Chapter 7: Some ABC Exhibits

MANAGEMENT AND ACCOUNTING WEB

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Management Accounting: Concepts, Techniques & Controversial Issues

James R. Martin

Chapter 7
Activity Based Product Costing

Some Key Exhibits

Exhibit 7-1: Summary of Cost Distortions in traditional costing	Figure 7-1: Cost Assignment Based on ABC Logic
Exhibit 7-2: Examples of Activity Cost Pools & Activity Measures	Exhibit 7-3: ABC Concepts & Terminology
Some Exhibits from Example 7-1

EXHIBIT 7-1
SUMMARY OF COST DISTORTIONS
THAT TEND TO OCCUR IN TRADITIONAL COST SYSTEMS

TYPE OF DIVERSITY	PRODUCT TYPE OR CHARACTERISTIC	TYPE OF COST DISTORTION THAT TENDS TO OCCUR IN TRADITIONAL COST SYSTEMS
Production volume	Low Volume specialty	Undercost, i.e., too little overhead is allocated to these products.
Production volume	High Volume main line	Overcost, i.e., too much overhead is allocated to these products.
Product Size	Small	Undercost
Product Size	Large	Overcost
Product Complexity	Complex design	Undercost
Product Complexity	Simple design	Overcost
Product Materials requirements	Requires many, or unique parts, i.e., only used on a single product.	Undercost
Product Materials requirements	Requires few, or common parts, i.e., same part used on many products.	Overcost
Product Machine setup requirements	Requires many, long or complex machine setups.	Undercost
Product Machine setup requirements	Requires few, short or simple machine setups.	Overcost

Figure 7-1 Cost Assignment Based on ABC Logic

EXHIBIT 7-2
EXAMPLES OF ACTIVITY COST POOLS AND ACTIVITY MEASURES

ACTIVITY COST POOL	POTENTIALLY USEFUL ACTIVITY MEASURES	PROBABLE COST CLASSIFICATION
Machining parts	Number of machine hours.	Unit level.
Purchasing	Number of purchase orders or ordering hours.	Product or batch level.
Receiving and Storing	Number of purchase orders or shipments received.	Product or batch level.
Engineering	Number of engineering work orders or hours.	Product level.
Packing	Number of shipments, number of cubic feet or packing hours.	Product or batch level.
Shipping	Number of pounds shipped.	Product or batch level.
Machine Setup	Number of setups or setup time.	Batch level.
Materials handling	Number of times handled or material handling hours.	Product or batch level.
Inventory control and materials planning	Number of part numbers or administrative hours.	Product or batch level.
Inspection and quality control	Number of inspections or inspections time.	Product or batch level.

EXHIBIT 7-3
ABC CONCEPTS AND TERMINOLOGY

Activities - A type of work or function.
Type	Definition	Examples
Main activities	A major type of work, function or high level activity.	Purchasing raw materials.
Sub activities	A lower level type of work, or activity that supports a main activity.	Preparing purchased orders.
Tasks	A minor type of work that supports a sub activity.	Calling vendors.
Sub tasks	Part of a task.	Dialing a vendor's phone number.

Drivers - Whatever causes the need for activities to be performed.
Type	Definition	Examples
Primary drivers	The initial cause of an activity that requires resources, i.e., whatever creates the demand for an activity.	Company's overall objectives, customer demands and product specifications.
Secondary drivers	A resource consuming activity that is caused by a previous activity or event.	Purchasing raw materials, preparing purchase orders.

Activity measures - A unit of measure chosen to represent an activity volume.
Type	Definition	Examples
Frequency measures	The number of times an activity is performed.	Number of purchase orders, number of engineering work orders.
Duration measures	The time consumed performing the activity.	Ordering hours, engineering hours, machine hours.
Physical measures	The quantity of a resource processed by an activity.	Cubic feet packed, pounds shipped.

