Destin Brass Products Company

Activity Based Costing

Prepared by: Heidi Meilinger
1
Standard System
Step 4:
Indirect Cost Pool
Step 3:
Cost Allocation Base
Step 5:
439 o! direct
r"n labor cost
Step 1:
Cost ob#ects:
$alves% p"&ps%
And 'o( controllers
Step ):
*irect Costs
)
All Indirect Costs
+,-)%,--
*irect ."n
/abor Cost
+155%,00
*irect ."n
/abor Cost
+155%,00
Step ,: Indirect Costs
*irect Costs
*irect
Mater
ials
*irect
Mater
ials
*irect
/abor
*irect
/abor
S
t
e
p

Revised System
Step 4:
Indirect Cost
Pool
Step 3:
Cost Allocation
Base
4- o! direct +4)159 per direct
&an"!act"ring &an"!act"ring
&aterial cost &ac2ine 2o"r
Step 1:
Cost ob#ects: Step 3
$alves% p"&ps%
And 'o( controllers
Step ):
*irect costs
3
Material
4ver2ead
+))0%000
4t2er
4ver2ead
+4,0%000
*irect
&aterial
costs

+45-%000
*irect
&aterial
costs

+45-%000
*irect
&an"!act1
&ac2ine
"sage 52o"rs
10%-00
*irect
&an"!act1
&ac2ine
"sage 52o"rs
10%-00
Step ,: Indirect costs
*irect Costs
*irect
&ateri
als
*irect
&ateri
als
Set
"p
labor
Set
"p
labor
*irect
labor
*irect
labor
Activity Based Costing System

Step 4:
Indirect cost
Pool
Step 3:
Cost6
Allocation
Base
+)5 per 2o"r +1, per 2o"r +155104 per 7 +1550139 per 7
+)%000 per 7 +)13- per
4! "se per r"n o! transactions o! transactions o!
transactions &ac2ine
2o"r

Step 1:
Cost ob#ects:
$alves% P"&ps%
And 'o(
Controllers
Step ):
*irect Costs
4
Mac2ine
*epreciati
on
Set "p
/abor
.eceivi
ng
Material
s
Handlin
8ngineeri
ng
Pac9ing
:
S2ippin
Maintenan
ce
Ho"r
s o!
"se
10%-
00
Ho"r
s o!
"se
10%-
00
Ho"r
s per
r"n
1,-
Ho"r
s per
r"n
1,-
7 o!
trans
action
s
1)9
7 o!
trans
action
s
1)9
7 o!
trans
actio
ns
1)9
7 o!
trans
actio
ns
1)9
;"ot
ed
(or9
orde
r
;"ot
ed
(or9
orde
r
7 o!
trans
actio
ns 30
7 o!
trans
actio
ns 30
Mac2i
ne
2o"rs
10-0
0
Mac2i
ne
2o"rs
10-0
0
Step ,: Indirect Costs
*irect Costs
*irect
Materia
ls
*irect
Materia
ls
*irect
/abor
*irect
/abor
5
11< =2e sc2ed"les above s2o( t2e rates o! t2e valves% p"&ps% and 'o( controllers i!
t2ey (ere costed "sing an activity based costing syste&1 >it2 t2is syste& t2ere
are a total o! seven over2ead activities% eac2 2aving t2eir o(n cost allocation base%
and only t(o direct costs1 8?ec"tion o! t2is syste& (o"ld ca"se a c"t in pricing !or
t2e p"&ps% (2ic2 (o"ld 2elp t2e co&pany &aintain a co&petitive edge in t2is
&ar9et@ 2o(ever% t2ere (o"ld not be &"c2 c2ange in valve prices and t2e 'o(
controllerAs price (o"ld al&ost do"ble !ro& (2at it (as be!ore1 =2ese prices% even
t2o"g2 t2ey &ay see& drastic% (ill be &ore realistic !or t2e &ar9et in (2ic2 *estin
Brass is selling to1
,


