550
40,050
20,600
$163,800

9-4

LO
9-1

Product Costs and Decision


Making
Direct materials
Direct labor
Manufacturing overhead
Total costs

Original

C-20s only

$ 76,000
150,000
180,000
$406,000

$ 36,000
78,000
163,800
$277,800

The cost per unit for the C-20s will


increase from $6,920 to $9,260.

9-5

LO
9-2

Two-Stage Cost Allocation


Cost
pool

Overhead

Intermediate
cost pools

Department A

Department B

Cost
allocation rule

Direct labor
hours

Machine
hours

9-6

LO
9-2

Two-Stage Cost Allocation


Third Quarter Production and Cost Data
J25P

J40X

Total

Number of units
Machine hours Assembly

100,000
6,000

40,000
30,000

140,000
36,000

Direct materials
Direct labor Assembly
Direct labor Packaging
Total direct labor
Total direct cost
Overhead costs:
Assembly
Packaging
Total overhead
Total costs

$1,500,000
$ 750,000
990,000
$1,740,000
$3,240,000

$2,400,000
$ 600,000
360,000
$ 960,000
$3,360,000

$3,900,000
$1,350,000
1,350,000
$2,700,000
$6,600,000
$1,620,000
810,000
$2,430,000
$9,030,000

The cost system allocates manufacturing overhead


to products based on direct labor costs.
9-7

LO
9-2

Two-Stage Cost Allocation


Third Quarter Unit Cost Report One allocation rate
J25P

J40X

Units produced

100,000

40,000

Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct cost
Applied overhead
(@ 90% of direct labor costs)

$ 15.00

$ 60.00

7.50
9.90
$ 17.40
$ 32.40

$ 15.00
9.00
$ 24.00
$ 84.00

15.66
$ 48.06

21.60
$105.60

9-8

LO
9-2

Two-Stage Cost Allocation


Third Quarter Unit Cost Report Two Stage Allocation
J25P

J40X

Units produced

100,000

40,000

Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct cost
Applied overhead:
Assembly @ $45/machine hour
Packaging @ 60% of direct labor cost
Total overhead
Unit costs

$ 15.00

$ 60.00

7.50
9.90
$ 17.40
$ 32.40

$ 15.00
9.00
$ 24.00
$ 84.00

$ 33.75
5.40
$ 39.15
$123.15

2.70
5.94
$ 8.64
$ 41.04

9-9

LO
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
9-10

LO
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.

9-11

LO
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
Lubricating oil
Machine repair

Direct labor cost


Machine-hours
Number of units

Batch related

Setup costs
Material handling
Shipping costs

Setup hours
Production runs
Number of shipments

Product related

Compliance costs
Design and
specification costs

Number of products

Facility related

General plant costs


Plant admin. costs

Direct costs
Value added
9-12

LO
9-5

Activity-Based Costing
Illustrated

LO 9-5 Compute product costs using activity-based costing.


Third Quarter Production and Cost Data
J25P

J40X

Total

Number of units
Machine hours Assembly

100,000
6,000

40,000
30,000

140,000
36,000

Direct materials
Direct labor Assembly
Direct labor Packaging
Total direct labor
Total direct cost
Overhead costs:
Assembly
Packaging
Total overhead
Total costs

$1,500,000
$ 750,000
990,000
$1,740,000
$3,240,000

$2,400,000
$ 600,000
360,000
$ 960,000
$3,360,000

$3,900,000
$1,350,000
1,350,000
$2,700,000
$6,600,000
$1,620,000
810,000
$2,430,000
$9,030,000
9-13

LO
9-5

Activity-Based Costing Illustrated


Step 2: Identify the Cost Drivers
Cost Driver Volume
Activity
Assembly building:
Assembling
Setting up machines
Handling material
Packaging building:
Inspecting and packing
Shipping

Cost Driver
Machine-hours
Setup hours
Production runs

J25P

J40X

Total

6,000 30,000 36,000


40
400
440
8
40
48

Direct labor hours 60,000 22,800 82,800


No. of shipments
100
200
300

9-14

LO
9-5

Activity-Based Costing Illustrated


Step 3: Compute the Cost Driver Rates
Building and Activity

Assembly building:
Assembling
Setting up machines
Handling material
Total assembly overhead
Packaging building:
Inspecting and packing
Shipping
Total packaging overhead
Total overhead

Overhead
Cost

Cost Driver
Volume

Cost Driver
Rate

$1,080,000 36,000 machine hour =


396,000 440 hours
=
144,000
48 runs
=
$1,620,000

$ 30/machine hour
$ 900/setup hour
$3,000/run

$ 414,000 82,800 direct labor hr =


396,000 300 shipments
=
$ 810,000

$ 5/direct labor hour


$ 1,320/shipment

$2,430,000

9-15

LO
9-5

Activity-Based Costing Illustrated


Step 4: Assign Costs Using ABC
Overhead

J25P

J40X

Assembly building:
Assembling @ $30/machine hour
Machine setup @ $900/setup hour
Handling material @ $3,000/run

$180,000
36,000
24,000

$ 900,000
360,000
120,000

Packaging building:
Inspection and packaging @ $5/direct labor hour
Shipping @ $1,320/ shipment
Total ABC overhead

300,000
132,000
$672,000

114,000
264,000
$1,758,000

9-16

LO
9-5

Cost Flow Diagram ABC


System
Direct
costs

Manufacturing
overhead

Directly
assigned

Assembly building

Assembling
Machine
hours

Setup
Setup
hours

J25P

Packaging building

Handling
material

Inspecting/
packaging
Direct
LH

Runs

Shipping
Shipments

J40X

9-17

LO
9-5

Activity Based Costing


Illustrated
J25P

Direct material
Direct labor:
Assembly
Packaging
Total direct labor
Direct costs
Overhead:
Assembly building:
Assembling @ $30 per machine hour
Machine setup @ $900 per setup hour
Handling material @ $3,000 per run
Package building:
Inspecting and packing @ $5 per direct labor hour
Shipping @ $1,320 per shipment
Total ABC overhead
Total ABC cost
Number of units
Unit cost

J40X

$1,500,000

$2,400,000

$ 750,000
990,000
$1,740,000
$3,240,000

$ 600,000
360,000
$ 960,000
$3,360,000

$ 180,000
36,000
24,000

$ 900,000
360,000
120,000

300,000
132,000
$ 672,000
$3,912,000
100,000
$
39.12

114,000
264,000
$1,758,000
$5,118,000
40,000
$ 127.95

9-18

LO
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

Plantwide rate
Department (building) rate
Activity-based costing

J25P

J40X

$48.06
$41.04
$39.12

$105.60
$123.15
$127.95

9-19

End of Chapter 9

9-20