Activity based costing and management MAS A7

Activity-based management  Idle time – the time goods spend in storage or

 This involves focusing on activities to eliminate waiting at a production operation for processing
waste, decrease processing time, and reduce time (NVA).
defects.
 A business process model that focuses on controlling Cycle time or lead time = Value added time + Non-value
production or performance activities to improve added time.
customer value and enhance profitability and helps
company to: Manufacturing (service) cycle efficiency = Total value added
o Produce more efficiently. time ÷ Total cycle time or lead time.
o Determine costs more accurately.
o Control and evaluate performance more Throughput time = Process + Inspection + Moving + Queue
effectively.
Delivery cycle time = Wait + throughput
Terms used under activity based costing management
 Activity analysis – is the process of studying activities Activity based costing
both to classify them and to devise ways of  A costing method that is designed to provide
minimizing or eliminating the activities that increase managers with cost information for strategic and
costs but provide little or no customer value. other decisions that potentially affect capacity and
therefore fixed as well as variable costs.
 Activity – any event that causes the consumption of  Focuses on an organization’s activities and collects
overhead resources. It is also a repetitive action that costs on the basis of the underlying nature and
is performed in the fulfillment if a business function. extent of those activities.

 Value added activity – increases the worth of a Difference between traditional costing and activity based
product or service to a customer and is one for costing
which customer is willing to pay.  Nonmanufacturing as well as manufacturing costs
may be assigned to products, but only on a cause-
 Business value added activity – activity that is and-effect basis.
essential to business operations for which customers  Some manufacturing costs may be excluded from
would not be willing to pay. product cost.
 Numerous overhead cost pools are used, each of
 Non-value-added activity – increases the time spent which is allocated to products and other cost objects
on a product or service but does not increase its using its own unique measure of activity.
worth.
Terms used under activity based costing
 Process – a series of activities that, when performed  Activity cost pool – a bucket in which costs are
together, satisfy a specific objective. accumulated that relate to a single activity measure
in the ABC system.
 Process map – refers to a detailed flowchart that is  Activity measure (cost driver) – an allocation base in
prepared to indicate every step in every area that an activity costing system.
goes into making or doing something. o Transaction driver – simple counts of the
number of times an activity occurs.
Classification of activities under ABM o Duration driver – measure the amount of
 Processing (service) time – the actual time spent time required to perform an activity.
performing all necessary functions to manufacture  Benchmarking – is a systematic approach to
the product or perform the service (VA). identifying the activities with the greatest room for
 Inspection time – the time required to perform improvement based on comparing the performance
quality control other than what is internal to the in an organization with the performance of other.
process (NVA).
 Transfer time – the time consumed moving products
or components from one place to another (NVA).

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Activity based costing and management MAS A7

Levels of activity The following costs are incurred in a fast-food restaurant that
 Unit level – performed each time a unit is produced relies on computer-controlled equipment to prepare
(direct materials, direct labor, other traceable costs). customers’ food. Classify each cost as unit, batch,
 Batch level – performed each time a batch is handled product/process or organizational level:
or processed, regardless of how many units are in a. Maintenance of the restaurant building.
the batch (purchase order, setup, inspection, b. Refrigeration of raw materials.
movement). c. Cardboard boxes for food order.
 Product or process level – relates to specific d. Store managers’ salary.
products and typically must be carried out regardless e. Electricity expense for pizza oven.
of how many batches are produced or sold f. Wages of employees who clear and clean tables.
(engineering change, equipment maintenance, g. Depreciation on equipment.
product development). h. Property taxes.
 Customer – relates to specific customers. i. Oil for deep fat fryer (changed every four hours).
 Organization-sustaining or facility level – carried out j. French fries.
regardless of which customers are served, which
products are produced, how many batches are run, Swagg Jewelry Corporation manufactures custom jewelry. In
or how many units are made (building depreciation, the past, Swagg has been using a traditional overhead
plant or division manager’s salary, organizational allocation system based solely on direct labor hours.
advertising). Sensing that this system was distorting costs and selling
prices, Swagg has decided to switch to an activity-based
Steps for implementing ABC costing system using three activity cost pools. Information
 Define activity cost pools and activity measures. on these activity cost pools are as follows:
 Assign overhead costs to cost pools.
 Calculate activity rates. Activity Cost Estimated
 Assign overhead to cost objects using the activity Pool Estimated Activity Overhead Cost
rates and activity measures. Labor related 8,000 direct labor hours P40,000
Machine related 12,500 machine hours P50,000
 Prepare management reports.
Quality control 800 number of inspections P12,000
Exercises
Job #309 incurred P900 of direct material, 30 hours of direct
labor at P40 per hour, 80 machine hours, and 5 inspections.
The following activities take place in SN Department Store.
Upon receipt, SN’s discounts all products 25% from
a. What is the cost of the job under the activity-based
manufacturer’s suggested retail price. Only after the goods
costing system?
have been in stock for 90 days will additional discounts be
b. Relative to the activity-based costing system, would Job
given.
#309 have been over costed or under costed under the
a. Attending trade shows to review new products.
traditional system and by how much?
b. Reviewing supplier catalogs.
c. Ordering merchandise.
Danno Company manufactures two products, Product F and
d. Waiting for shipments to be received.
Product G. The company expects to produce and sell 600
e. Inspecting goods for damage.
units of Product F and 6,000 units of Product G during the
f. Matching receiving reports and purchase orders.
current year. The company uses activity-based costing to
g. Placing discounted price tags on merchandise.
compute unit product costs for external reports. Data relating
h. Moving goods to retail area.
to the company's three activity cost pools are give for the
i. Stocking shelves.
current year:
j. Training salespersons in store merchandise.
Estimated
k. Checking out customers.
Overhead Expected Activity
l. Handling customer receipts.
Activity Cost Pool Costs Product F Product G Total
m. Wrapping gift items.
Machine setups P5,250 60 150 210
n. Helping customers with return or exchanges.
Purchase orders P74,100 620 1,280 1,900
General factory P89,880 840 12,000 12,840
Indicate which activities are value-added, business value
added and non-value added.
Using the activity-based costing approach, determine the

