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Activity Based Costing Example/Problem:

Ferris Corporation makes a single product - a fire resistant commercial filing cabinet - that it sells to office furniture distributors. The company has a simple ABC system that it uses for internal decision making. The company has two overhead departments whose costs are listed below:
 

Manufacturing overhead $5,00,000
Selling and administrative overhead $300,000
 
Total overhead costs $8,00,000

 The company's activity based costing system has the following activity cost pools and activity measures:
 

Activity Cost Pool Activity Measures
Assembling units Number of units
Processing orders Number of orders
Supporting customers Number of customers
Other Not applicable

Costs assigned to the "other" activity cost pool have no activity measure; they consist of the costs of unused capacity and organization-sustaining costs - neither of which are assigned to products, orders or customers.

Ferris Corporation distributes the costs of manufacturing overhead and of selling and administrative overhead to the activity cost pools based on employee interviews, the results of which are reported below:
 

Distribution of Resource Consumption Across Activity Cost Pools

  Assembling Units Processing Orders Supporting Customers Other Total
Manufacturing overhead 50% 35% 5% 10% 100%
Selling and administrative overhead 10% 45% 25% 20% 100%
Total activity 1,000 units 250 orders 100 customers -- --

Required:

  1. Perform the first stage allocation of overhead costs to the activity cost pools.
  2. Compute activity rates for the activity cost pools.
  3. OfficeMart is one of the Ferris Corporation's customers. Last year OfficeMart ordered filing cabinet four different times. OfficeMart ordered a total of 80 cabinets during the year. Construct a table showing the overhead costs of these 80 units and four orders.

Solution:

1. The first stage allocation of costs to the activity cost pools appears below:

                                         Activity Cost Pools


  Assembling Units Processing Orders Supporting Customers Other Total
Manufacturing overhead $250,000 $175,000 $25,000 $50,000 $500,000
Selling and administrative overhead 30,000 135,000 75,000 60,000 300,000
 




Total activity $280,000 $310,000  $100,000 $110,000 $800,000
 

2. The activity rates for the activity cost pools are:
 

Activity Cost Pools Total Cost Total Activity Activity Rate
Assembling units $280,000 1,000 units $280 per unit
Processing orders $310,000 250 units $1,240 per order
Supporting customers $100,000 100 customers $1,000 per customer

3. The overhead cost for the four orders of a total of 80 filing cabinets would be computed as follows:
 

Activity Cost Pools Total Cost Total Activity Activity Rate
Assembling units $280 per unit 80 units $22,400
Processing orders $1,240 per order 4 units $4,960
Supporting customers $1000 per customer Not applicable  

4. The product and customer margin can be computed as follows:
 

Filing Cabinet Product Margin:    
Sales ($595 per unit 80 units)   $47,600
Cost:    
     Direct materials ($180 per unit 80 units) $14,400  
     Direct materials ($50 per unit 80 units) 4,000  
     Volume related overhead (above) 22,400  
     Order related overhead (above) 4,960 45,760
 

    $1,840
    ==========
Customer profitability Analysis - OfficeMart    
Product margin (above) $1,840  
Less: Customer support overhead (above) 1,000  
 
 
  $840  
  ===========  
     

Relevant Articles:

Definition and Explanation of Activity Based Costing
Treatment of Costs Under Activity Based Costing (ABC) System
Activity Based Costing and Top Management
Activity Based Costing, GAAP and External Reports
Designing and Implementing Activity Based Costing System
Targeting Process Improvements
Advantages, Disadvantages and Limitations of Activity Based Costing
Activity Based Costing Example

 

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 

 

 

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