Activity-Based Costing and Analysis

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Chapter 17

• Activity-Based Costing and Analysis

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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.

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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.

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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.

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Levels of types of activities
P3
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Levels of activities
P3

• 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.

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Levels of Activities
P3

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

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Levels of Activities
P3

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

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Facility Level Activities
P3

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

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Assigning Overhead Costs
C1
Direct
Materials
Indirect
Goods in Process
FinishedGoods
FactoryOverhead
Allocate
Indirect
Cost of GoodsSold
Direct
Labor
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Assigning Overhead Costs
C1
Overhead can be assigned to production in one of
three ways
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Plant Wide Overhead Rate Method Illustration
P1
Plantwide overhead rate

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Plant Wide Overhead Rate Method Illustration
P1
Plantwide overhead rate

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Plant Wide Overhead Rate Method Illustration
P1
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Plant Wide Overhead Rate Method Advantages and
Disadvantages
P1

• 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

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Departmental Overhead Rate Method First Stage
P2
Overhead Cost 4,800,000
First Stage
Machining Dept. 4,200,000
Assembly Dept. 600,000
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Departmental Overhead Rate Method Second Stage
P2
Departmental Overhead Rate

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Departmental Overhead Rate Method Second Stage
P2
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Departmental Overhead Rate Method Second Stage
P2
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Advantages and Disadvantages of Departmental
Overhead Rate Method
A2

• Disadvantages
• Can distort product costs
• Assumes that products are similar in volume,
  complexity, batch size
• Assumes that departmental overhead costs are
  proportional to the allocation base

• Advantages
• More accurate overhead allocations
• More refined than the plantwide overhead rate
  method

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Applying Activity-Based Costing
P3

• 4 steps
• Identify activities and the costs they cause.
• Group similar activities into activity pools.
• Determine an activity rate for each activity cost
  pool.
• Allocate overhead costs to products using those
  activity rates.

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Step Two Trace Overhead Costs to Cost Pools
P3
Overhead Cost
Activity Cost Pool X
Activity Cost Pool Y
Activity Cost Pool Z
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Step Three Determine Activity Rate
P3
Total cost in activity pool Measure of the
activity
Activity rate

• 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

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Step Four Assign Overhead Costs to Cost Objects
P3

• 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

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Step Four Assign Overhead Costs to Cost Objects
P3
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Step Four Assign Overhead Costs to Cost Objects
P3
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Comparison of Overhead Allocations by Method
C1
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Advantages and Disadvantages of Activity-Based
Costing
A3

• Advantages
• More accurate overhead cost allocation
• More effective overhead cost control
• Focus on relevant factors
• Better management of activities

• Disadvantages
• Costs to implement and maintain
• Uncertainty with decisions still remains

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End of Chapter 17