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Chapter4-1

Activity-Based CostingManagerial AccountingFifth EditionWeygandt Kimmel KiesoChapter4-2

study objectivesChapter4-31.Recognize the difference between traditional costing andactivity-based costing.2.Identify the steps in the development of an activity-basedcosting system.3.Know how companies identify the activity cost pools used inactivity-based costing.4.Know how companies identify and use cost drivers in activitybased costing.5.Understand the benefits and limitations of activity-basedcosting.6.Differentiate between value-added and non–value-addedactivities.7.Understand the value of using activity levels in activity-basedcosting.8.Apply activity-based costing to service industries.

preview of chapter 4Chapter4-4

Managerial Accounting BasicsManagerial accounting, also called managementaccounting, is a field of accounting that provideseconomic and financial information for managers andother internal users.Managerial accounting applies to all types ofbusinesses. ot-for-profit

Traditional Costing and Activity-Based CostingTraditional Costing SystemsAllocates overhead using a single predetermined rate. Job order costing: direct labor cost is assumedto be the relevant activity base. Process costing: machine hours is the relevantactivity base.Assumption was satisfactory when direct labor was amajor portion of total manufacturing costs. Wide acceptance of a high correlation betweendirect labor and overhead costs.Chapter4-6SO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingThe Need for a New ApproachTremendous change in manufacturing and serviceindustries.Decrease in amount of direct labor usage.Significant increase in total overhead costs.Inappropriate to use plant-wide predeterminedoverhead rates when a lack of correlation exists.Complex manufacturing processes may requiremultiple allocation bases; this approach is calledActivity-Based Costing (ABC).Chapter4-7Illustration 4-1Traditional one-stagecosting systemSO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingActivity-Based CostingAllocates overhead to multiple activity costpools, andAssigns the activity cost pools to products orservices by means of cost drivers.Chapter4-8SO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingActivity-Based CostingActivity: any event, action, transaction, or worksequence that incurs cost when producing a product orproviding a service.Activity Cost Pool: the overhead cost attributed to adistinct type of activity For example: ordering materialsor setting up machinesCost Drivers: any factor or activity that have a directcause-effect relationship with the resources consumed.Chapter4-9SO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingActivity-Based CostingABC allocates overhead costs in two stages:Stage 1: Overhead costs are allocated to activitycost pools.Stage 2: The overhead costs allocated to the costpools is assigned to products using costdrivers.The more complex a product’s manufacturingoperation, the more activities and cost drivers likelyto be present.Chapter4-10SO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingActivity-Based CostingChapter4-11Illustration 4-2Activities and related cost driversSO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingActivity-Based CostingChapter4-12Illustration 4-3ABC system design—Lift Jack CompanySO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingIndicate whether the following statementsare true or false.FalseTrueTrue1. A traditional costing system allocates overhead bymeans of multiple overhead rates.2. Activity-based costing allocates overhead costs in atwo-stage process.3. Direct material and direct labor costs are easier totrace to products than overhead.Solution onnotes pageChapter4-13SO1 Recognize the difference between traditional costing and activity-based costing.

Traditional Costing and Activity-Based CostingIndicate whether the following statementsare true or false.False4. As manufacturing processes have become moreautomated, more companies have chosen to allocateoverhead on the basis of direct labor costs.True5. In activity-based costing, an activity is any event,action, transaction, or work sequence that incurs costwhen producing a product.Solution onnotes pageChapter4-14SO1 Recognize the difference between traditional costing and activity-based costing.

Example of ABC Versus Traditional CostingABC allocates overhead costs in two stages:Stage 1: Overhead costs are allocated to activitycost pools.Stage 2: The overhead costs allocated to the costpools is assigned to products using costdrivers.The more complex a product’s manufacturingoperation, the more activities and cost drivers likelyto be present.Chapter4-15SO2 Identify the steps in the development of an activity-based costing system.