Some Exhibits from Example 7-1

EXHIBIT 7-4
ANNUAL PRODUCT DATA FOR COMPANY A

PRODUCT RELATED DATA
V1 V2

Annual production quantity in units
Material cost per unit
Direct labor hours per unit
Direct labor cost per hour
Number of purchase orders required per year
Number of engineering work orders required per year
Number of machine setups required per year 100
$50
1
$10
1
4
2 1,000
$50
1
$10
2
8
4

EXHIBIT 7-5
ANNUAL ACTIVITY COSTS FOR COMPANY A

ACTIVITY
ANNUAL
COSTS
ACTIVITY MEASURE

Purchasing and receiving
Engineering
Machine setup
Machining, power & maintenance
Materials planning & handling
Total factory overhead costs $24,000
18,000
24,600
22,000
11,000
$99,600
====== Number of purchase orders
Number of engineering work orders
Number of machine setups
Number of direct labor hours
Number of materials dollars

EXHIBIT 7-6
ANNUAL ACTIVITY COSTS FOR COMPANY A
COMBINED HOMOGENEOUS COST POOLS

ACTIVITY POOL

ANNUAL
COSTS

ACTIVITY MEASURE

Non-production volume related
Production volume related
Total factory overhead costs $66,600
33,000
$99,600 Number of purchase orders
Number of direct labor hours

EXHIBIT 7-7
COMPANY A COSTS TRACED TO PRODUCTS V1 AND V2
USING AN ACTIVITY BASED COST (ABC) SYSTEM

COST POOL OR CATEGORY

ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE (Rj)(Aji)

C1=COST
TRACED TO V1

ABC UNIT COST
V1*

C2=COST TRACED TO V2

ABC
UNIT COST V2**

1. Non-production volume related:

($22,200)(1 PO)
($22,200)(2 PO'S)

$22,200

$222.00

$44,400

$44.40

2. Production volume related:

($30)(100 DLH)
($30)(1,000 DLH)

3,000

$30.00

30,000

30.00

Total Overhead

$25,200

$252.00

$74,400

$74.40

3. Direct Material:

($50)(100)
($50)(1,000)

5,000

50.00

50,000

50.00

4. Direct Labor:

($10)(1hr)(100)
($10)(1hr)(1,000)

1,000

10.00

10,000

10.00

Totals

$31,200
=======

$312.00
======

$134,400
=======

$134.40
======

* C1 = $6,000 + ($22,200)(1PO) + ($30)(100DLHs) = $31,200. ABC unit cost for V1 = $31,200 ÷ 100 units.
** C2 = $60,000 + ($22,200)(2POs) + ($30)(1,000DLHs) = $134,400. ABC unit cost for V2 = $134,400 ÷ 1,000 units.

EXHIBIT 7-8
COMPANY A COST TRACED TO PRODUCTS V1 AND V2 USING A
TRADITIONAL PRODUCTION VOLUME BASED (PVB) COST SYSTEM

COST POOL OR CATEGORY

ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE

COST ALLOCATED TO V1

PVB UNIT COST
V1*

COST ALLOCATED TO V2

PVB UNIT COST V2**

1.Non-production volume related:

($60.5455)(100DLH)
($60.5455)(1,000)

$6,054.55

$60.55

$60,545.45

$60.55

2. Production volume related:

($30)(100 DLH)
($30)(1,000)

3,000.00

$30.00

30,000.00

30.00

Total Overhead

$9,054.55

$90.55

$90,545.45

$90.55

3. Direct Material:

($50)(100 units)
($50)(1,000)

5,000.00

50.00

50,000

50.00

4. Direct Labor:

($10)(1hr)(100 units)
($10)(1hr)(1,000)

1,000.00

10.00

10,000

10.00

Totals

$15,054.55
========

$150.55
======

$150,545.45
========

$150.55
======

* PVB unit cost for V1 = $15,054.55 ÷ 100 units.
** PVB unit cost for V2 = $150,545.45 ÷ 1,000 units.

