management accounting process costing and abc costing by: associate professor dr. gholamreza zandi...

Masters of Business AdministrationAccounting for Managers

Management AccountingProcess Costing and ABC Costing

By: Associate Professor Dr. GholamReza Zandi [email protected]

• Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost.

• Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods.

• The flow of costs through the manufacturing accounts is basically the same in both systems.

• Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost.

• Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods.

• The flow of costs through the manufacturing accounts is basically the same in both systems.

Similarities Between Job-Orderand Process Costing

• Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period.

• Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs.

• Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

• Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period.

• Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs.

• Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job on the job cost sheet.

Differences Between Job-Orderand Process Costing

Process costing is used for products that are:a. Different and produced continuously.b. Similar and produced continuously.c. Individual units produced to customer specifications.d. Purchased from vendors.

Process costing is used for products that are:a. Different and produced continuously.b. Similar and produced continuously.c. Individual units produced to customer specifications.d. Purchased from vendors.

Quick Check

Processing Departments

Any location in an organization where materials, labor or overhead are added to the product.

The activities performed in a processingdepartment are performed uniformly on all

units of production. Furthermore, the output ofa processing department must be

homogeneous.

FinishedGoods

FinishedGoods

Cost of GoodsSold

Cost of GoodsSold

Work inProcess

Direct MaterialsDirect Materials

Direct LaborDirect Labor

ManufacturingOverhead


Flow of Materials, Labor and Overhead Costs

FinishedGoods

FinishedGoods

Cost of GoodsSold

Cost of GoodsSold




JobsJobs

Costs are traced andapplied to individual

jobs in a job-ordercost system.

Costs are traced andapplied to individual

jobs in a job-ordercost system.

Direct MaterialsDirect Materials


FinishedGoods

FinishedGoods

Cost of GoodsSold

Cost of GoodsSold




ProcessingDepartmentProcessing

Department

Costs are traced and applied to departments in a

process cost system.

Costs are traced and applied to departments in a

process cost system.Direct MaterialsDirect Materials


For purposes of this example, assume there are two processing

departments – Departments A and B.

We will use T-accounts and journal entries.

T-Account and Journal EntryViews of Process Cost Flows

Raw Materials

Work in Process Department B

Work in Process Department A

• DirectMaterials

• Direct Materials


Process Cost Flows(in T-Account form)

GENERAL JOURNAL Page 4

Date DescriptionPost. Ref. Debit Credit

Work in Process - Department A XXXXX

Work in Process - Department B XXXXX

Raw Materials XXXXX

To record the use of direct material.

Process Cost Flows(in journal entry form)


Work in Process Department ASalaries and Wages

Payable



• Direct Labor

• Direct Labor • Direct

Labor






Salaries and Wages Payable XXXXX

To record direct labor costs.



Work in Process Department A

Manufacturing Overhead

• OverheadApplied to

Work inProcess

• AppliedOverhead

• AppliedOverhead

• Direct Labor


• Direct Labor


• Actual Overhead






Manufacturing Overhead XXXXX

To apply overhead to departments.



Work in ProcessDepartment A

• Direct Materials• Direct

Labor• AppliedOverhead



Transferred to Dept. B

• Transferred from Dept. A






To record the transfer of goods from

Department A to Department B.


Finished Goods Work in Process Department B

• Cost of Goods

Manufactured




• Cost of Goods

Manufactured




Finished Goods XXXXX


To record the completion of goods

and their transfer from Department B

to finished goods inventory.


Finished Goods

Cost of Goods Sold


• Cost of Goods

Manufactured




• Cost of GoodsSold

• Cost of GoodsSold

• Cost of Goods

Manufactured




Cost of Goods Sold XXXXX

Finished Goods XXXXX

To record cost of goods sold.


Equivalent Units of Production

Equivalent units are the product of the numberof partially completed units and the percentage

of completion of those units.

Equivalent units are the product of the numberof partially completed units and the percentage

of completion of those units.

We need to calculate equivalent units because a department usually has some partially completed

units in its beginning and ending inventory.

We need to calculate equivalent units because a department usually has some partially completed

units in its beginning and ending inventory.

Two half completed products are equivalent to one completed product.