Example of ABC Versus Traditional CostingIllustration:Atlas Company produces two automobile antitheft devices: The Boot: a high volume item with sales totaling 25,000 per year The Club: a low volume item with sales totaling 5,000 per yearEach product requires 1 hour of direct labor Total annual direct labor hours (DLH) 30,000 (25,000 5000) Direct labor cost 12 per unit for each productExpected annual manufacturing overhead costs 900,000Direct materials cost:Chapter4-16 The Boot - 40 per unit The Club - 30 per unitRequired: Calculate unitcosts under ABC.SO2 Identify the steps in the development of an activity-based costing system.

Example of ABC Versus Traditional CostingIllustration:Manufacturing costsDirect materialsDirect laborOverheadTotal unit costProductsThe Boot The Club 40 30121230*30* 82 72* Overhead rate 900,000/30,000 DLH 30 per DLHOverhead ( 30 X 1 hr. 30)Chapter4-17SO2 Identify the steps in the development of an activity-based costing system.

Example of ABC Versus Traditional CostingActivity-based costing involves the following four steps.1.Identify and classify the major activities and allocatemanufacturing overhead costs to the appropriate costpools.2.Identify the cost driver that has a strong correlation tothe costs in the cost pool.3.Compute the overhead rate for each pool.4.Assign overhead costs for each costs to products usingthe overhead rates.Chapter4-18SO3 Know how companies identify the activity cost pools used in activity-based costing.

Example of ABC Versus Traditional CostingIdentify and Classify Activities and AllocateOverhead to Cost Pools (Step 1)Overhead costs are assigned directly to the appropriateactivity cost pool.Illustration 4-4Chapter4-19SO3 Know how companies identify the activity cost pools used in activity-based costing.

Example of ABC Versus Traditional CostingIdentify Cost Drivers (Step 2)The cost driver must accurately measure the actualconsumption of the activity by the various products.Illustration 4-5Chapter4-20SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingCompute Overhead Rates (Step 3)Next, the company computes an activity-based overheadrate per cost driver.Illustration 4-6Illustration 4-7Chapter4-21SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingAssign Overhead Cost to Products (Step 4)In assigning overhead costs, it is necessary to know theexpected use of cost drivers for each product. Because ofits low volume, The Club requires more set-ups andinspections than The Boot.Illustration 4-8Chapter4-22SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingAssign Overhead Cost to Products (Step 4)To assign overhead costs, Atlas multiplies the activity-basedoverhead rates per cost driver (Ill. 4-7) by the number of costdrivers expected to be used per product (Ill. 4-8).Illustration 4-9Chapter4-23SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingAssign Overhead Cost to Products (Step 4)To assign overhead costs, Atlas multiplies the activity-basedoverhead rates per cost driver (Ill. 4-7) by the number of costdrivers expected to be used per product (Ill. 4-8).Illustration 4-9Chapter4-24SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingComparing Unit CostsIllustration 4-10A likely consequence of the differences in assigning overhead isthat Atlas has been overpricing The Boot and possibly losing marketshare to competitors. It also has been sacrificing profitability byunderpricing The Club.Chapter4-25SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingComparing Unit CostsUnder ABC, overhead costs are shifted from the high volumeproduct (The Boot) to the low volume product (The Club)because:Low volume products often require more specialhandling.Assigning overhead using ABC will usually increase thecost per unit of low volume products.Chapter4-26SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingLift Jack Company has seven activity cost pools and twoproducts. It expects to produce 200,000 units of its automobilescissors jack and 80,000 units of its truck hydraulic jack. Havingidentified its activity cost pools and the cost drivers for each costpool, Lift Jack Company accumulated the following data relative tothose activity cost pools and cost drivers.Chapter4-27SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional CostingLift Jack Company has seven activity cost pools and twoproducts. It expects to produce 200,000 units of its automobilescissors jack and 80,000 units of its truck hydraulic jack. Havingidentified its activity cost pools and the cost drivers for each costpool, Lift Jack Company accumulated the following data relative tothose activity cost pools and cost drivers.Using the previous data, do the following:a.Prepare a schedule showing the computations of the activitybased overhead rates per cost driver.b. Prepare a schedule assigning each activity’s overhead cost to thetwo products.c.Compute the overhead cost per unit for each product.d. Comment on the comparative overhead cost per unit.Chapter4-28SO4 Know how companies identify and use cost drivers in activity-based costing.

