Identify and Define Activities and Activity Cost Pools

1. Activity Based Costing: A Tool
to Aid Decision Making
UAA – ACCT 202
Principles of Managerial Accounting
Dr. Fred Barbee
Chapter

2. Cost
Measurement
Cost
Accumulation
Cost
Assignment
Direct
Direct
Materials
Materials
Direct
Direct
Labor
Labor
Mfg.
Mfg.
Overhead
Overhead
Work-inWork-inProcess
Process
Finished
Finished
Goods
Goods
Cost-of
Cost-of
Goods Sold
Goods Sold
Goal: Accurately costed
products.

3. Actual
Costing
System
Normal
Costing
System
Standard
Costing
System
Actual DM
Actual DL
Actual MOH
Actual DM
Measuring
Actual DL
Costs
Estimated MOH
Standard DM
Standard DL
Standard MOH

4. Cost Accounting Systems
Product Costs
Job-Order Costing
Process Costing
Total/Unit Cost

5. Assigning Manufacturing Costs
Functional Based
Costing
Activity Based
Costing

6. Activity Based Costing (ABC)
ABC is designed to
provide managers
with cost information
for strategic and
other decisions that
potentially affect
capacity and
therefore “fixed”
costs.
ABC is a
good supplement
to our traditional
cost system
I agree!

7. Activity Based Costing (ABC)
Both manufacturing
Both manufacturing
and nonmanufacturing
and nonmanufacturing
costs may be
costs may be
assigned to
assigned to
products.
products.
A number
A number
of cost pools each
of cost pools each
allocated to a product
allocated to a product
or cost object.
or cost object.
Some manufacturing
Some manufacturing
costs may be excluded
costs may be excluded
from product
from product
costs.
costs.
Allocation bases often
Allocation bases often
differ from
differ from
traditional costing
traditional costing
systems.
systems.
Overhead rates may
Overhead rates may
be based on activity
be based on activity
at capacity.
at capacity.

8. How Costs are Treated Under
Activity-Based Costing
Activity Based
Activity Based
Costing
Costing
Departmental
Departmental
Overhead
Overhead
Rates
Rates
Plantwide
Plantwide
Overhead
Overhead
Rate
Rate
lo
ve
Le
om
fC
it y
x
le
p
Overhead Allocation

9. Functional Based
(Traditional) Costing

10. Departmental Overhead Rates
Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products
Indirect
Labor
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3
Direct
Labor
Hours
Machine
Hours
Raw
Materials
Cost
Products
Departmental Allocation Bases

11. Peanut-butter costing describes a
cost approach that uniformly
assigns (“spreads” or “smooths
out”) the cost of resources to cost
objects.

12. Functional-Based
Management
Model
Cost View
Resources
Operational View
Efficiency
Analysis
Functions
Products
Performance
Analysis

13. The problem with this approach
is that individual products,
services, etc., may use those
resources in a nonuniform way.
The end result is that some
products will be overcosted
while others will be
undercosted.

14. Refining a Cost System
Reclassify
indirect costs as direct
costs.
Define
more cost pools.
Identify
Use
cost drivers.
Activity-Based Costing.

15. Activity-Based
Management
Model
Cost View
Resources
Operational View
Driver
Analysis
Activities
Products &
Customers
Performance
Analysis

16. Designing an ABC System
Cost Objects
(e.g., products
and customers)
Activities
Consumption
of Resources
Cost

17. Designing an ABC System
1.
Identify and define activities and
activity cost pools.
2.
Whenever possible, directly trace costs
to activities and cost objects.
3.
Assign costs to activity cost pools.
4.
Calculate activity rates.

18. Designing an ABC System
5.
Assign costs to cost objects using the
activity rates and activity measures.
6.
Prepare management reports.

19. Identify and Define
Activities and
Activity Cost Pools

20. Step #1:Identify and Define
Activities and Activity Cost Pools
An Activity Cost
Pool is a “bucket” in
which costs are
accumulated that
relate to a single
activity measure in
the ABC system.
$$
$
$$$

21. Activity Levels (Step #1)
Batch
Level
Product
Level
Activity
Levels
Unit
Level
Customer
Level
Organization-Sustaining Level

22. Step #1: Identify and Define
Step #1 For Classic Brass
Activities and Activity Cost Pools
At Classic Brass, the ABC team, selected the
following activity cost pools and activity
measures:
Activity Cost Pools at Classic Brass
Activity Cost Pool
Customer orders
Product design
Order size
Customer relations
Other
Activity Measure
Number of customer orders
Number of product designs
Machine-hours
Number of active customers
Not applicable

23. Step #1:Identify and Define
Activities and Activity Cost Pools
 Customer
Orders - assigned all costs of
resources that are consumed by taking
and processing customer orders.
 Product
Designs - assigned all costs of
resources consumed by designing
products.
 Order
Size - assigned all costs of
resources consumed as a consequence of
the number of units produced.

