Activity-

Based
Costing
Prepared by
Douglas Cloud
Pepperdine University

12-1
 Objectives
1. Discuss the limitations of using only unit-based
After studying this
drivers to assign costs.
chapter, you should
2. Provide a detailed description of activity-based
be able to:
product costing.
3. Explain how homogenous cost pools can be used
to reduce the number of activity rates.
4. Describe activity-based system concepts
including an ABC relational database and ABC
software.

12-2
 Functional-Based Product
Costing Model
Direct Direct
Overhead
Materials Labor

Direct Tracing
Driver Tracing
Direct Direct Allocation
Tracing Tracing
Plant/Departmental
Cost Pools

Unit-Based Driver

PRODUCTS
12-3
Goodmark Company—An Example
Goodmark Company produces two products: scented and
regular birthday cards.

12-4
 Goodmark Company—An Example
Product Costing Data

Scented Cards Regular Cards Total

Unit produced per year 20,000 200,000 --
Prime costs $160,000 $1,500,000 $1,660,000
Direct labor hours 20,000 160,000 180,000
Number of setups 60 40 100
Machine hours 10,000 80,000 90,000
Inspection hours 2,000 16,000 18,000
Number of moves 180 120 300

12-5
 Goodmark Company—An Example
Product Costing Data

Departmental Data
Cutting Dept. Printing Dept. Total
Direct labor hours:
Scented cards 10,000 10,000 20,000
Regular cards 150,000 10,000 160,000
Total 160,000 20,000 180,000
Machine hours:
Scented cards 2,000 8,000 10,000
Regular cads 8,000 72,000 80,000
Total 10,000 80,000 90,000
Continued
12-6
 Departmental Data
Cutting Dept. Printing Dept. Total
Overhead costs:
Setting up equipment $120,000 $120,000 $240,000
Moving materials 60,000 60,000 120,000
Machining 20,000 180,000 200,000
Inspecting products 16,000 144,000 160,000
Total $216,000 $504,000 $720,000

12-7
Goodmark Company—An Example
Plantwide Overhead Rate

Total overhead cost

Plantwide rate =
Direct labor hours
$720,000
=
180,000 DLH

= $4 per direct labor hour

12-8
Goodmark Company—An Example
Departmental Rates

Dept. overhead cost

Cutting Department rate =
Cutting Dept. DLH
$216,000
=
160,000 DLH

= $1.35 per dlh

12-9
Goodmark Company—An Example
Departmental Rates

Dept. overhead cost

Printing Department rate =
Printing Dept. MH
$504,000
=
80,000 MH

= $6.30 per mh

12-10
 Goodmark Company—An Example
Unit Cost Computation: Plantwide Rates

Scented Cards Regular Cards

Prime costs $160,000 $1,500,000
Overhead costs:
$4.00 x 20,000 80,000
$4.00 x 160,000 640,000
Total manufacturing costs $240,000 $2,140,000
Units of production ÷ 20,000 ÷ 200,000
Unit cost $ 12.00 $ 10.70

12-11
 Goodmark Company—An Example
Unit Cost Computation: Departmental Rates

Scented Cards Regular Cards

Prime costs $160,000 $1,500,000
Overhead costs:
[($1.35 x 10,000) + ($6.30 x 8,000)] 63,900
[($2.35 x 150,000) +
($6.30 x 72,000)] 656,100
Total manufacturing costs $223,900 $2,156,100
Units of production ÷ 20,000 ÷ 200,000
Unit cost $ 11.20 * $ 10.78 *

*Rounded to nearest cent

12-12
 The Inadequacy of Plantwide and
Departmental Rates
There are at least two major factors that can impair the
ability of the unit-based plantwide and departmental
rates to assign overhead costs accurately:
(1) the proportion of nonunit-related overhead costs
to total overhead costs is large, and
(2) the degree of product diversity is great.

