Activity Based Costing

Acct 310
Professor Rick S. Hayes, Ph.D., CPA
MicroMash CPE Course Example
• Make sure that costing done correctly, reduce
costs
• Direct labor and materials costs [prime costs]–
easy to trace to product
• Manufacturing overhead is indirect cost – hard
to trace, control – estimate, calculate cost per
unit
Traditional Unit Based Cost (UBC)
Accounting
• Standard costing is about assigning overhead costs
based upon one predetermined rate based on
volume
• Easier, less accurate; Works best with one product;
• Could be misleading
• Standard costing – steps
1. Accumulate total overhead costs
2. Identify activity and total amount of activity that
best applies overhead costs to the product (base),
e.g. labor hours
3. Calculate application base rate
(total overhead/ total amount of the activity)
$20,000 total oh/ 1,000 labor hrs = $20 base rate
per hour worked
4. Apply overhead rate - Multiply base rate by total
base activity used for each product. A product
that takes 2 hours at $20 base rate would be
allocated $40 of overhead (2 x $20)
 Standard Costing Method

Total manufacturing overhead $10,000,000

Direct labor hours 500,000

10,000,000/50,000 = $20/labor hour application base

rate
$20 * 2 hours per product to mfg. = $40 overhead cost
per unit
Product A = manufacturing overhead cost per unit- $40
Product B = manufacturing overhead cost per unit- $40
Product A = total manufacturing cost /unit - $150
Product B = total manufacturing cost/unit - $110
 Standards
Standard costing
Costing Methodexample total
cost per unit

A B
Direct Materials $90 $50
Direct Labor @ $10/hr $20 $20
Manufacturing OH $40 $40
Total per unit cost $150 $110
The organization is viewed as a pool of activities. Many of these
activities will cut across deparments with departments often
participating in many different activities
ABC costing – steps
1. Re-categorize overhead costs into activity pools
2. Calculate total costs and total physical base for each
activity
3. Calculate application base rate for each category (total
overhead/ total physical base)
4. Calculate proportion of physical base for each category
5. Multiply rate by base for each product
6. Calculate total overhead cost for each product
7. Divide total cost for each product by total products
manufactured = overhead cost per unit
8. Add overhead cost per unit to direct labor cost per unit
and direct material cost per unit = total cost per unit
 Activity Based Costing
• Two stage allocation process
– Assign costs to pools, then assign to products using cost
drivers
• I.e. Sell 50,000 units – Product A, 200,000 units –
Product B = 250,000 units total
– Both require two direct labor hours to complete =
500,000 direct labor-hours
– Total manufacturing overhead = $10,000,000
 ABC Costing

Table 1 Expected activity

Activity Center and Costs Costs Total Product A Product B

Labor related (labor hours) $800,000 500,000 100,000 400,000

Machine related (machine hours) $2,100,000 1,000,000 300,000 700,000
Machine setups (# of setups) $1,600,000 4,000 3,000 1,000
Production orders (# orders) $450,000 1,200 400 800
Material receipts (# of receipts) $1,000,000 5,000 1,800 3,200
Parts administration ( part types) $350,000 700 400 300
Product testing (# of tests) $1,700,000 20,000 16,000 4,000
General overhead (machine
hours) $2,000,000 1,000,000 300,000 700,000

Total $10,000,000
 Total
Table 2 Estimated Expected Overhead
Overhead
Costs Activity Rate

Labor related $800,000 500,000 $1.60

Machine related $2,100,000 1,000,000 $2.10
Machine setups $1,600,000 4,000 $400.00
Production orders $450,000 1,200 $375.00
Material receipts $1,000,000 5,000 $200.00
Parts administration $350,000 700 $500.00
Product testing $1,700,000 20,000 $85.00
General Factory $2,000,000 1,000,000 $2.00
Table 3 Product A Product B

Labor related Rate * activity $160,000 $640,000

Machine related $630,000 $1,470,000
Machine setups $1,200,000 $400,000
Production orders $150,000 $300,000
Material receipts $360,000 $640,000
Parts administration $200,000 $150,000
Product testing $1,360,000 $340,000
General Factory $600,000 $1,400,000

Total $4,660,000 $5,340,000

Units produced 50,000 200,000

Overhead per unit $93.20 $26.70

Product A - manufacturing overhead costs = $93.20

Product B - manufacturing overhead costs = $26.70
 A B
Direct Materials $90 $50
Direct Labor @ $10/hr $20 $20
Manufacturing OH $93.20 $26.70
Total per unit cost $203.20 $96.70
QUESTIONS?
ABC Hierarchical Production Model
Facility Support Activities not ABC