24. Step #1:Identify and Define
Activities and Activity Cost Pools
 Customer
Relations – assigned all costs
associated with maintaining relations
with customers.
 Other
– assigned all overhead costs that
are not associated with the other cost
pools.

25. Whenever Possible,
Directly Trace Overhead
Costs to Activities and
Cost Objects.

26. The overhead costs at Classic Brass
Exhibit 8-2

27. Assign Costs to
Activity Cost Pools

28. The overhead costs at Classic Brass
Exhibit 8-2

29. Assign Costs to Activity Cost Pools
At Classic Brass the following distribution of resource
consumption across activity cost pools is determined.
Activity Cost Pools
Customer Product
Order
Orders
Design
Size
Production Department
Indirect factory wages
Factory equipment depreciation
Factory utilities
Factory building lease
Shipping costs **
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Customer
Relations
Other
Total
25%
20%
0%
0%
40%
0%
10%
0%
20%
60%
50%
0%
10%
0%
0%
0%
5%
20%
40%
100%
100%
100%
100%
100%
15%
30%
0%
5%
0%
0%
10%
0%
0%
30%
25%
0%
40%
45%
100%
100%
100%
100%
20%
10%
10%
0%
0%
0%
60%
70%
10%
20%
100%
100%
**Not included because they are directly traced to customer orders.

30. Assign Costs to Activity Cost Pools
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)
Activity
Customer
Orders
Production Department
Indirect factory wages
Factory equipment depreciation
Factory utilities
Factory building lease
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total
$ 125,000
Production Department
$
CostIndirect factory wages
Pools
Factory equipment depreciation
Product utilities
Order
Customer
Factory
Design
Size
Factory building lease Relations
Shipping costs traced to customer orders
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total overhead costs
500,000
300,000
120,000
Other $
80,000
Total
1,000,000
40,000
400,000
50,000
60,000
510,000
250,000
50,000
$
300,000
1,850,000
Indirect factory wages
$500,000
Indirect factory wages
$500,000
Percent consumed by customer orders
25%
Percent consumed by customer orders
25%
$125,000
$125,000

31. Assign Costs to Activity Cost Pools
Overhead Costs at Classic Brass
(Manufacturing and NonManufacturing)
Activity
Customer
Orders
Production Department
Indirect factory wages
Factory equipment depreciation
Factory utilities
Factory building lease
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total
$ 125,000
60,000
Production Department
$
CostIndirect factory wages
Pools
Factory equipment depreciation
Product utilities
Order
Customer
Factory
Design
Size
Factory building lease Relations
Shipping costs traced to customer orders
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total overhead costs
500,000
300,000
120,000
Other $
80,000
Total
1,000,000
40,000
400,000
50,000
60,000
510,000
250,000
50,000
$
300,000
1,850,000
Factory equipment depreciation
$300,000
Factory equipment depreciation
$300,000
Percent consumed by customer orders
20%
Percent consumed by customer orders
20%
$ 60,000
$ 60,000

32. Assign Costs to Activity Cost Pools
Activity Cost Pools
Customer
Product
Orders
Design
Production Department
Indirect factory wages
Factory equipment depreciation
Factory utilities
Factory building lease
General Administrative Department
Administrative wages and salaries
Office equipment depreciation
Administrative building lease
Marketing Department
Marketing wages and salaries
Selling expenses
Total
Order
Size
Customer
Relations
Other
Total
$ 125,000
60,000
-
$ 200,000
12,000
-
$ 100,000
180,000
60,000
-
$ 50,000
-
$ 25,000
60,000
48,000
80,000
$
500,000
300,000
120,000
80,000
60,000
15,000
-
20,000
-
40,000
-
120,000
12,500
-
160,000
22,500
60,000
400,000
50,000
60,000
50,000
5,000
$ 315,000
25,000
$ 257,000
$ 380,000
150,000
35,000
$ 367,500
25,000
10,000
$ 490,500
250,000
50,000
$ 1,810,000

33. Calculate the
Activity Rates

34. Activity Cost Pools For
Step #1: Identify and Define
Classic Brass Activity Cost Pools
Activities and
At Classic Brass, the ABC team, selected the
following activity cost pools and activity
measures:
Activity Cost Pools at Classic Brass
Activity Cost Pool
Customer orders
Product design
Order size
Customer relations
Other
Activity Measure
Number of customer orders
Number of product designs
Machine-hours
Number of active customers
Not applicable

35. Calculate Activity Rates
The ABC team determines that Classic Brass will
have these total activities for each activity cost
pool . . .