Two half completed products are equivalent to one completed product.

So, 10,000 units 70% completeare equivalent to 7,000 complete units.

So, 10,000 units 70% completeare equivalent to 7,000 complete units.

+ = 1

Equivalent Units – The Basic Idea

For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process that are 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 b. 11,500 c. 13,500 d. 15,000


Quick Check



10,000 units + (5,000 units × 0.30) = 11,500 equivalent units

Quick Check

Calculating Equivalent Units

Equivalent units can be calculated two ways:

The First-In, First-Out Method (FIFO).

The Weighted-Average Method.

Equivalent units can be calculated two ways:

The First-In, First-Out Method (FIFO).

The Weighted-Average Method.

The weighted-average method . . .• Makes no distinction between work done in prior or current periods.• Blends together units and costs from prior and current periods.

The weighted-average method . . .• Makes no distinction between work done in prior or current periods.• Blends together units and costs from prior and current periods.

Characteristics of the Weighted Average Method

The equivalent units of production for a department are the number of units transferred to the next

department (or finished goods) plus the equivalent units in the department’s ending work in process

inventory.

The equivalent units of production for a department are the number of units transferred to the next

department (or finished goods) plus the equivalent units in the department’s ending work in process

inventory.

Direct labor costsmay be small

in comparison toother product

costs in processcosting systems.




DirectMaterials

Type of Product Cost

Dol

lar A

mou

nt

DirectLabor

Conversion

Treatment of Direct Labor

Type of Product Cost

Dol

lar A

mou

nt

Conversion

Direct labor and manufacturing overhead may becombined into one product cost called conversion.Direct labor and manufacturing overhead may becombined into one product cost called conversion.

DirectMaterials

Treatment of Direct Labor







Weighted-Average Example

Percent Completed

Shaping and Milling Department Units Materials Conversion

Beginning work in process 200 55% 30%

Units started into production in May 5,000

Units completed during May and 4,800 100% 100% transferred to the next department

Ending working process 400 40% 25%

Double Diamond Skis reported the following activity in Shaping and Milling Department for

the month of May:


The first step in calculating the equivalent unitsis to identify the units completed and transferred

out of the Department in May (4,800 units).

Materials Conversion

Units completed and transferred to the next department 4,800 4,800




Work in process, June 30:

400 units × 40% 160

Equivalent units of Production in during the month of May 4,960

The second step is to identify the equivalent units of production in ending work in process with respect to

materials for the month (160 units) and add this to the 4,800 units from step one.





400 units × 40% 160

400 units × 25% 100

Equivalent units of Production in during the month of May 4,960 4,900

The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the

month (100 units) and add this tothe 4,800 units from step one.


Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process

Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process




400 units × 40% 160

400 units × 25% 100

Equivalent units of Production in during the month of May 4,960 4,900


BeginningWork in Process

200 Units55% Complete

EndingWork in Process


5,000 Units Started

4,800 Units Startedand Completed

MaterialsMaterials

4,800 Units Completed 160 Equivalent Units 400 × 40%

4,960 Equivalent units of production

5,000 Units Started

4,800 Units Completed


100 Equivalent Units 400 × 25%






ConversionConversion


The following table includes some additional facts for DoubleDiamond Skis’ Shaping and Milling Department for May.


Computing Cost Per Equivalent Unit

Beginning work in process: 200 units

Materials: 55% complete $ 9,600Conversion: 30% complete 5,575

Production started during May 5,000 unitsProduction completed during May 4,800 units

Costs added to production in MayMaterials cost $ 368,600Conversion cost 350,900

Ending work in process 400 unitsMaterials: 40% completeConversion: 25% complete






Compute and Apply Costs

The formula for computing thecost per equivalent unit is :

Cost perequivalent

unit

=

Cost of beginningwork in process

inventory Cost added during the

period

Equivalent units of production

+


TotalCost Materials Conversion

Cost to be accounted for: Work in process, May 1 15,175$ 9,600$ 5,575$ Costs added in the Shipping and Milling Department 719,500 368,600 350,900

Total cost 734,675$ 378,200$ 356,475$

Equivalent units 4,960 4,900

Cost per equivalent unit

Here is a schedule with the costand equivalent unit information.


