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Mastery Problem: Activity-Based Costing (Advanced)

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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

Illustrated Example of Activity-Based Costing

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 products development process relevant to costs.

Product S		Product T
Requires 4,000 hours of testing		Requires 1,000 hours of testing
Requires 5,250 units of computing power		Requires 2,250 units of computing power
Requires 30 developer hours to implement		Requires 70 developer hours to implement

Cost Items	Cost of Each Activity
Testing:	$25,600
Computing power:	$38,400
Developer hourly cost:	$12 per hour

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.

Product S			Product T
Percentage of developer hours	30%		Percentage of developer hours	70%
Testing cost	$fill in the blank 7e5d19fc7fc0faf_1		Testing cost	$fill in the blank 7e5d19fc7fc0faf_2
Computing cost	$fill in the blank 7e5d19fc7fc0faf_3		Computing cost	$fill in the blank 7e5d19fc7fc0faf_4
Developer cost	$fill in the blank 7e5d19fc7fc0faf_5		Developer cost	$fill in the blank 7e5d19fc7fc0faf_6
Total cost	$fill in the blank 7e5d19fc7fc0faf_7		Total cost	$fill in the blank 7e5d19fc7fc0faf_8

Percentage of developer hours

+ Percentage of developer hours for Product S (30%)

Allocation basis for Product S: The amount of labor hours associated directly with Product S, as a percentage of all developer hours worked (regardless of product). The amounts for overhead to be allocated are multiplied by this value to determine the overhead to be assigned to Product S under the traditional costing method.

30

(30+70)

+ Percentage of developer hours for Product T (70%)

Allocation basis for Product T: The amount of labor hours associated directly with Product T, as a percentage of all developer hours worked (regardless of product). The amounts for overhead to be allocated are multiplied by this value to determine the overhead to be assigned to Product T under the traditional costing method.

70

(30+70)

Review the resources each product (S and T) requires for production and compare that to the costs calculated above under traditional costing. Does traditional costing serve as an accurate gauge of costs?

YesNoNot enough informationNo