1,000 customer orders

200 new designs

20,000 machine-hours

100 customer relations activities
Now the team can compute the individual
activity rates by dividing the total cost for
each activity by the total activity levels.

36. Calculate Activity Rates
Computation of Activity Rates
Activity Cost Pools
Customer orders
Product design
Order size
Customer relations
Other
(a)
Total Cost
$ 315,000
257,000
380,000
367,500
490,500
(b)
Total Activity
1,000 orders
200 designs
20,000 MHs
100 customer
Not applicable
÷
(a) (b)
Activity Rate
$315 per order
$1,285 per design
$19 per MH
$3,675 per customer
Not applicable

37. Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Labor
Shipping
Costs
Traced
Traced
Traced
Overhead Costs
Cost Objects:
Products, Customer Orders, Customers

38. Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Labor
Shipping
Costs
Overhead Costs
First-Stage Allocation
Order
Size
Customer
Orders
Product
Design
Customer
Relations
Cost Objects:
Products, Customer Orders, Customers
Other

39. Activity-Based Costing at Classic Brass
Activity-Based Costing at Classic Brass
Direct
Materials
Direct
Labor
Shipping
Costs
Overhead Costs
First-Stage Allocation
Order
Size
Customer
Orders
Product
Design
Customer
Relations
Other
Second-Stage Allocations
$/MH
$/Order
$/Design
$/Customer
Cost Objects:
Products, Customer Orders, Customers
Unallocated

40. Assign Costs to
Cost Objects

41. Assigning Costs to Cost Objects
Let’s take a look at how our system works for just one
customer – Windward Yachts.
Standard Stanchions (no design required)
1. 400 units ordered with 2 separate orders.
2. Each stanchion required 0.5 machine-hours .
3. Selling price is $34 each.
4. Direct materials total $2,110.
5. Direct labor totals $1,850.
6. Shipping costs total $180.
Custom Compass Housing (requires new design)
1. One order during the year.
2. Each housing required 4 machine-hours .
3. Selling price is $650 each.
4. Direct materials total $13.
5. Direct labor totals $50.
6. Shipping costs total $25.

42. Computation of Activity Rates
Activity Cost Pools
Customer orders
Product design
Order size
Customer relations
Other
(a)
Total Cost
$ 315,000
257,000
380,000
367,500
490,500
(b)
Total Activity
1,000 orders
200 designs
20,000 MHs
100 customer
Not applicable
Standard Stanchions (no design required)
1. 400 units ordered with 2 separate orders.
2. Each stanchion required 0.5 machine-hours .
3. Selling price is $34 each.
4. Direct materials total $2,110.
5. Direct labor totals $1,850.
6. Shipping costs total $180.
(a) (b)
Activity Rate
$315 per order
$1,285 per design
$19 per MH
$3,675 per customer
Not applicable

43. Custom Compass Housing (requires new design)
1. One order during the year.
2. Each housing required 4 machine-hours .
3. Selling price is $650 each.
4. Direct materials total $13.
5. Direct labor totals $50.
6. Shipping costs total $25.
Computation of Activity Rates
Activity Cost Pools
Customer orders
Product design
Order size
Customer relations
Other
(a)
Total Cost
$ 315,000
257,000
380,000
367,500
490,500
(b)
Total Activity
1,000 orders
200 designs
20,000 MHs
100 customer
Not applicable
(a) (b)
Activity Rate
$315 per order
$1,285 per design
$19 per MH
$3,675 per customer
Not applicable

44. Prepare
Management
Reports

47. Product Margins
Traditional Cost Accounting System
Sales
Costs
Direct materials
Direct labor
Manufacturing overhead
Product margin
Standard
Stanchions
$
13,600
$
(2,110)
(1,850)
(10,000)
(360)
Compass
Housing
$
650
$
(13)
(50)
(200)
387
400 units x 0.5 MH/unit x $50/MH = $10,000
400 units x 0.5 MH/unit x $50/MH = $10,000
Predetermined manufacturing
=
overhead rate
$1,000,000
20,000 MH
= $50/MH