Cost to be accounted for: Work in process, May 1 15,175$ 9,600$ 5,575$ Costs added in the Shipping and Milling Department 719,500 368,600 350,900

Total cost 734,675$ 378,200$ 356,475$


Cost per equivalent unit 76.25$ 72.75$ Total cost per equivalent unit = $76.25 + $72.75 = $149.00


$378,200 ÷ 4,960 units = $76.25

Here is a schedule with the costand equivalent unit information.

$356,475 ÷ 4,900 units = $72.75

Computing the Cost of EndingWork in Process Inventory

Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100

Cost of ending work in process inventory -$ -$ -$

Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$

Shaping and Milling DepartmentCost of Ending Work in Process Inventory and the Units Transferred Out

Step 1: Record the equivalent units of production in ending work in process inventory.

Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$




Step 2: Record the cost per equivalent unit.





Step 3: Compute the cost of ending work in process inventory.

Computing the Cost ofUnits Transferred Out



Shaping and Milling DepartmentCost of Ending Work in Porcess Inventory and the Units Transferred Out

Step 1: Record the units transferred out to the next department.



Shaping and Milling DepartmentCost of Ending Work in Porcess Inventory and the Units Transferred Out







Step 3: Compute the cost of units transferred out.

Reconciling Costs

Step 1: Compute the costs to be accounted for by adding the cost of beginning work in process and the production costs added in May.

Costs to be accounted for: Cost of beginning work in process inventory 15,175$ Costs added to production during the period 719,500 Total cost to be accounted for 734,675$

Shaping and Milling DepartmentCost Reconciliation


Cost accounted for as follows: Cost of ending work in process inventory 19,475$ Cost of units transferred out 715,200 Total cost accounted for 734,675$


Reconciling Costs

Step 2: Compute the costs to accounted for by adding the cost of ending work in process and the cost of units transferred out in May.

FIFO vs. Weighted-Average Method

The FIFO method (generally considered more accurate that the weighted-average method) differs from the weighted-average method in

two ways:

1. The computation of equivalent units.

2. The way in which the costs of beginning inventory are treated.

1. The computation of equivalent units.

2. The way in which the costs of beginning inventory are treated.

Equivalent Units – FIFO Method

Percent Completed

Units Materials Conversion

Work in process, June 1 200 55% 30%

Units started into production in June 5,000

Units completed and transferred out 4,800 of Department A during June

Work in process, June 30 400 40% 25%

Let’s revisit the Double Diamond Skis example. Assume the following activity is reported in the

Shaping and Milling Department for May:


Step 1: Determine equivalent units needed to complete beginning inventory.


To complete beginning work in process: Materials: 200 units × (100% - 55%) 90

Conversion: 200 units × (100% - 30%) 140


Step 2: Determine units started and completed during the period.




Units started and completed during May 4,600 4,600


Step 3: Add the equivalent units in ending working in process inventory.




Units started and completed during May 4,600 4,600

Ending work in process

Materials: 400 units × 40% complete 160 Conversion: 400 units × 25% complete 100

Equivalent units of production 4,850 4,840





5,000 Units Started


FIFO Example

MaterialsMaterials

4,600 Units Completed 160 Equivalent Units

400 × 40%


90 Equivalent Units200 × 45%





5,000 Units Started


FIFO Example

ConversionConversion

4,600 Units Completed 100 Equivalent Units

400 × 25%


140 Equivalent Units200 × 70%

Equivalent Units:Weighted Average vs. FIFO

Materials ConversionEquivalent units - weighted average method 4,960 4,900 Less equivalent units in beginning inventory: 200 units × 55% 110 200 units × 30% 60 Equivalent units - FIFO method 4,850 4,840

As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of

production per the weighted-average method to obtain the equivalent units

of production under the FIFO method.

As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of

production per the weighted-average method to obtain the equivalent units

of production under the FIFO method.

