Blueprint Problem: Activity-based costing Activity-Based Costing Traditionally,
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Blueprint Problem: Activity-based costing
Activity-Based Costing
Traditionally, overhead costs are assigned based arbitrarily on the rate of either direct labor or direct materials associated with production. This makes sense when companies only make a few products, production processes are simple, and overhead costs are less pervasive. However, today production processes are more complex, companies make a wider array of products, and fewer costs are directly traceable to units of production. To address this, companies use activity-based costing (ABC).
Specifically, activity-based costing identifies and traces costs and expenses to activities and then to specific products. ABC uses multiple factory overhead rates based on activities. Activities are the types of work, or actions, involved in a manufacturing process or service activity. For example, assembly, inspection, and engineering design are activities.
The estimated activity costs are allocated to products using an activity rate. Activity rates are determined as follows:
Activity Rate = Estimated Activity Cost / Estimated Activity Base Usage
Comparing Two Products under Traditional and Activity-Based Costing
Compare two projects under development by the same company. The following are a few aspects of each product's development process relevant to costs.
Traditional Costing
Traditional costing would take the proportion of a direct cost, such as direct labor hours, and use it as the basis for allocating overhead costs, such as computing power and testing. In the following table, use developer hours as the basis for assigning overhead costs (computing and developer costs) to each project If required, round your answers to the nearest dollar.
+ Percentage of developer hours for Product A (25%)
+ Percentage of developer hours for Product B (75%)
Seeing how many resources each product (A and B) requires for production compared to the costs calculated under traditional costing, does traditional costing serve as an accurate gauge of costs?
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Using traditional cost assignment means pegging overhead costs based on a direct cost, such as direct labor or direct materials. In this case, you use direct labor (developer hours) as the basis for overhead allocation.
For product A, the percentage of developer labor costs as a proportion of the whole is already calculated. This is the figure that, when multiplied by the overhead values, will yield the overhead assigned to each project under traditional costing.
Activity-Based Costing
Using the data above for products A and B, calculate the costs using activity-based costing. Allocate the costs of testing, computing, and development based on the rates of activity consumed by each product's development process. If required, in your computations, round per unit costs to the nearest cent. Round your final answers to the nearest dollar.
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The budgeted activity costs are assigned to products using factory overhead rates for each activity. These rates are called activity rates because they are related to activities. Activity rates are determined as follows:
Activity Rate = Budgeted Activity Cost / Total Activity Base Usage
The costs are allocated to the product by multiplying the activity-base usage by the computed activity rate.
Activity-based costing for varying batch production
A manufacturing company has the following two activities associated with completion of products:
The setting up of machines for running batches of products
The actual production of units produced
The company has annual manufacturing overhead costs of $2,000,000, of which $200,000 is directly involved in setting up machines for batch runs. During the year, the company expects to perform 400 machine setups, one setup per batch for a total of 400 batches of production. Assume that the batch sizes vary considerably, but the work involved in setting up the machines is not appreciably different from one job to the next.
If the company estimates that the $200,000 costs associated with setups will yield 400 setups this year, the cost associated directly with each setup will be $ per setup. Because each job will require its own setup, setup costs are viewed as batch costs. Because $200,000 of the $2,000,000 are costs associated with setups, this means that costs associated directly with the production of units equal $ .
Illustrated Example of Activity-Based CostingExplanation / Answer
Activity based costing Cost drivers Product A Product B Total Ratio (A: B) Hours in Testing 4000 1000 5000 4000:1000' Units in computing power 5320 2280 7600 5320:2280' Developers hour 25 75 100 allocation of costs on basis of cost drivers Cost driver Cost Items cost Ratio (A: B) Product A Product B Hours in Testing Testing 25600 4000:1000' 20480.00 5120.00 Units in computing power Computing power 38400 5320:2280' 26880.00 11520.00 Developers hour Developers hourly cost 13 per hour 325.00 975.00 Total cost 47685.00 17615.00 Developers cost has been calculated as Product A = 13 per hour x 25 hours 325 Product B = 13 per hour x 75 hours 975 Under Traditional cost method single overhead rate of developers time is used Cost Items cost Testing 25600 Computing power 38400 Developers hourly cost 1300 ( 325 + 975) Total cost 65300 Product A 16325 = 65300 / 100 * 25 Product B 48975 = 65300 / 100 * 75