ACTG 321 Agenda for Lecture 8

• Activity-Based Costing Overview

• Levi Strauss factory example

ACTG 321ACTG 321Agenda for Lecture 8Agenda for Lecture 8

PRODUCT COST BY INDUSTRYPRODUCT COST BY INDUSTRY

0

10

20

30

40

50

60

70

Aero-space

Compu-ters

MotorVehicles

Direct Materials

Direct Labor

Manufacturing O/ H

Overview of Costing for Manufacturing Companies

Manufacturing Overhead

Machine Hours

DirectLabor

Direct Materials

IndirectCost Pool

CostAllocationBase

CostObject

DirectCosts

Product Cost

Five Step Approach to Job Costing1 Identify the cost object.

2 Identify the direct costs for the job.

3 Identify the indirect cost pools associated with the job.

4 Select the cost allocation base for each indirect cost pool.

5 Calculate the rate per unit of the allocation base to allocate indirect costs.

Calculation of Overhead Rates

Total Quantity of the CostAllocation Base

Total Costs in the Cost Pool

Overhead Rate =

Activity-Based CostingActivity-Based Costing

The key assumption in Activity-Based Costing is that overhead costs are caused by a variety of activities, and that different products utilize these activities in a non-homogeneous fashion. ABC attempts to select as the allocation base the best cost driver for each overhead cost item; i.e., the cost driver that best captures the cause and effect relation-ship between products and overhead costs.

Overview of Costing for Manufacturing Companies

Manufacturing Overhead

Machine Hours

DirectLabor

Direct Materials

IndirectCost Pool

CostAllocationBase

CostObject

DirectCosts

Product Cost

Overview of Costing Under ABC

INDIRECT COSTSDIRECT COSTS

D.M. D.L. WARRANTY

# OF PARTS MACH. HRS D.L. HR.S

PURCH-ASING

PERSONNEL MACHINE SHOP

INDIRECTCOST POOLS

COST ALLO-CATION BASES

COSTOBJECT

COSTTRACING

DIRECTCOSTS

Cost Allocation Bases used for Cost Allocation Bases used for Manufacturing OverheadManufacturing Overhead

U.S. ManufacturersU.S. Manufacturers

31%

31%

12%

4% 5% 17%

Direct labor-hr.sDirect labor-$Machine Hr.sDirect Material $Units of ProductionOther

Cost Allocation Bases used for Cost Allocation Bases used for Manufacturing OverheadManufacturing Overhead Japanese Manufacturers Japanese Manufacturers

507

12

11

1621

Direct Labor-hr.s

Direct Labor-$

Machine-hr.s

Direct Materials $

Units of Production

Prime cost (%)

Cost Allocation Bases used for Cost Allocation Bases used for Manufacturing OverheadManufacturing Overhead

U.K. ManufacturersU.K. Manufacturers

31

29

27

17

22 10

Direct labor-hr.s

Direct labor-$

Machine hr.s

Direct materials $

Units of production

Prime cost (%)

• Activity-Based Costing Overview

• Levi Strauss factory example

ACTG 321ACTG 321Agenda for Lecture 8Agenda for Lecture 8

Activity-Based Costing at LS&Co

SHIP-PING

CUTTINGROOM

PRODUCTIONLINE 1

LINE 2

FRONT OFFICECAFE-TERIA

COSTS: SALARIES MAINTENANCE DEPRECIATION

RECEIV-ING

Activity-Based Costing at LS&Co

Production Information:

501s Dockers

units made 420,000 200,000

direct labor hrs 70,000 40,000

Rolls of fabric 1,750 640

Boxes shipped 52,500 20,000

Activity-Based Costing at LS&CoOverhead Costs:

Forklifts:

Salaries $ 80,000 Maintenance 8,000 Depreciation 7,500 Other 2,500

total for forklifts 98,000

All other Overhead 1,400,000

Total Overhead $1,498,000

Traditional Costing MethodOverhead Rate:

total overhead costs ÷ total direct labor hrs $1,498,000 / 110,000 hr.s

$13.62 per direct labor hour

How much of this $13.62 is for forklift costs?

$98K / 110K hr.s = $0.89 / direct labor hr.

Traditional Costing Method

Allocation to 501s:

$0.89 x 70,000 hours = $62,364

This is $0.15 per 501.

Allocation to Dockers:

$0.89 x 40,000 hours = $35,636

This is $0.18 per Docker.

$62,364 + $35,636 = $98,000

Activity-Based Costing MethodFirst Stage Allocation:

Allocate total costs of $98,000 to the Receiving and Shipping departments.

Forklifts spend 70% of their time in shipping, and 30% in receiving:

30% of $98,000 is $29,400

which is allocated to Receiving

70% of $98,000 = $68,600

which is allocated to Shipping

Activity-Based Costing Method

Receiving Department:

Overhead rate = $29,400 / 2390 rolls

= $12.30 per roll

Allocation to 501s:

1750 rolls x $12.30 per role = $21,527

Allocation to Dockers:

640 rolls x $12.30 per role = $7,873

Activity-Based Costing Method

Shipping Department:

Overhead rate =

$68,600 / 72,500 boxes = $0.946 per box

Allocation to 501s:

52,500 boxes x $0.946 per box = $49,676

Allocation to Dockers:

20,000 boxes x $0.946 per box = $18,924

Activity-Based Costing MethodTotal Forklift Costs:

501s:

from Receiving $ 21,527

from Shipping 49,676

Total $ 71,203 or $0.17/unit Dockers:

from Receiving $ 7,873

from Shipping 18,924

Total $ 26,797 or $0.14 /unit