Cost per Equivalent Unit - FIFO














The formula for computing the cost per equivalent unit under FIFO method is:

Cost perequivalent

unit

= Cost added during the period

Equivalent units of production



Costs added in the Shaping and Milling Department 719,500$ 368,600$ 350,900$


Cost per equivalent unit 76.00$ 72.50$ Total cost per equivalent unit = $76.00 + $72.50 = $148.50


Step 1: Record the equivalent units of production in ending work in process inventory.




Step 3: Compute the cost of ending work in process inventory.






Step 1: Record the cost in beginning work in process inventory.

Materials Conversion TotalUnits transferred out: Cost in beginning work in process (WIP) 9,600$ 5,575$ 15,175$ Cost to complete beginning WIP: Equivalent units to complete 90 140 Cost per equivalent unit 76.00$ 72.50$ Cost to complete beginning WIP 6,840$ 10,150$ 16,990$ Cost of units started and completed in May Units started and completed in May 4,600 4,600 Cost per equivalent unit 76.00$ 72.50$ Cost of units started and completed in May 349,600$ 333,500$ 683,100$ Cost of units transferred out 715,265$


Step 2: Determine the cost to complete the units in beginning work in process inventory.




Step 3: Determine the cost of units startedand completed this period.


Materials Conversion TotalUnits transferred out: Cost in beginning work in process (WIP) 9,600$ 5,575$ 15,175$ Cost to complete beginning WIP: Equivalent units to complete 90 140 Cost per equivalent unit 76.00$ 72.50$ Cost to complete beginning WIP 6,840$ 10,150$ 16,990$ Cost of units started and completed in May Units started and completed in May 4,600 4,600 Cost per equivalent unit 76.00$ 72.50$ Cost of units started and completed in May 349,600$ 333,500$ 683,100$


Step 4: Determine the total cost of units transferred out.




Reconciling Costs




A Comparison of Costing Methods

In a lean production environment, FIFO and weighted-average methods yield similar

unit costs.

In a lean production environment, FIFO and weighted-average methods yield similar

unit costs.

When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period.

When considering cost control, FIFO is superior to weighted-average because it does not mix costs of the current period with costs of the prior period.

CostCost

Activity-Based Costing (ABC)

Consumption of ResourcesConsumption of Resources

ActivitiesActivities

Cost Objects(e.g., products and customers)

Cost Objects(e.g., products and customers)

A number of allocation bases are used for assigning costs to products.


ActivityAn event that causes the

consumption of overhead resources

Setting upmachines

Examples of Activities

Admitting hospitalpatients

Opening a bank account

Billingcustomers


Activity Cost Pool

A “cost bucket” in which costs related to a particular activity

are accumulated

Activity Measure

Expresses how much of the activity is carried out and is used

as the allocation base for applying overhead costs


Activity RateA predetermined overhead rate

for each activity cost pool.


For each activity inisolation, this system works exactly

like the job-order costing systemdescribed in Chapter 2.

A predetermined overhead rate is computed foreach activity and then applied to jobs andproducts based on the amount of activity

consumed by the job or product.

A predetermined overhead rate is computed foreach activity and then applied to jobs andproducts based on the amount of activity

consumed by the job or product.

Designing an Activity-BasedCosting System

The challenge is to select a reasonably small number of activities that explain the

bulk of the variation in overhead costs.

The challenge is to select a reasonably small number of activities that explain the

bulk of the variation in overhead costs.

Activities are usually chosen by interviewing a broad range of managers to find out what activities they think consume most of the

organization’s resources.

Activities are usually chosen by interviewing a broad range of managers to find out what activities they think consume most of the

organization’s resources.

Related activities arefrequently combined to reduce

the amount of detail andrecord-keeping costs.

An activity dictionary defines each of the activitiesthat will be included in the activity-based costingsystem and how the activities will be measured.

An activity dictionary defines each of the activitiesthat will be included in the activity-based costingsystem and how the activities will be measured.

For example, several activities maybe involved in handling and moving

raw materials, but these may becombined into a single activity

entitled material handling.