Example of ABC Versus Traditional Costinga. Prepare a schedule showing the computations of the activity-based overhead rates per cost driver.Solution on notes pageChapter4-29SO4 Know how companies identify and use cost drivers in activity-based costing.

b. Prepare aschedule assigningeach activity’soverhead cost tothe two products.Chapter4-30Solution on notes pageSO4

b. Prepare aschedule assigningeach activity’soverhead cost tothe two products.Chapter4-31Solution on notes pageSO4

Example of ABC Versus Traditional Costingc. Compute the overhead cost per unit for each product.d. Comment on the comparative overhead cost per unit.These data show that the total overhead assigned to 80,000hydraulic jacks is nearly as great as the overhead assigned to200,000 scissors jacks. However, the overhead cost per hydraulicjack is 41. It is only 17.60 per scissors jack.Chapter4-32SO4 Know how companies identify and use cost drivers in activity-based costing.

Chapter4-33

Activity-Based Costing: A Closer LookBenefits of ABCMore accurate product costing through:Use of more cost pools to assign overhead costsEnhanced control over overhead costsBetter management decisionsChapter4-34SO5 Understand the benefits and limitations of activity-based costing.

Activity-Based Costing: A Closer LookLimitations of ABCCan be expensive to useSome arbitrary allocations continueChapter4-35SO5 Understand the benefits and limitations of activity-based costing.

Chapter4-36

Activity-Based Costing: A Closer LookWhen to Use ABCFactors to consider:1.Product lines differ in volume and manufacturing complexity.2. Product lines are numerous and diverse.3. Overhead costs constitute a significant portion of totalcosts.4. The manufacturing process or the number of products haschanged significantly.5. Production or marketing managers are ignoring data providedby the existing system.Chapter4-37SO5 Understand the benefits and limitations of activity-based costing.

Activity-Based Costing: A Closer LookValue-Added Versus Non–Value-Added ActivitiesActivity-Based Management (ABM):An extension of ABC from a product costing system to amanagement function that focuses on reducing costs andimproving processes and decision making. Value-added activities Non–value-added activitiesChapter4-38SO6 Differentiate between value-added and non–value-added activities.

Activity-Based Costing: A Closer LookValue-Added Versus Non–Value-Added ActivitiesAn activity that increases the worth of a product orservice such as:Manufacturing CompanyService CompanyEngineering designPerforming surgeryMachining servicesLegal researchAssemblyDelivering packagesPaintingPackagingChapter4-39SO6 Differentiate between value-added and non–value-added activities.

Activity-Based Costing: A Closer LookValue-Added Versus Non–Value-Added ActivitiesAn activity that adds cost to, or increases the timespent on, a product/service without increasing its marketvalue such as:Chapter4-40Manufacturing CompanyService CompanyRepair of machinesStorage of inventoryMoving of inventoryBuilding maintenanceInspectionsInventory controlTaking appointmentsReceptionBookkeeping and billingTravelingOrdering suppliesAdvertisingSO6 Differentiate between value-added and non–value-added activities.

Chapter4-41

Activity-Based Costing: A Closer LookClassify each of the following activitieswithin a dental practice as value-added (VA)or non–value-added (NVA).NVA1. Ordering supplies.NVA2. Taking appointments.VA3. Completing continuing education requirements.VA4. Explaining dental-hygiene techniques to patients.NVAVAChapter4-425. Completing insurance documents.6. Examining patients.Solution onnotes pageSO6 Differentiate between value-added and non–value-added activities.

Activity-Based Costing: A Closer LookClassification of Activity LevelsABC activities levels:1. Unit-level activities2. Batch-level activities3. Product-level activities4. Facility-level activitiesChapter4-43SO7 Understand the value of using activity levels in activity-based costing.

