Chapter 5 Activity Based Costing This chapter covers volume based costing and activity based costing ABC I Overhead Assignment Methods A Volume Based Costing B Activity Based Costing II Volume Based Costing volume based costing overhead using a volume based driver such as direct labor hours or machine hours A Overhead inputs Direct labor hours labor supervising orders direct materials parts setups machine setup hours setups Machine hours machines utilities purchasing B Limitations Accounts for the bulk of product costs factory overhead o i e repair maintenance depreciation utilities insurance taxes and supervisor salaries No single allocation basis may reflect the use of overhead Could cause cross subsidization of outputs o i e high volume products will be over costed and low volume products will be under costed C Plantwide OH rate Plantwide OH Rate Total budged overhead costs dollars Total budgeted overhead input hours D Departmental OH rate OH rate for Department A Total budged department costs dollars Total budgeted department input hours OH rate for Department B Total budged department costs dollars Total budgeted department input hours Department A may use machine hours while Department B may use direct labor hours III Activity Based Costing activity based costing assigns resource costs to cost objects and links costs to products A Resource consumption cost drivers B Activity consumption cost drivers Example 1 Company XYZ makes two products Standard and Deluxe Direct labor hours are used to calculate the overhead rate which is 20 DLH Total overhead is 10 M Observe how the costs differ for Standard and Deluxe in volume based costing and activity based costing Volume Based Costing Deluxe requires 100 000 DLH 100 000 DLH 20 DLH 2M Total OH 10M Standard requires 400 000 DLH 400 000 DLH 20 DLH 8M Activity Based Costing Labor 800K Machine 2100K Setups 1600K Product Orders 450K Product Tests 1700K Material Receipts 1000K Parts Admin 350K General Labor 2000K Deluxe 4 660 000 Standard 5 340 000 Factory Conversion Costs Salaries Supplies Factory expense Example 2 Activity Based Costing with Two Stage Procedure EyeGuard Equipment Inc EEI manufactures protective eyewear for use in commercial and home applications The firm has two main product lines the highest quality product Safe T and a low cost value version Safe V Information on the factory conversion costs for EEI is as follows EEI uses ABC costing to determine the unit costs of its products The firm has four activities job setup assembly inspecting and finishing and packaging and uses resource consumption cost drivers to assign costs to activities The resource consumption cost drivers and the driver levels are given as follows 850 000 150 000 550 000 1 550 000 17 10 22 000 The activity cost drivers for the two products are summarized below Activities Setup Assembly Inspect and finishing Packaging Activity Driver Batches Units Hours Hours 850 132 000 Supplies 150 000 Factory Expenses 550 000 Solution Salaries 850 000 Activity Based Costing Stage 1 1 Calculate the rates for stage 1 Salaries 850 000 50 000 employee 17 employees Supplies 150 000 15 000 machine 10 machines Factory Expenses 550 000 25 sq feet 22 000 sq ft Activity Based Costing Stage 2 activities Setup batches Assembly units Inspect Finishing hours Packaging hours 2 Calculate the total cost per activity using rates from stage 1 and then the activity based rates for stage 2 Setup Total Cost 5 employees 50 000 employee 250 000 3 machines 15 000 machine 45 000 100 000 4000 sq feet 25 sq ft 395 000 Rate 395 000 850 batches 464 71 batch Assembly Total Cost 6 employees 50 000 employee 300 000 3 machines 15 000 machine 45 000 200 000 8000 sq feet 25 sq ft 545 000 Rate 5455 000 132 000 units 3 15 unit Inspecting and Finishing Total Cost 4 employees 50 000 employee 200 000 3 machines 15 000 machine 45 000 150 000 6000 sq feet 25 sq ft 395 000 Rate 395 000 72 000 units 3 finishing hours unit 60 000 units 2 finishing hours unit 11 76 finishing hr Packaging Total Cost 2 employees 50 000 employee 100 000 1 machines 15 000 machine 15 000 100 000 4000 sq feet 25 sq ft 215 000 Rate 215 000 72 000 units 15 packaging hours unit 60 000 units 10 packaging hours unit 11 76 packaging hr 3 Calculate the activity based total unit cost for each product Safe T and Safe V 278 826 600 batches 464 71 batch 297 360 72 000 units 4 13 unit 72 000 units 3 finishing hours unit 11 76 finishing hr 254 016 72 000 units 15 packaging hours unit 12 80 packaging hr 138 240 Conversion allocated 968 442 Divided by 72 000 units Conversion cost unit 13 45 unit Total Cost Unit Direct materials Conversion cost 6 00 13 45 19 45 Safe T Safe V 116 177 50 250 batches 464 71 batch 247 800 60 000 units 4 13 unit 60 000 units 2 finishing hours unit 11 76 finishing hr 141 120 60 000 units 10 packaging hours unit 12 80 packaging hr 76 000 Conversion allocated 581 897 50 Divided by 60 000 units Conversion cost unit 9 70 unit Total Cost Unit Direct materials Conversion cost 3 50 9 70 13 20