Designing an Activity-BasedCosting System

Hierarchy of Activities

Level Activities Activity MeasureUnit-level Processing units on machines Machine-hours

Processing units by hand Direct labor-hoursConsuming factory supplies Units produced

Batch-level Processing purchase orders Purchase orders processedProcessing production orders Production orders processedSetting up equipment Number of setupsHandling materials Pounds of material handled

Product-level Testing new products Hours of testing timeAdministering parts inventories Number of part typesDesigning products Hours of design time

Facility-level General factory administration Direct labor-hoursPlant building and grounds Direct labor-hours

Graphic Example of Activity-Based Costing

LaborRelated Pool

LaborRelated Pool

MachineRelated Pool

MachineRelated Pool

SetupPool

SetupPool

ProductionOrder PoolProductionOrder Pool

GeneralFactory Pool

GeneralFactory Pool

PartsAdmin. Pool

PartsAdmin. Pool

First-Stage Cost Assignment

Various Manufacturing Overhead CostsVarious Manufacturing Overhead Costs

Unit-LevelActivity

Batch-LevelActivity

Facility-LevelActivity

Product-LevelActivity

Graphic Example ofActivity-Based Costing

LaborRelated Pool

LaborRelated Pool

MachineRelated Pool

MachineRelated Pool

SetupPool

SetupPool

ProductionOrder PoolProductionOrder Pool

GeneralFactory Pool

GeneralFactory Pool

PartsAdmin. Pool

PartsAdmin. Pool

First-Stage Cost Assignment

Various Manufacturing Overhead CostsVarious Manufacturing Overhead Costs

ProductsProducts

$/DLH $/MH $/Setup $/Order $/MH$/Part Type

Second-Stage Allocations

Using Activity-Based CostingComtek Sound, Inc.

Comtek Sound, Inc. makes two products: CD players and DVD players.

The company has been losing bids to supply CD players, its main product, to lower priced competitors.

The company has been winning all bids to supply DVD players, its secondary product.

Comtek Sound, Inc. makes two products: CD players and DVD players.

The company has been losing bids to supply CD players, its main product, to lower priced competitors.

The company has been winning all bids to supply DVD players, its secondary product.


For the current year, Comtek has budgeted sales of 50,000 DVD units and 200,000 CD units.

Comtek’s traditional cost system applies manufacturing overhead to products based on direct labor hours.

Both products require two direct labor-hours to complete, for a total of 500,000 direct labor hours.

For the current year, Comtek has budgeted sales of 50,000 DVD units and 200,000 CD units.

Comtek’s traditional cost system applies manufacturing overhead to products based on direct labor hours.

Both products require two direct labor-hours to complete, for a total of 500,000 direct labor hours.

HoursDVDs: 50,000 units @ 2 hours per unit = 100,000 CDs: 200,00 units @ 2 hours per unit = 400,000 Total direct labor-hours 500,000


Unit costs for materials and labor are: Unit costs for materials and labor are:DVD CDUnits Units

Direct materials 90$ 50$ Direct Labor 20$ 20$

Total manufacturing overhead costs for the current year are estimated to be $10,000,000. The

company develops the following overhead rate based upon labor-hours:

Total manufacturing overhead costs for the current year are estimated to be $10,000,000. The

company develops the following overhead rate based upon labor-hours:

Predeterminedoverhead rate = $20 per DLH=

$10,000,000500,000 DLHs

Direct Labor-Hours as a Base

DVD Unit CD UnitDirect materials 90$ 50$ Direct labor 20 20 Manufacturing overhead 40 40 (2 DLHs x $20 per DLH)

Unit product cost 150$ 110$

Direct Labor-Hours as a Base

Since each product requires two hours of direct labor, $40 of overhead is assigned to each

product.

Since each product requires two hours of direct labor, $40 of overhead is assigned to each

product.

The ABC project team at Comtek hasdeveloped the following basic information.