Activity-Based Costing: A Closer LookClassificationof ActivityLevelsChapter4-44Illustration 4-13SO7

Activity-Based Costing: A Closer LookMorgan Toy Company manufactures six primaryproduct lines in its Morganville plant. As a result ofan activity analysis, the accounting department has identified eightactivity cost pools. Each of the toy products is produced in largebatches, with the whole plant devoted to one product at a time.Classify each of the following activities as either unit-level, batchlevel, product-level, or ng design,Batch-levelb.Machine setup,Product-levelc.Inventory management,Facility-leveld.Plant cafeteria,Solution onnotes pageSO7 Understand the value of using activity levels in activity-based costing.

Activity-Based Costing: A Closer LookMorgan Toy Company manufactures six primaryproduct lines in its Morganville plant. As a result ofan activity analysis, the accounting department has identified eightactivity cost pools. Each of the toy products is produced in largebatches, with the whole plant devoted to one product at a time.Classify each of the following activities as either unit-level, batchlevel, product-level, or facility-level:Chapter4-46Batch-levele.Inspections after each setup,Unit-levelf.Polishing parts,Unit-levelg.Assembling parts,Batch-levelh.Health and safety.Solution onnotes pageSO7 Understand the value of using activity levels in activity-based costing.

Activity-Based Costing in Service IndustriesOverall objective: Identify key cost-generation activitiesand keep track of quantity of activities performed for eachservice provided.General approach is to identify activities, cost pools, andcost drivers.Labeling of activities as value-added or non-value-added.A larger proportion of overhead costs are company-widecosts that cannot be directly traced to specific servicesprovided by the company.Chapter4-47SO8 Apply activity-based costing to service industries.

Activity-Based Costing in Service IndustriesTraditional Costing ExampleThe public accounting firm of Check and Doublecheckprepares the following condensed annual budget.Illustration 4-14Chapter4-48SO8

Activity-Based Costing in Service IndustriesTraditional Costing ExampleUnder traditional costing Check and Doublecheck wouldcompute applied overhead and operating income as:Illustration 4-15Chapter4-49SO8 Apply activity-based costing to service industries.

Activity-Based Costing in Service IndustriesActivity-Based Costing ExampleCheck and Doublecheck distributes its estimated annualoverhead costs of 1,200,000 to several activity cost pools.Illustration 4-16Chapter4-50SO8 Apply activity-based costing to service industries.

Activity-Based Costing in Service IndustriesActivity-Based Costing ExampleAssigning overhead in a service industryChapter4-51Illustration 4-17SO8 Apply activity-based costing to service industries.

Activity-Based Costing in Service IndustriesActivity-Based Costing ExampleComparison of traditional costing with ABC in a servicecompany.Illustration 4-18Chapter4-52SO8 Apply activity-based costing to service industries.

The average worker wastes about 2.1 hours per eight-hourworkday. This does not include lunch and scheduled breaks.According to human resources managers, companies assumethat employees will waste about one hour per day. The top time-wasting activities cited by employees aresurfing the Internet, socializing with coworkers, andconducting personal business.Chapter4-53

Older people waste less time at work than younger people.Men and women waste about the same amount of time. The average worker earns 19.13 per hour. If, as statedabove, the average worker wastes about 1.1 hours more perday than employers expect, then the total lost salarydollars is about 759 billion per year. A third (33%) of survey respondents said that they wastetime at work because they do not have enough work to do.About a quarter (23%) of respondents said they waste timeat work because they are not paid enough.Chapter4-54

A recent survey found that only about 11% of full-timestudents spend more than 25 hours a week preparing for class(which is about thenumber of hoursthat instructorssay is needed todo well in college).About 44% of thestudents in thesurvey said thatthey spend less than10 hours per week.Chapter4-55

Many “self-help” books and websites offer suggestions on howto improve your time management. Should you minimize the“non–value-added” hours in your life by adopting themethods suggested by these sources?YES: There are a limited number of hours in a day. You shouldtry to maximize your chances of achieving your goals byeliminating the time that you waste.NO: Life is about more than working yourself to death. Beingan efficiency expert doesn’t guarantee that you will be happy.Schedules and daily planne

Chapter 4-6 Allocates overhead using a single predetermined rate. Job order costing: direct labor cost is assumed to be the relevant activity base. Process costing: machine hours is the relevant activity base. Assumption was satisfactory when direct labor was a

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