12-13
 Goodmark Company—An Example
Product Diversity: Consumption Ratios

Overhead Activity Scented Cards Regular Cards Activity Drivers

Setups 0.60 a 0.40 a Production runs
Moving materials 0.60 b 0.40 b Number of moves
Machining 0.11 c* 0.89 c* Machine hours
Inspection 0.11 d* 0.89 d* Inspection hours
a 60/100 (scented) and 40/100 (regular)
b 180/300 (scented) and 120/300 (regular)
c 10,000/90,000 (scented) and 80,000/90,000 (regular)
d 2,000/18,000 (scented) and 16,000/18,000 (regular)
*rounded

12-14
 Goodmark Company—An Example
Unit Cost Computation: Activity Rates

Scented Cards Regular Cards

Prime costs $160,000 $1,500,000
Overhead costs:
Setting up:
$2,400 x 60 144,000
$2,400 x 40 96,000
Machining:
$2.20 x 10,000 22,200
$2.20 x 80,000 177,600
Continued
12-15
 Scented Cards Regular Cards
Overhead costs(cont’d):
Inspecting:
$8.89 x 2,000 17,780
$8.89 x 16,000 142,240
Moving materials:
$400 x 180 72,000
$400 x 120 48,000
Total manufacturing costs $415,980 $1,963,840
Units of production ÷ 20,000 ÷ 200,000
Unit cost $ 20.80 $ 9.82

Rounded

12-16
Activity-Based Costing Model

Cost of Resources
Costs assigned using driver
tracing and direct tracing

Activities
Costs assigned using
activity drivers

Products
12-17
 Design Steps for an Activity-
Based Costing System
1. Identify, define, and classify activities and key attributes.
2. Assign the cost of resources to activities.
3. Assign the cost of secondary activities to primary
activities.
4. Identify cost objects and specify the amount of each
activity consumed by specific cost objects.
5. Calculate primary activity rates.
6. Assign activity costs to cost objects.

12-18
 Activity-Based Costing
A primary activity is an activity that is consumed
by a final cost object such as a product or
customer.
A secondary activity is one that is consumed by
intermediate cost objects such as primary
activities, materials, or other secondary activities.

12-19
 Activity Dictionary: Cardiology Ward
Activity Activity Activity Cost Activity
Name Description Type Object(s) Driver

Supervising Scheduling, Secondary Activities Percentage

nurse coordinating, within time nurses
and performance department spend on
evaluation each activity

Treating Administering Primary Patient types Number of

patients medicine and treatments
changing
dressings

Continued
12-20
Activity Activity Activity Cost Activity
Name Description Type Object(s) Driver

Providing Bathing, Primary Patient types Labor hours

hygienic care changing
bedding and
clothes, walking
patients

Responding to Answering Primary Patient types Number of

patient calls, counseling, requests
requests providing
snacks, etc.

Monitoring Monitoring Primary Patient types Monitoring

patients vital signs hours
and posting
patient information
12-21
 Cardiology Ward Example (Cont’d)

Percentage of Time for Each Activity

Activity Supervisor Nurses

Supervising nurses 100 % 0%
Treating patients 0 25
Providing hygienic care 0 20
Responding to requests 0 40
Monitoring patients 0 15

12-22
Cardiology Ward Example (Cont’d)
Unbundling of General Ledger Costs —
Chart of Accounts View

Supervising

$ 50,000
Supplies

40,600
Uniforms

8,200
Salaries 12-23
Cardiology Ward Example (Cont’d)
Unbundling of General Ledger Costs —ABC
View

Supervising nurses $ 52,280

Treating patients 90,000
Providing hygienic care 76,600
Responding to requests 133,200
Monitoring patients 127,920
Total $480,000

12-24
 Cardiology Ward Example (Cont’d)
Assignment of Secondary Activity
Costs to Primary Activities

Treating patients
$90,000 + (0.25 x $52,280) $103,070
Providing hygienic
$76,600care
+ (0.20 x $52,280) 87,056
Responding$133,200
to requests
+ (0.40 x $52,280) 154,112
$133,200 + (0.40 x $52,280)
Monitoring patients 135,762
$127,920 + (0.15 x $52,280)