Activity and Activity Measures

Estimated Overhead

Cost Total DVD CD

Labor related (DLH) 800,000$ 500,000 100,000 400,000 Machine related (MH) 2,100,000 1,000,000 300,000 700,000 Machine setups (setups) 1,600,000 4,000 3,000 1,000 Production orders (orders) 3,150,000 1,200 800 400 Parts administration (part types) 350,000 700 400 300 General factory (MH) 2,000,000 1,000,000 300,000 700,000

10,000,000$

Expected Activity

Computing Activity Rates

We can calculate the following activity rates:

Activity and Activity Measures

Estimated Overhead

Cost

Total Expected Activity

Labor related (DLHs) 800,000$ ÷ 500,000 = 1.60$ per DLHMachine related (MHs) 2,100,000 ÷ 1,000,000 = 2.10 per MHMachine setups (setups) 1,600,000 ÷ 4,000 = 400.00 per setupProduction orders (orders) 3,150,000 ÷ 1,200 = 2,625.00 per orderParts administration (part types) 350,000 ÷ 700 = 500.00 per part typeGeneral factory (MHs) 2,000,000 ÷ 1,000,000 = 2.00 per MH

10,000,000$

Activity Rate

Using the new activity rates, let’s assign overheadto the two products based upon expected activity.

Computing Activity Rates

Computing Overhead Cost per Unit

Activity and Activity MeasuresExpected Activity

Activity Rate

Labor related (DLHs) 100,000 × 1.60$ = 160,000$ Machine related (MHs) 300,000 × 2.10 = 630,000 Machine setups (setups) 3,000 × 400.00 = 1,200,000 Production orders (orders) 800 × 2,625.00 = 2,100,000 Parts administration (part types) 400 × 500.00 = 200,000 General factory (MHs) 300,000 × 2.00 = 600,000 Total overhead cost assigned 4,890,000$ Number of units produced 50,000 Overhead cost per unit 97.80$

Amount

DVD Units

Computing Overhead Cost per Unit

Activity and Activity MeasuresExpected Activity

Activity Rate

Labor related (DLHs) 400,000 × 1.60$ = 640,000$ Machine related (MHs) 700,000 × 2.10 = 1,470,000 Machine setups (setups) 1,000 × 400.00 = 400,000 Production orders (orders) 400 × 2,625.00 = 1,050,000 Parts administration (part types) 300 × 500.00 = 150,000 General factory (MHs) 700,000 × 2.00 = 1,400,000 Total overhead cost assigned 5,110,000$ Number of units produced 200,000 Overhead cost per unit 25.55$

Amount

CD Units

Note that the unit product cost of a CD unit decreased from $110 to $95.55 . . . .

Note that the unit product cost of a CD unit decreased from $110 to $95.55 . . . .

. . . . while the unit cost of a DVD unit increased from $150 to $207.80.

. . . . while the unit cost of a DVD unit increased from $150 to $207.80.

Comparing the Two Approaches

DVD Unit CD Unit DVD Unit CD UnitDirect material 90.00$ 50.00$ 90.00$ 50.00$ Direct labor 20.00 20.00 20.00 20.00 Manufacturing overhead 97.80 25.55 40.00 40.00 Unit product cost 207.80$ 95.55$ 150.00$ 110.00$

Activity-Based Costing Direct-Labor Costing




The ABC system assigns $14.45 less overhead than the traditional

system to each CD player.

The ABC system assigns $14.45 less overhead than the traditional

system to each CD player.




The ABC system assigns $57.80 more overhead than the traditional

system to each DVD player.

The ABC system assigns $57.80 more overhead than the traditional

system to each DVD player.



When a company implements activity-based costing, overhead cost often shifts from high-volume to low-

volume products with a higher unit product cost resulting for the low-volume products.

When a company implements activity-based costing, overhead cost often shifts from high-volume to low-

volume products with a higher unit product cost resulting for the low-volume products.

Low-volume product

Shifting of Overhead Cost



High-volume product


The traditional system assigns the same amount of all overhead costs to each CD or DVD player

($40 per unit).

The traditional system assigns the same amount of all overhead costs to each CD or DVD player

($40 per unit).


DVD Units CD UnitsNumber of units produced per year 50,000 200,000 Number of production orders issued per year 800 400 Number of units processed per production order 62.5 500

1. Compute the number of units processedper production order for each product.

1. Compute the number of units processedper production order for each product.

Production Orders Activity Cost Pool (a batch-level cost pool)

The ABC system assigns different amounts ofProduction Order-related overhead costs to each product.

This fact can be illustrated in a two-step process.

Production Orders Activity Cost Pool (a batch-level cost pool)

The ABC system assigns different amounts ofProduction Order-related overhead costs to each product.