)1< As is s2o(n above% eac2 o! t2e prod"cts is costed by t2e sa&e a&o"nt !or direct
&aterials and direct labor1 =2e only diBerence% in t2e direct costs% is t2at "nder t2e
revised costing syste& set6"p labor is also considered a direct cost and is allocated
to eac2 prod"ct "nder t2is syste&1
=2e &ain diBerence in t2e costing proced"re in eac2 o! t2ese syste&s is 2o( t2e
over2ead is allocated1 Beginning (it2 t2e standard costing syste&% t2ere are seven
indirect costs Cas s2o(n above< (2ic2 co&e to a total cost o! +,-)% ,--1 =o obtain
t2e over2ead rate !or t2e indirect costs one (o"ld divide t2e total indirect cost by
total r"n labor% +155%,00@ t2is (o"ld t2en &a9e a rate o! 4391 =o allocate t2e
over2ead to eac2 prod"ct one (o"ld t2en 2ave to &"ltiply t2e rate% 439% by t2e
cost o! direct labor t2at (as allocated to eac2 prod"ct1
Dnder t2e second syste&% revised costing% t2ere are t(o over2ead categories:
&aterial related over2ead and ot2er over2ead1 Material related over2ead is
co&prised o! t(o indirect costs and ot2er over2ead is co&prised o! !o"r indirect
costs Cas s2o(n above<1 =2e over2ead rate !or &aterial related over2ead is
calc"lated by ta9ing t2e total indirect costs !or &aterial related and dividing it by
t2e total costs o! &aterial% +45-%000@ t2is (o"ld t2en &a9e a rate o! 4-1 =o
allocate t2is over2ead to eac2 prod"ct one (o"ld 2ave to &"ltiply t2e rate% 4-% by
t2e direct &aterial cost t2at (as allocated to eac2 prod"ct1 =2e over2ead rate !or
t2e ot2er over2ead is Eg"red by ta9ing t2e total indirect costs !or t2e ot2er
over2ead and dividing it by t2e total a&o"nt o! &ac2ine "sage% 10%-00 2o"rs@ t2is
(o"ld t2en &a9e a rate o! +4)159 per &ac2ine 2o"r1 Fet again% t2is a&o"nt (o"ld
be allocated to eac2 prod"ct by &"ltiplying t2e rate% +4)159% to t2e a&o"nt o!
&ac2ine "sage cons"&ed by eac2 prod"ct1
=2e Enal syste&% activity based costing% is very diBerent !ro& t2e ot2er t(o
syste&s in t2at it does not total "p t2e indirect costs and t2en divide it to &a9e one
single over2ead rate1 Instead% eac2 indirect cost 2as t2eir o(n allocation base%
(2ic2 in t"rn creates t2eir o(n rate@ eac2 cost is t2en allocated to t2e prod"cts
according to eac2 prod"ctAs "sage o! t2e indirect cost Cs2o(n in detail on page 5<1
31< Gro& (2at (as calc"lated above% it appears t2at t2e activity based costing (o"ld be
t2e best sol"tion in 9eeping t2e co&pany as a co&petitive s"pplier1 Also% t2is (o"ld
solve *estin BrassAs proble& o! over costing t2eir p"&ps% (2ic2 c"rrently acco"nts
!or 55 o! t2e co&panyAs reven"e1 By i&ple&enting activity based costing% t2e
co&pany (o"ld c"t t2e p"&p cost by )1 in co&parison to t2e revised cost and by
)9 in co&parison to t2e standard cost1 Ho(ever% t2is syste& (o"ld raise t2e cost
o! 'o( controllers by abo"t 50% b"t considering t2is prod"ct attrib"tes only a s&all
percentage to reven"e% )1% and t2ere is no apparent co&petition in t2is &ar9et as
o! no(% t2en it (o"ld not be s"c2 a detri&ent to raise t2is price1 =2is syste& (o"ld
3
not c2ange t2e valve price considerably !ro& t2at costed "nder standard% b"t it
(o"ld still 9eep t2e& co&petitive1 4verall% activity based costing is (2at t2e
co&pany (ill 2ave to do to ce&ent t2eir standing as being co&petitive in t2eir
prod"ct pricing1
Last Months Actual Selling Price
Standard vs. Activity Based
Net ncome Per Last Month Production
Standard vs. Activity Based
41< In t2e top t(o bo?es s2o(n above t2e standard and t2e activity based costing (ere
bot2 eval"ated per t2e act"al selling price o! eac2 prod"ct !or last &ont2As
prod"ction1 As one can see% t2e standardAs gross &argin !or 'o( controllers C4)<
(as &"c2 2ig2er t2an t2at o! t2e activityAs gross &argin C64<@ 2o(ever% t2e
activityAs gross &argin !or t2e p"&ps (as 1- 2ig2er t2an t2at o! t2e standard and
bot2 o! t2e syste&As gross &argins !or valves (as t2e sa&e1 8ven t2o"g2% activity
based costing (o"ld 2ave lost &oney "nder t2e act"al selling price !or 'o(
controllers% t2e syste& still co&pletely o"t per!or&ed standard costing in total net
inco&e1 =2ese tables s2o( t2at (it2 so&e reva&ping o! selling prices% t2e
-
co&pany co"ld still &eet its reH"ired gross &argin o! 35 and co"ld even s"rpass
t2is percentage by instit"ting an activity based costing syste&1
9