12-25
 Cardiology Ward Example (Cont’d)
Rate Calculations

Treating patients: $103,070/30,000 = $3.44 per treatment

Providing hygienic care: $87,056/16,000 = $5.44 per hour of

care
Responding to requests: $154,112/80,000 = $1.93 per request

Monitoring patients: $135,762/200,000 = $0.68 per monitoring

hour

12-26
 Cardiology Ward Example (Cont’d)
Bill of Activities

Activity Intensive
Activity Driver Normal Intermediate Care Total
Production (output) Patient days 10,000 5,000 3,000
Treating patients Treatments 5,000 10,000 15,000 30,000
Providing hygienic care Hygienic hours 5,000 2,500 8,500 16,000
Responding to requests Requests 30,000 40,000 10,000 80,000
Monitoring patients Monitoring hours 20,000 60,000 120,000 200,000

12-27
 Cardiology Ward Example (Cont’d)
Assigning Cost: Final Cost Objects

Normal
Treating patients: $3.44 x 5,000 $ 17,200
Providing hygientic care: $5.44 x 5,000 27,200
Responding to requests: $1.93 x 30,000 57,900
Monitoring patients: $0.68 x 20,000 13,600
Total cost $115,900
Units ÷ 10,000
Nursing cost per patient day $ 11.59

12-28
 Cardiology Ward Example (Cont’d)
Assigning Cost: Final Cost Objects

Intermediate
Treating patients: $3.44 x 10,000 $ 34,400
Providing hygientic care: $5.44 x 2,500 13,600
Responding to requests: $1.93 x 40,000 77,200
Monitoring patients: $0.68 x 60,000 40,800
Total cost $166,000
Units ÷ 5,000
Nursing cost per patient day $ 33.20

12-29
 Cardiology Ward Example (Cont’d)
Assigning Cost: Final Cost Objects

Intensive Care
Treating patients: $3.44 x 15,000 $ 51,600
Providing hygientic care: $5.44 x 8,500 46,240
Responding to requests: $1.93 x 10,000 19,300
Monitoring patients: $0.68 x 120,000 81,600
Total cost $198,740
Units ÷ 3,000
Nursing cost per patient day $ 66.25

12-30
 Activity-Level Classification
Unit-level activities are those that are performed
each time a unit is produced.
Examples: Power and machine hours are used
each time a unit is produced. Direct
materials and direct labor activities
are also unit-level activities, even
though they are not overhead costs.

12-31
 Activity-Level Classification

Batch-level activities are those

that are performed each time a
batch of products is produced.
Examples: Setups,
inspections,
purchasing, and
material handling.

12-32
 Activity-Level Classification
Product-level (sustaining) activities are those activities
performed that enable the various products of a
company to be produced. These activities and their
costs tend to increase as the number of different
products increases.
Examples: Engineering changes, developing
product-testing procedures, introducing
new products, and expediting goods.

12-33
 Activity-Level Classification
Facility-level activities are those that sustain a factory's
general manufacturing processes.
Examples: Plant management, landscaping,
maintenance, security, property taxes, and plant
depreciation.

12-34
 Activities Classification and
Homogeneous Sets

A1 A2 A3 A4 A5

Proces
Activity sLevel
Filter

Processed –
P1
classified P2 P3 P4
activities

To activity filter
12-35
 From processed-classification activities

Activit
y Level
Filter

Unit Batch Product Facility

Level Level Level Level

Drive Drive Drive

Level-
r r r
Classification
Filter Filter Homogenous
Filter sets
activities
Set 1 Set 2 Set 3 Set 4 Set 5 Set 6 Set 7
12-36
 ABC Database
An ABC database is the collected data sets that are
organized and interrelated for use by an organization’s
activity-based costing information system.
A data set is a grouping of logically related data.

12-37
 End of

Chapter

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12-39