This fact can be illustrated in a two-step process.


2. Compute production order cost per unit for each product.2. Compute production order cost per unit for each product.

DVD Units CD UnitsCost to issue a production order 2,625$ 2,625$ Average number of units processed per production order 62.5 500 Production order cost per unit 42.00$ 5.25$

Notice, the costs are being shifted from the highvolume CD players to the low volume DVD players.Notice, the costs are being shifted from the high

volume CD players to the low volume DVD players.

Activity-Based ManagementFocuses on managing activities to eliminate waste

and reduce delays and defects.

Activity-Based ManagementFocuses on managing activities to eliminate waste

and reduce delays and defects.

Targeting Process Improvements

An ABC system can help identifyareas where the company can benefitfrom improving its current processes.

An ABC system can help identifyareas where the company can benefitfrom improving its current processes.

The first step in any improvementprogram is deciding what to improve.

The first step in any improvementprogram is deciding what to improve.

Targeting Process Improvements

The Theory of Constraintsapproach targets the

highest impactimprovement opportunities.

The Theory of Constraintsapproach targets the

highest impactimprovement opportunities.

Activity rates can beused to target areaswhere costs seemexcessively high.

Activity rates can beused to target areaswhere costs seemexcessively high.

Benchmarking can be used to compare activity cost information with world-class standards of performance

achieved by other organizations.

Benchmarking can be used to compare activity cost information with world-class standards of performance

achieved by other organizations.

Benefits of Activity-Based Costing

ABC improves the accuracy of product costing by:• Increasing the number of cost pools used to accumulate

overhead costs.• Using activity cost pools that are more homogeneous than

departmental cost pools.• Assigning overhead costs using activity measures that cause

those costs, rather than relying solely on direct labor hours.

ABC improves the accuracy of product costing by:• Increasing the number of cost pools used to accumulate

overhead costs.• Using activity cost pools that are more homogeneous than

departmental cost pools.• Assigning overhead costs using activity measures that cause

those costs, rather than relying solely on direct labor hours.

Activity-based costing also highlights activities that could benefit most from process

improvement efforts, such as Six Sigma.

Activity-based costing also highlights activities that could benefit most from process

improvement efforts, such as Six Sigma.

Costs of implementing an ABC system may outweighthe benefits. However, the benefits are more likely to be worth the costs when:

1. Products differ substantially in volume, batch size, and in activities required.

2. Conditions have changed substantially since the existing cost system was established.

3. Overhead costs are high and increasing and no one seems to understand why.

4. Management does not trust the existing cost system and it ignores data from it when making decisions.

Costs of implementing an ABC system may outweighthe benefits. However, the benefits are more likely to be worth the costs when:

1. Products differ substantially in volume, batch size, and in activities required.

2. Conditions have changed substantially since the existing cost system was established.

3. Overhead costs are high and increasing and no one seems to understand why.

4. Management does not trust the existing cost system and it ignores data from it when making decisions.

Limitations Activity-Based Costing

The cost in each activity pool is strictly proportional to its activity measure. When this assumption is

violated, the accuracy of ABC data can be called into question.

The cost in each activity pool is strictly proportional to its activity measure. When this assumption is

violated, the accuracy of ABC data can be called into question.

Activity-Based CostingCritical Assumption

For example, managers should be particularly alert to product costs that contain allocated facility-level

costs.

For example, managers should be particularly alert to product costs that contain allocated facility-level

costs.

Modifying the ABC Model

The illustrations in the chapter assume that ABC is being used for external reporting purposes. If the system is used for internal decision-making purposes, two important modifications should be made: 1. Selling and administrative costs should be assigned to products, where appropriate. 2. Facility-level costs should be removed from product costs.

The illustrations in the chapter assume that ABC is being used for external reporting purposes. If the system is used for internal decision-making purposes, two important modifications should be made: 1. Selling and administrative costs should be assigned to products, where appropriate. 2. Facility-level costs should be removed from product costs.

Sarvik Company uses activity-based costing. The company has five cost pools shown below.

Sarvik Company uses activity-based costing. The company has five cost pools shown below.

