ABC Costing
Practice As You Learn
Activity based costing is simply the process of allocating costs to products or customers based on what must be done to make the product or service the customer. The thing that is done is called an “activity”.
There are two things that you will be asked to do relative to ABC Costing:
1st Determine the type of activity an activity is.
(Your professor may not think this step is important, so check your notes before you spend time on this.)
2nd Assign overhead costs to products or customers
Follow these 4 steps:
1) identify the activities that cause costs to occur and assign a cost/activity driver
2) group the costs that are associated with each activity
3) divide total costs by total cost driver for each group of activity to get the cost per
4) multiply the cost per by how many times the cost driver occurs to get the total cost per product or customer
ABC Costing – Practice as You Learn – Problem 1.
Foley Instruments produces 2 products: instruments and gauges. During January 50 instruments and 300 gauges were produced and total overhead costs of $90,000 were incurred. The following activity caused the overhead costs
| Activity | Cost Driver | Total Cost | # for Instruments | # for Gauges |
| Materials Handling | Requisitions | $35,000 | 400 | 600 |
| Machine Setups | Setups | $27,000 | 200 | 300 |
| Quality Inspections | Inspections | $28,000 | 200 | 400 |
| $90,000 |
Allocate the total overhead cost of $90,000 to the instruments and the gauges.
Follow the 4 steps noted above.
Answer
Follow the 4 steps:
1) Identify the activities that cause costs to occur, called an activity and cost driver that can be counted.
The overhead costs are caused by handling material, setting up machines and inspecting the product.
The cost driver or activity driver will be something that happens that can be counted.
2) Group the costs that are associated with each activity
This has been done and will be given to you in each problem you work.
Notice that the total of all 3 activities is equal to the total overhead of $90,000.
3) divide total cost for each activity by the total cost driver for each group
Total Cost / Total cost driver = $ Per
Material Handing $35,000 / 1,000 = $35
Machine Set-ups $27,000 / 500 = $54
Quality Inspection $28,000 / 600 = $46.67
4) multiply the cost per by how many times the cost driver occurs to get the total cost per product or customer.
Allocate the overhead costs to each product:
Instruments: Gauges:
Material Handling 400 x $35 =14,000 600 x $35 = 21,000
Machine Set-ups 200 x $54 = 10,800 300 x $54 = 16,200
Quality Inspection 200 x $46.67 = 9,333 400 x $46.67 = 18,667
Total cost: $34,133 $55,867
Notice that you are allocating the $90,000 total overhead to the two product groups.
$34,133 + $55,867 = $90,000
The next step is to take the overhead costs / units produced = cost per unit for the instrument and for the gauge.
Instruments: $34,133 / 50 = $682.66 overhead cost per unit
Gauges: $55,867 / 300 = $186.22 overhead cost per unit
ABC Costing – Practice as You Learn – Problem 2.
A manufacturing company produces two products at the same production plant. Selected budgeted production information is as follows:
| Product X | Product Y | |
| Units Produced | 10,000 | 25,000 |
| Assembly (hrs per unit) | 2 | 3 |
| Total number of set-ups | 50 | 100 |
| Total number of parts | 10 | 20 |
| Material cost per unit | $9 | $28 |
| Labor cost per hour | $14 | $15 |
Manufacturing overhead costs are grouped into activities as follows:
Plant indirect labor is paid $250,000 – driver is direct labor hours
Total machine set-up costs $80,000 – driver is number of set-ups
Total cost to purchase materials is $140,000 – driver is number of parts
Determine the total product cost for each product.
Follow these steps no matter what format the data is provided to you:
1) identify the cost pool total dollars and the matching cost driver total
2) Total cost pool $ / total cost driver for each group of costs equals the cost per every time the cost driver occurs
3) multiply each cost per by the driver quantity for each activity for each product or customer to get the total overhead costs allocated
4) divide the total overhead by the number of units to get cost per unit for the product or customer
Answer
1) Identify the activities that cause costs to occur, called an activity/cost driver and 2) group the costs that are associated with each activity
This has been done and will be given to you in each problem you work.
Activity & overhead dollars Total Activity X Y
Indirect labor $ 250,000 labor hours 95,000 20,000 75,000
Machine set-up $ 80,000 set-ups 150 50 100
Purchase materials $140,000 parts 30 10 20
3) Divide total cost for each activity by the total driver quantity for each group to get the cost per
Total Cost / Total driver = $ Per
Indirect labor $250,000 / 95,000 = $2.63
Machine Set-up $80,000 / 150 = $533.33
Purchase materials $140,000 / 30 = $4,666.67
4) multiply the cost per by how many times the driver occurs to get the total cost per product
Product X:
Indirect labor $2.63 x 20,000 = 52,600
Machine Set-ups $533.33 x 50 = 26,667
Quality Inspection $4,666.67 x 10 = 46,667
Total cost: $125,934
Product Y:
Indirect labor $2.63 x 75,000 =197,250
Machine Set-ups $533.33 x 100 = 53,333
Quality Inspection $4,666.67 x 20 = 93,333
Total cost: $343,916
You did steps 1 to 4 to get total overhead allocated to each product. You must now take the total cost and divide by units produced to get an overhead cost per unit.
Product X: $125,934 / 10,000 units = $12.59 per unit
Product Y: $343,916 / 25,000 units = $13.76 per unit
Now you must total all product costs to get the cost to make one unit of each:
| Product X | Product Y | |
| Direct material | $9 | $28 |
| Direct labor (hrs. x rate) | $ 28 | $45 |
| Overhead | $12.59 | $13.76 |
| Total | $49.59 | $86.76 |
ABC Costing – Practice as You Learn – Problem 3.
Memorize the quick definition of each of the following types of activities.
Unit level activities: each time a unit is produced
Batch level activities: each time a batch/group is handled or processed
Product level activities: done for a group of products
Customer level activities: related to customers
Organization Sustaining: done regardless of how many products are sold
For each type of cost, ask yourself why and when you are spending the money
and match the reason with the type of activity above.
State the type of activity for each type of cost below:
b. advertising expense
c. utility costs at the manufacturing facility
d. office supplies at corporate
e. direct materials
f. assembly line workers
g. quality inspectors of the product
h. executive salaries
i. catalogue of products provided to customers
j. research and development on new products
k. the cost of patents and trademarks
l. corporate accounting salaries
m. depreciation on corporate office equipment
n. market research
o. purchasing materials
p. invoicing customers
q. machine set up costs
r. improving a product
Answer
ABC Costing – Problem 3. Answers
State the type of activity for each type of cost below:
Answer
a. Maintenance on factory machines Product
b. advertising expense Product
c. utility costs at the manufacturing facility Product
d. office supplies at corporate Organization
e. direct materials Unit
f. assembly line workers Unit
g. quality inspectors of the product Product or Batch
h. executive salaries Organization
i. catalogue of products provided to customers Customer
j. research and development on new products Product
k. the cost of patents and trademarks Organization
l. corporate accounting salaries Organization
m. depreciation on corporate office equipment Organization
n. market research Customer
o. purchasing materials Batch
p. invoicing customers Batch
q. machine set up costs Batch
r. improving a product Product