EXHIBIT 7-9 COMPANY A
ABC AND PVB UNIT COST COMPARISONS

Cost Pool or Category ABC Unit Cost V1 PVB Unit Cost V1 Amount V1 PVB Unit Cost is Understated ABC Unit Cost V2 PVB Unit Cost V2 Amount V2 PVB Unit Cost is Overstated

1. Non
   production
   volume
   related

$222 $60.55 $161.45 $44.40 $60.55 $16.15

2. Production
    volume
    related 30 30.00 0 30.00 30.00 0

Total
overhead $252 $90.55 $161.45 $74.40 $90.55 $16.15

3. Direct
   material 50 50.00 0 50.00 50.00 0

4. Direct labor 10 10.00 0 10.00 10.00 0

Totals $312
==== $150.55
====== $161.45
====== $134.40
====== $150.55
====== $16.15
=====

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PRODUCT RELATED DATA	V1	V2
Annual production quantity in units Material cost per unit Direct labor hours per unit Direct labor cost per hour Number of purchase orders required per year Number of engineering work orders required per year Number of machine setups required per year	100 $50 1 $10 1 4 2	1,000 $50 1 $10 2 8 4

ACTIVITY	ANNUAL COSTS	ACTIVITY MEASURE
Purchasing and receiving Engineering Machine setup Machining, power & maintenance Materials planning & handling Total factory overhead costs	$24,000 18,000 24,600 22,000 11,000 $99,600 ======	Number of purchase orders Number of engineering work orders Number of machine setups Number of direct labor hours Number of materials dollars

ACTIVITY POOL	ANNUAL COSTS	ACTIVITY MEASURE
Non-production volume related Production volume related Total factory overhead costs	$66,600 33,000 $99,600	Number of purchase orders Number of direct labor hours

COST POOL OR CATEGORY	ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE (Rj)(Aji)	C1=COST TRACED TO V1	ABC UNIT COST V1*	C2=COST TRACED TO V2	ABC UNIT COST V2**
1. Non-production volume related:	($22,200)(1 PO) ($22,200)(2 PO'S)	$22,200	$222.00	$44,400	$44.40
2. Production volume related:	($30)(100 DLH) ($30)(1,000 DLH)	3,000	$30.00	30,000	30.00
Total Overhead		$25,200	$252.00	$74,400	$74.40
3. Direct Material:	($50)(100) ($50)(1,000)	5,000	50.00	50,000	50.00
4. Direct Labor:	($10)(1hr)(100) ($10)(1hr)(1,000)	1,000	10.00	10,000	10.00
Totals		$31,200 =======	$312.00 ======	$134,400 =======	$134.40 ======

COST POOL OR CATEGORY	ACTIVITY RATE MULTIPLIED BY QUANTITY OF ACTIVITY MEASURE	COST ALLOCATED TO V1	PVB UNIT COST V1*	COST ALLOCATED TO V2	PVB UNIT COST V2**
1.Non-production volume related:	($60.5455)(100DLH) ($60.5455)(1,000)	$6,054.55	$60.55	$60,545.45	$60.55
2. Production volume related:	($30)(100 DLH) ($30)(1,000)	3,000.00	$30.00	30,000.00	30.00
Total Overhead		$9,054.55	$90.55	$90,545.45	$90.55
3. Direct Material:	($50)(100 units) ($50)(1,000)	5,000.00	50.00	50,000	50.00
4. Direct Labor:	($10)(1hr)(100 units) ($10)(1hr)(1,000)	1,000.00	10.00	10,000	10.00
Totals		$15,054.55 ========	$150.55 ======	$150,545.45 ========	$150.55 ======

Cost Pool or Category	ABC Unit Cost V1	PVB Unit Cost V1	Amount V1 PVB Unit Cost is Understated	ABC Unit Cost V2	PVB Unit Cost V2	Amount V2 PVB Unit Cost is Overstated
1. Non production volume related	$222	$60.55	$161.45	$44.40	$60.55	$16.15
2. Production volume related	30	30.00	0	30.00	30.00	0
Total overhead	$252	$90.55	$161.45	$74.40	$90.55	$16.15
3. Direct material	50	50.00	0	50.00	50.00	0
4. Direct labor	10	10.00	0	10.00	10.00	0
Totals	$312 ====	$150.55 ======	$161.45 ======	$134.40 ======	$150.55 ======	$16.15 =====