Activity Cost Pool Activity Measure

Estimated Overhead

CostMachine related Machine hours 175,000$ 5,000 MHsPurchase orders Number of orders 63,000 700 ordersMachine setups Number of setups 92,000 460 setupsProduct testing Number of tests 160,000 200 testsGeneral factory Direct labor hours 300,000 25,000 DLHs

790,000$

Expected Activity

Cost Flows in an ABC System

Activity rates are determined as follows:Activity rates are determined as follows:

Activity Cost Pool

Estimated Overhead

Cost

Total Expected Activity

Machine related 175,000$ ÷ 5,000 MHs = 35$ per MHPurchase orders 63,000 ÷ 700 orders = 90$ per orderMachine setups 92,000 ÷ 460 setups = 200$ per setupProduct testing 160,000 ÷ 200 tests = 800$ per testGeneral factory 300,000 ÷ 25,000 DLH = 12$ per DLH

790,000$

Activity Rate


Overhead is applied on the basis of actual activities during the year.

Overhead is applied on the basis of actual activities during the year.

Activity Cost PoolActivity

RateActual Activity

Applied Overhead

CostMachine related $35/MH × 4,600 MHs = 161,000$ Purchase orders $90/order × 800 orders = 72,000 Machine setups $200/setup × 500 setups = 100,000 Product testing $800/test × 190 tests = 152,000 General factory $12/DLH × 23,000 DLHs = 276,000 Total Overhead Applied 761,000$


Selected transactions recorded by the company:

a. Raw materials purchased on account, $915,000.

b. Raw materials used in production, $900,000 ($810,000 direct and $90,000 indirect).

c. Factory labor costs, $370,000 ($95,000 direct and $275,000 indirect).

d. Depreciation of factory assets, $180,000.

e. Miscellaneous manufacturing overhead costs incurred on account, $230,000.

f. Manufacturing overhead applied, $761,000.

g. Goods costing $1,650,000 were manufactured.

Selected transactions recorded by the company:

a. Raw materials purchased on account, $915,000.

b. Raw materials used in production, $900,000 ($810,000 direct and $90,000 indirect).

c. Factory labor costs, $370,000 ($95,000 direct and $275,000 indirect).

d. Depreciation of factory assets, $180,000.

e. Miscellaneous manufacturing overhead costs incurred on account, $230,000.

f. Manufacturing overhead applied, $761,000.

g. Goods costing $1,650,000 were manufactured.


The following journal entries would be usedto record transactions (a) and (b).

The following journal entries would be usedto record transactions (a) and (b).


Description Debit Credita. Raw Materials 915,000

Accounts Payable 915,000

b. Work in Process 810,000 Manufacturing Overhead 90,000 Raw Materials 900,000

The following journal entries would be usedto record transactions (c) and (d).

The following journal entries would be usedto record transactions (c) and (d).


Description Debit Creditc. Work in Process 95,000

Manufacturing Overhead 275,000 Salaries and Wages Payable 370,000

d. Manufacturing Overhead 180,000 Accumulated Depreciation 180,000

Description Debit Credite. Manufacturing Overhead 230,000

Cash/Accounts Payable 230,000

The following journal entry would be used to record transaction (e).

The following journal entry would be used to record transaction (e).


Description Debit Creditf. Work in Process 761,000

Manufacturing Overhead 761,000

The following journal entry would be used to record transaction (f).

The following journal entry would be used to record transaction (f).


Description Debit Creditg. Finished Goods 1,650,000

Work in Process 1,650,000

The following journal entry would be used to record transaction (g).

The following journal entry would be used to record transaction (g).


Bal. 14,000

Manufacturing Overhead

(b) 90,000(c) 275,000(d) 180,000(e) 230,000

(g) 761,000

Underapplied Overhead CostsUnderapplied

Overhead Costs



The flow of costs through Raw Materials, Work in

Process, and other accounts is the same under activity based

costing.The only difference in

activity based costing is that more than one

predetermined overhead rate is used to apply costs

to products.

The End

management accounting process costing and abc costing by: associate professor dr. gholamreza zandi...

Documents

process costing slide

abc costing

overhead costs

unit costs

flow of costs

job cost sheet

manufacturing overhead

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