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Activity based costing and management MAS A7

overhead cost per unit for each product. Making drapes ...... 4,000 yards
Job support ........... 100 jobs
Cabalo Company manufactures two products, Product C and Other ..................... Not applicable
Product D. The company estimated it would incur P130,890 in
manufacturing overhead costs during the current period. a. Prepare the first-stage allocation of overhead costs to the
Overhead currently is applied to the products on the basis of activity cost pools by filling in the table below:
direct labor hours. Data concerning the current period's Making Job
operations appear below: Drapes Support Other Total
Production overhead
Product C Product D Office expense
Estimated unit production 400 units 1,200 units Total
Direct labor hours per unit 0.70 hour 1.20 hours
Direct materials cost per unit P10.70 P16.70 b. Compute the activity rates (i.e., cost per unit of activity)
Direct labor cost per unit P11.20 P19.20 for the Making Drapes and Job Support activity cost pools
by filling in the table below:
a. Compute the predetermined overhead rate under the Making Job
current method, and determine the unit product cost of Drapes Support
each product for the current year. Production overhead
Office expense
a. The company is considering using an activity-based
Total
costing system to compute unit product costs for
external financial reports instead of its traditional system
c. Prepare an action analysis report in good form of a job
based on direct labor hours. The activity-based costing
that involves making 53 yards of drapes and has direct
system would use three activity cost pools. Data relating
materials and direct labor cost of P1,480. The sales
to these activities for the current period are given below:
revenue from this job is P5,200. For purposes of this
Estimated
action analysis report, direct materials and direct labor
Overhead Expected Activity
should be classified as a Green cost; production overhead
Activity Cost Pool Costs Product C Product D Total
as a Red cost; and office expense as a Yellow cost.
Machine setups P13,570 100 130 230
Purchase orders 91,520 810 1,270 2,080
Duckhorn Housecleaning provides housecleaning services to
General factory 25,800 280 1,440 1,720
its clients. The company uses an activity-based costing system
for its overhead costs. The company has provided the
Determine the unit product cost of each product for the
following data from its activity-based costing system.
current period using the activity-based costing approach.
Total
Imai Draperies makes custom draperies for homes and
Activity Cost Pool Cost Total Activity
businesses. The company uses an activity-based costing
Cleaning P645,576 72,700 hours
system for its overhead costs. The company has provided the
Job support P129,546 5,400 jobs
following data concerning its annual overhead costs and its
Client support P20,900 760 clients
activity cost pools.
Other P110,000 Not applicable
Total P906,022
Overhead costs:
Production overhead P240,000
The "Other" activity cost pool consists of the costs of idle
Office expense 160,000
capacity and organization sustaining
Total P400,000
costs. One particular client, the Lumbard family, requested 31
Distribution of resource consumption:
jobs during the year that required a total of 62 hours of
Making Job
housecleaning. For this service, the client was charged
Activity Cost Pools Drapes Support Other Total
P1,620
Production overhead 35% 45% 20% 100%
Office expense 15% 55% 30% 100%
a. Compute the activity rates (i.e., cost per unit of activity)
for the activity cost pools. Round off all calculations to
The “Other” activity cost pool consists of the costs of idle
the nearest whole cent.
capacity and organization sustaining costs. The amount of
b. Using the activity-based costing system, compute the
activity for the year is as follows:
customer margin for the Lumbard family. Round off all
Activity Cost Pool Annual Activity

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Activity based costing and management MAS A7

calculations to the nearest whole cent.

c. Assume the company decides instead to use a traditional
costing system in which ALL costs are allocated to
customers on the basis of cleaning hours. Compute the
margin for the Lumbard family. Round off all calculations
to the nearest whole cent.

Pardun Corporation's management keeps track of the time it

takes to process orders. During the most recent month, the
following average times were recorded per order:
Days
Wait time 15.6
Inspection time 0.8
Process time 1.6
Move time 0.7
Queue time 3.9

a. Compute the throughput time.

b. Compute the manufacturing cycle efficiency (MCE).
c. What percentage of the production time is spent in non-
value-added activities?
d. Compute the delivery cycle time.

Rintharamy Corporation's management reports that its

average delivery cycle time is 25.2 days, its average
throughput time is 7.6 days, its manufacturing cycle efficiency
(MCE) is 0.25, its average move time is 0.9 day, and its
average queue time is 4.0 days.

a. What is the wait time?

b. What is the process time?
c. What is the inspection time?