ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT
(20 min.) Cost hierarchy.
Indirect manufacturing labor costs of $1,450,000 support direct manufacturing labor and are output unit-level costs. Direct manufacturing labor generally increases with output units, and so will the indirect costs to support it.
Batch-level costs are costs of activities that are related to a group of units of a product rather than each individual unit of a product. Purchase order-related costs (including costs of receiving materials and paying suppliers) of $850,000 relate to a group of units of product and are batch-level costs.
Cost of indirect materials of $275,000 generally changes with labor hours or machine hours which are unit-level costs. Therefore, indirect material costs are output unit-level costs.
Setup costs of $630,000 are batch-level costs because they relate to a group of units of product produced after the machines are set up.
Costs of designing processes, drawing process charts, and making engineering changes for individual products, $775,000, are product-sustaining because they relate to the costs of activities undertaken to support individual products regardless of the number of units or batches in which the product is produced.
Machine-related overhead costs (depreciation and maintenance) of $1,500,000 are output unit-level costs because they change with the number of units produced.
Plant management, plant rent, and insurance costs of $925,000 are facility-sustaining costs because the costs of these activities cannot be traced to individual products or services but support the organization as a whole.
The complex boom box made in many batches will use significantly more batch-level overhead resources compared to the simple boom box that is made in a few batches. In addition, the complex boom box will use more product-sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine-hours, both the simple and the complex boom box will be allocated the same amount of overhead costs per boom box if Hamilton uses only machine-hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relatively high level of resources but is reported to have a relatively low cost) and the simple boom box will be overcosted (it consumes a relatively low level of resources but is reported to have a relatively high cost).
Using the cost hierarchy to calculate activity-based costs can help Hamilton to identify both the costs of individual activities and the cost of activities demanded by individual products. Hamilton can use this information to manage its business in several ways:
Pricing and product mix decisions. Knowing the resources needed to manufacture and sell different types of boom boxes can help Hamilton to price the different boom boxes and also identify which boom boxes are more profitable. It can then emphasize its more profitable products.
Hamilton can use information about the costs of different activities to improve processes and reduce costs of the different activities. Hamilton could have a target of reducing costs of activities (setups, order processing, etc.) by, say, 3% and constantly seek to eliminate activities and costs (such as engineering changes) that its customers perceive as not adding value.
Hamilton management can identify and evaluate new designs to improve performance by analyzing how product and process designs affect activities and costs.
Hamilton can use its ABC systems and cost hierarchy information to plan and manage activities. What activities should be performed in the period and at what cost? 5-17
(25 min.) ABC, cost hierarchy, service.
Output unit-level costs
a. Direct-labor costs, $146,000
b. Equipment-related costs (rent, maintenance, energy, and so on), $350,000...
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